Capital Gains tax on owner occupied rental property owned by LLC?

[Ryan Flood]

I'm part of a 3-person LLC that recently sold a rental property. We recently sold the property and I lived in one of the 3 units for >2 of the 5 years prior to the sale of the property.

When we filed out annual K-1s, I would get a lesser tax write-off than the other partners because I couldn't claim the 'loss' for the unit I lived in - you can't 'pay yourself' rent. In other words, I only benefitted from the tax break for 2 of the 3 units.

To what extent do I owe capital gains tax from the sale? I've gotten 3 conflicting answers and my accountant has no idea: a) I owe nothing because I lived in the building b) I only pay on 2/3 of my portion of the gains because I lived in the 3rd unit c) I can't claim the owner-occupied exception at all because the property was owned by an LLC.

If anyone has an answer, I'd be most appreciative!

[Michael Plaks]

@Ryan Flood

Only one thing is certain: the (a) answer is wrong. You definitely have capital gain taxes.

Actually, another thing is certain, too: it should not have been set up this way.

You do not get to decide on your capital gain. It is (mostly) decided for you at the partnership level. Whatever is allocated to you on your K-1 is what you have to go by. If those K-1s are correct, that is.

What has been happening is your partners subsidizing your home. I have a strong suspicion that your arrangement with your partners has not been clearly defined and all your partnership returns and K-1s were prepared wrong for all these years.

The correct approach is to let a very experienced accountant review ALL your partnership returns and then suggest to either redo all of them or somehow compensate for the old errors. It should be a labor-intensive and expensive project to do it right. And, in the end, all 3 partners will be affected and probably need to redo their personal returns.

An alternative is to pretend that everything has been OK, trust the most recent K-1s and hope that the whole thing will go unnoticed, and the IRS will never ask you guys any questions, and neither will any of the partners. Would not be my recommendation.