Capital gains exclusion for primary lost when transferring to LLC?

Question

My husband and I own two SFH in western Kentucky; one is a rental that we’ve been working on, the other is our primary. We’re planning on moving out of state by the end of the year. We’re looking at setting up a KY LLC that will hold these properties and rent them out through a local property manager.

We’d like to take advantage of Sec 121, capital gains exclusion and plan on selling what is our primary in two years (to get in under the five years qualification). We would like to transfer both properties to an LLC for an extra layer of protection but don’t want to nullify/disqualify for the cap gains exclusion for the primary in doing so. It reads like you can transfer to a SMLLC, but we’re both on the title. For it to be “like kind” wouldn’t it need to be a multi-member LLC? But then it wouldn’t be a disregarded entity… Adding to my confusion is Kentucky’s Community Property Trust Act of 2020.

Tried calling the IRS for clarification and talked with several accountants who said they didn’t know. At this point it seems like the path of least resistance would be to leave it in our names and skip the LLC altogether. (If we go this route, would still likely set up a multi-member LLC for management, just not holding of the properties). Any insight would be greatly appreciated!

Account Closed · Answer

• Primary Residence Exclusion (Section 121): To qualify for the capital gains exclusion on your primary residence, you must have owned and used the property as your primary residence for at least two of the five years preceding the sale. If you plan to move out of your primary residence and convert it to a rental property, you can still potentially qualify for the exclusion if you sell it within three years of moving out.
• Transfer to an LLC: Transferring your primary residence to an LLC can be complicated, and it may have tax implications. You may be able to transfer it to a Single-Member LLC (SMLLC) without affecting your eligibility for the Section 121 exclusion, but you should consult a tax advisor to ensure you structure it correctly.
• Community Property Trust Act: This act may have implications for married couples in community property states, like Kentucky, but it's relatively new, and the interpretation and application of the law may not be fully established yet. A local attorney with expertise in Kentucky's real estate laws can provide the best guidance.
• Rental Property in an LLC: It's common to hold rental properties in an LLC to provide an additional layer of liability protection. If your primary goal for the LLC is asset protection and management, it may make sense to transfer the rental property into the LLC. Keep in mind that this doesn't affect your eligibility for the Section 121 exclusion on your primary residence.
• Multi-Member LLC for Management: Establishing a multi-member LLC for property management is a good idea to separate the management activities from property ownership. This can help protect your personal assets from potential liabilities associated with property management.
• IRS Guidance: The IRS can be a source of information, but their guidance isn't always specific to every unique situation. It's often best to work with a tax professional who can apply general principles to your specific case.

In summary, your plan to move out of state, convert your primary residence to a rental property, and potentially transfer properties to an LLC is complex. It's crucial to work with a local attorney and a tax advisor who can provide personalized guidance based on the latest legal and tax regulations in your area. They can help you structure your real estate holdings and LLCs in a way that aligns with your goals while minimizing tax implications.

Kristie Buddenbaum · Answer

Thank you, Russell and Kislay! Appreciate the outline of the salient points; reading it that way, I'm thinking that it's going to be too many moving parts to handle ourselves. I've tried reaching out to several CPAs without much success. Think we're going to put it on hold for now as the cap gains exclusion is too attractive to miss because of a potential mis-step with structure.

Just for clarification, we have been in the home for over two years and would plan on selling within three.

Russell Brazil · Answer

The LLC is an entirely new owner. You are transferring it, you are selling it.

Kristie Buddenbaum · Answer

Thanks, @Bill Rapp - that's what I'm concerned about.

Bill Rapp · Answer

I would think that if you transfer the title into the LLC you will void your ability to sell a personal residence at that point because it would now become owned by an entity and not an individual. I'm not qualified CPA or tax professional, but that is just my $.02

Capital gains exclusion for primary lost when transferring to LLC?

Capital gains exclusion for primary lost when transferring to LLC?

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