turbotax icon
cancel
Showing results for 
Search instead for 
Did you mean: 
Close icon
Do you have a TurboTax Online account?

We'll help you get started or pick up where you left off.

Selling a property to a LLC to take Section 121 exemption

We have been living in our home for a decade and are considering putting the property on rent. The property is in Georgia, the mortgage is in my name but the title has both our names on it.

The question I’m grappling with is can I setup a LLC (single member with just me or partnership with my spouse) and “sell” the property at market rate to the LLC and take a section 121 deduction of up-to 500K on the sale of the property on our personal returns, then continue to rent the property through the LLC?

1 Best answer

Accepted Solutions

Selling a property to a LLC to take Section 121 exemption

The transaction you proposed would violate the Economic Substance doctrine of Section 7701(o).

 

See https://www.irs.gov/pub/irs-drop/n-14-58.pdf

View solution in original post

14 Replies

Selling a property to a LLC to take Section 121 exemption

The transaction you proposed would violate the Economic Substance doctrine of Section 7701(o).

 

See https://www.irs.gov/pub/irs-drop/n-14-58.pdf

Selling a property to a LLC to take Section 121 exemption

These are multiple parts to the transaction:

1. Create a separate entity for legal purposes to shield us personal liability while also creating a separate entity to handle the long term rental status

2. Take advantage of the section 121 to get a tax advantage

3. The LLC would have it's own tax advantages like writing of the interest, maintenance, property taxes, HoA, landlord insurance etc

 

The fact that we're looking to convert a residential property to a long term rental business, shouldn't that be enough to not violate the economic substance doctrine (we aren't planning to live it in and rent it back to us, it would be a new income stream for us)?

Selling a property to a LLC to take Section 121 exemption


@InformedB wrote:

The fact that we're looking to convert a residential property to a long term rental business, shouldn't that be enough to not violate the economic substance doctrine......?


No. The primary factor for selling the property to the LLC would be to take advantage of the Section 121 exclusion and, frankly, that is how the IRS would view the transaction.

 

The rationale for the foregoing conclusion is that you could accomplish everything you stated in your post, other than using the home sale exclusion, by contributing the property to the LLC.

Selling a property to a LLC to take Section 121 exemption

I'm wondering if I'm reading this correctly, Section d.8 of this seems to say that one cannot claim the exception if it's sold to a "related party". Is that right or does that only apply to minority interest?

 

https://www.law.cornell.edu/uscode/text/26/121#:~:text=Sales%20of%20Remainder%20Interests

Selling a property to a LLC to take Section 121 exemption

d.8 is for remainder interest which is not your situation.

 

In general terms, a remainder interest refers to someone with a future interest in an asset.  you own 100% of the property so there is no remainder/future interest.

 

Selling a property to a LLC to take Section 121 exemption

you certainly can transfer your ownership to an LLC. but the LLC will get your tax basis (as if the property had not been transferred). you will incur certain title and other fees and if you have a mortgage that can trigger the "due on sale clause". as has been stated you cannot transfer or sell the property to an LLC you control directly or indirectly and get the 121 exclusion.

 

Carl
Level 15

Selling a property to a LLC to take Section 121 exemption

In my limited experience (and limited knowledge) with transfering ownership of a property from one owner to another (i.e., you personally, to an LLC) doing so usually requires the permission of the mortgage holder. If you go and change the ownership or any portion of it without the knowledge and permission of the mortgage holder, that can result in a violation of the mortgage agreement which can make the mortage balance due an payable immediately.

Another thing affected is the property insurance too. For example, when converting a primary residence or other "personal use" property to a rental property, failure to update the insurance can have adverse affects. For example, a normal homeowner's policy does not cover claims that may arise out of business use of the property. You should check with your insurance agent on what (if anything) you may need to do to ensure you have valid coverage. If you don't do this and insurance does not pay out on a claim because the damage occurred while property was being used as a rental, then you've also got problems with the mortgage company, as they "could" considered the property uninsured, which would most likely be in violation of your mortgage agreement.

Now none of what I mentioned has anything to do with taxes, I know. But you "need" to address these things first, before you go making any final decisions.  On the tax front through, what you're wanting to do will not fly with the IRS, and would most likely result in an audit anywhere from 24-36 months down the road - possibly sooner. The fines and penalties could make your "savings" a moot point.

Selling a property to a LLC to take Section 121 exemption

So. that would mean I can't see the property to my son or brother in law and claims section 121? That would also violate the economic clause by the same logic? What is they were to buy the property in an LLC? Does this only apply to sale to spouses or where the spouses are a buyer and seller of the sale indirectly?

Selling a property to a LLC to take Section 121 exemption

I find nothing in the code or regs that would bar the 121 exclusion because you sold to a related party in this case an LLC that you had no ownership interest in.   

 

but say you sell to an LLC/S Corp where you do have a partial ownership interest. I think the IRS would rightfully deny an exclusion for the portion you retain. I'm looking at REG 1.121-4(e)  since in effect you would only be selling a partial interest. generally, for tax purposes sales to yourself are not recognized. though here your ownership would be through the entity.

 

 

 

 

 

 

 

Selling a property to a LLC to take Section 121 exemption

That’s very helpful. 

So would this next scenario be valid:

1. My spouse sets up the LLC as a the sole owner

2. I sell the house to the LLC an only take my half of section 121 (250k) 

Carl
Level 15

Selling a property to a LLC to take Section 121 exemption

While I don't know the legality of that, and doubt it's legal, you would basically be screaming at the top of your lungs for an audit - which you would most likely lose. But I'm no tax expert. Bottom line is, you're gonna do what you want. The other bottom line to that is, the IRS will do what "they" want too.  My suggestion? Don't poke the bear.

 

Selling a property to a LLC to take Section 121 exemption

I cannot see how this strategy will work in light of Section 1041.

 

https://www.law.cornell.edu/uscode/text/26/1041

Selling a property to a LLC to take Section 121 exemption

Great reference! Since this is a transfer to LLC but the liability is smaller than basis, the second half may not apply - other than can it argued that a single member LLC (spouse) is the same as a spouse individual (part a of the section)?

Selling a property to a LLC to take Section 121 exemption

The LLC is disregarded for federal income tax purposes. 

Use your Intuit Account to sign in to TurboTax.
By selecting Sign in, you agree to our Terms and acknowledge our Privacy Statement.
message box icon

Get more help

Ask questions and learn more about your taxes and finances.

Post your Question

Related Content

Manage cookies