Avoiding capital gains 2/5 rule

[Lindsey Clark]

Hi BP experts. Hoping to get some answers on a slightly complicated issue. I have asked a couple of accountants this question but they are not real estate specialists so I want to see what kind of  answers I get here.

I am in the process of selling my investment property. It is an inherited property with no mortgage so I will be making quite a bit of profit from it. I lived in the home for 2 of the last 5 years. As I understand this would allow me to be exempt for the first $500,000 profit as a married couple. However, about 6 months ago I transferred the title into an LLC with myself as the sole manager. So the property was in my name and is now in the LLC owned by me. Does the 2/5 rule still apply? Or did transferring the property to the LLC start the clock over?

[Eamonn McElroy]

(1) If it's an inherited property you should have received a stepped up basis.  You may not have as big of a gain as you think you do.

(2) SMLLC taxed as a disregarded entity doesn't add any wrinkles or complications under the Sec 121 regs.

(3) Both spouses must meet the 'use' requirement to potentially exempt $500k of capital gains.

(4) Unrecaptured depreciation gain.  You'll have a Sec 1250 gain on any depreciation allowed or allowable while the property was a rental.  This is a type of capital gain taxed up to 25% at the federal level and not excludable under Sec 121.

(5) If you rented the property before it was your residence, the math gets complicated.

Make sure to confirm everything with your tax professional.  Best of luck.