will this transfer affect our principal residence tax benefit ($500,000 tax free capital gain when sell)?
Yes. If the LLC owns any portion of your property, then that portion is business property and you will not qualify for any tax relief under the "2 of last 5 years" rules.
Besides, it's rather difficult to title a portion of the property to the LLC.
It's significantly cheaper to just increase your liability insurance. For one of my rentals, it only costs me an extra $125/mo to increase liability insurance from $300K to $1M.
