Sale of primary residence which is in an LLC

Taxpayer and wife place a personal residence in an LLC for liability purposes. The taxpayer is a lawyer. The property deed is in the name of the LLC. The property has a cottage which is a rental. The LLC reports the rental income and applicable expenses on a 1065. This is a new client so I have not reviewed the prior filed 1065s. Taxpayer and spouse have lived in one house on the property for the last 7 years and have rented the cottage.

The taxpayer question is : can he and his wife exclude ( section 121 ) the gain on the sale of the personal residence even though the house is deeded to the LLC?

The taxpayer question is : can he and his wife exclude ( section 121 ) the gain on the sale of the personal residence even though the house is deeded to the LLC?

In my opinion, no. Assuming that they don't reside in a community property state (if they did, then they could elect to treat the LLC as a disregarded entity under Rev. Proc. 2002-69), then the LLC, which is treated as a partnership, owns the residence. As a result, the taxpayers can't satisfy the ownership test of 121(a).

See under: bright thoughts.

Taxpayer and wife place a personal residence in an LLC for liability purposes.

Sounds like the only liability they really affected was their tax liability

They wanted to reduce liability due to the rental cottage on the property

Proper and adequate insurance would have been a strategy to achieve that result.

I assume the property is already sold.
Consider a position based on mistake.

Consider a position based on mistake.

What does that mean? You get favorable tax treatment because you goofed?

LOL. That opens up so many possibilities~

My apologies. I was wondering if there could be an argument that the personal home was not intended to be in the LLC with the rental. (But on reflection, that pig doesn't fly with the OP fact re intent.)

Gato- Property has not been sold. The taxpayer is a lawyer . Keiser- Lawyers do not like to pay for Proper and adequate insurance which is expensive . That is why they went with an LLC.

Given that the property has not been sold, it sure looks like a good time to deed the home to the members.

Good idea Gato. That is what I was thinking. Would deeding the property from the LLC to the husband and wife members trigger a taxable event ? I will have to look at the 2020 1065 balance sheet.

Deeding the property to the members won't solve your problem if they want to sell it right away. To get the 121 exclusion, they will still have to satisfy the 2-out-of-5-year ownership test, which would begin on the date of the deed.

Philly, an uninsured and inadequately capitalized LLC might not protect the lawyer's other assets when the issue is litigated following a catastrophic loss. I've been an attorney for 45 years and find property insurance [which TP should have no matter how he holds title - and needs to explicitly cover liability arising from the rental] reasonable enough and umbrella coverage cheap. TP needs to consult with a good insurance broker.

Keiser- Lawyers do not like to pay for Proper and adequate insurance which is expensive . That is why they went with an LLC.

Insurance is still advised. The liability to the tenant then would be limited to the assets of the LLC. Unless insured, they could lose the entire property.

Deeding the property to the members won't solve your problem if they want to sell it right away. To get the 121 exclusion, they will still have to satisfy the 2-out-of-5-year ownership test, which would begin on the date of the deed.. No, the measurement period goes back 5 years from date of sale, so it all depends when they sell and when they had transferred the home tot the LLC.

I know that. I assumed that they deeded the property to the LLC more than 5 years ago.

I think Frankly understands this but to clarify.
The LLC members risk more than the subject property if they are not insured, they risk personal liability if the project was undercapitalized. A $1M property encumbered by a $1M loan is undercapitalized. Unless the LLC carries adequate insurance, the LLC is likely to be disregarded and the members held personal liable.

The property was deeded to the LLC more than 5 years ago. Concerning the insurance liability issues I agree with the comments posted. However the client is an attorney and I do not give attorneys legal advice.