What's the best approach to buy out LLC partners in a rental property?

[Ryan McCaw]

Hello, my wife and I co-own a rental property in an LLC with her parents (my in-laws). They contributed $125,000 cash as the down payment (25% of purchase price) but my wife and I are the only individuals on the mortgage loan. We would like to buy them out as partners of the LLC per the terms of the operating agreement which are pretty basic and straightforward. Is the $125,000 taxable as a capital gain? Or just any amount above $125,000?

Additionally, I estimate the value of their holding to be $250,000 in addition to the $125,000 they put in upfront. I presume it would be advantageous for my in-laws to pay back that $250,000 in multi-year installments to limit their capital gains tax liability? But that might be a negative for the LLC?

Any feedback on how best to approach this transaction is greatly appreciated!