IF YOU OWN YOUR PERSONAL RESIDENCE IN AN LLC, ARE YOU SUBJECT TO CAPITAL GAINS TAX?
For privacy and liability reasons, some homeowners hold title to a personal residence in the name of a limited liability company (LLC). Generally, this is not advisable. However, there are many factors at play, and some property owners have reasons for doing so. In this situation, the following question may arise:Am I still eligible to be excluded from capital gains tax if I own my personal residence in an LLC?
The normal rule: A primary residence is typically excluded from capital gainstax.
Under current rules, the primary residence exemption is $250,000 for an individual and $500,000 for a married couple filing jointly. Previously, a homeowner had to “roll over” capital gains from one primary residence to another to take advantage of the exclusion. After the Taxpayer Relief Act of 1997, that is no longer the case. Now, there is a straightforward exemption from capital gains (with certain limitations) on the sale of a primary residence. There is no need to transfer the exemption from one residence to another.
However, bear in mind that the exemption applies only if the property has been “used as the taxpayers’ primary residence” for 2 out of the last 5 years (five years from the date the property was sold). See 26 U.S.C. 121(a).
Does LLC ownership count as time used as a “primary residence”?
For a single-member LLC, the answer is typically yes. For example, if the house is owned by an LLC. The Treasury Regulations allow for the capital gains exclusion when title is held by a single-member disregarded entity. See 26 C.F.R. § 1.121-1.If the residence is owned by a multi-member LLC, the analysis becomes more complex. Consult an attorney or tax professional.
What if the property is used partially for business and partially as a residence?
Even if the “primary residence” two-year rule is met, the amount of capital gain eligible for exclusion is reduced in proportion to “non-qualifying” use. See 26 U.S.C. 121(b)(5). Non-qualifying use is basically anything other than use as a primary residence (rental or vacancy is generally treated as non-qualifying use). A taxpayer’s total time of ownership is divided by the time of non-qualifying use. This fraction is multiplied by the amount of the gain to determine how much gain is disqualified from the exclusion.
For example, if a taxpayer used a property as a rental for 2 years and then as a personal residence for 3 years, the percentage of non-qualifying use would be 2/5, or 40%. Only 60% of the capital gain would qualify for the primary residence exclusion.However, bear in mind that the period of timeaftera homeowner stops using property as a primary residence, butbeforethe homeowner sells the property, does not count as non-qualifying use (for up to three years). See 26 U.S.C. 121(b)(5)(C)(ii)(I).Furthermore, the non-qualifying use rules were enacted in 2008, so anything prior to December 31, 2008, does not count as non-qualifying use.
Conclusion.
Determining tax liability can be complex, and it requires specific knowledge of your unique facts and circ*mstances. This article provides only a general starting point. If you own your personal residence in an LLC and have questions about your capital gains liability, be sure to consult your tax professional or an attorney.
FAQs
The tax issues you will face living in an LLC-owned home are even further-reaching. With your primary residence placed under an LLC, you lose your capital gains deduction due to how the property ownership changes under the IRS.
Does capital gains apply to personal residence? ›
You can sell your primary residence and avoid paying capital gains taxes on the first $250,000 of your profits if your tax-filing status is single, and up to $500,000 if married and filing jointly. The exemption is only available once every two years. But it can, in effect, render the capital gains tax moot.
Does LLC ownership count as time used as a primary residence? ›
Ownership of a property under an LLC typically does not count towards the time used as a primary residence for tax purposes. This can impact the owner's eligibility for certain tax benefits that apply to primary residences.
Why do people put their house under an LLC? ›
When you invest in California real estate using an LLC, or “limited liability company,” you don't own the property–the company does. This can afford you all sorts of protections and opportunities that are unavailable to those who use another method of holding the title to residential or commercial property.
Does LLC avoid capital gains tax? ›
The gain or loss on the sale is treated as capital gain or loss. This contradicts the common misconception that one can sell the company holding the real estate and avoid capital gain. Sales of an LLC interest generally do not terminate the LLC for tax purposes.
What is the 6 year rule for capital gains tax? ›
Here's how it works: Taxpayers can claim a full capital gains tax exemption for their principal place of residence (PPOR). They also can claim this exemption for up to six years if they move out of their PPOR and then rent it out. There are some qualifying conditions for leaving your principal place of residence.
How to avoid paying capital gains tax on a primary residence? ›
You can avoid capital gains tax when you sell your primary residence by buying another house and using the 121 home sale exclusion. In addition, the 1031 like-kind exchange allows investors to defer taxes when they reinvest the proceeds from the sale of an investment property into another investment property.
What is the 121 reduced gain exclusion loophole? ›
The Section 121 Exclusion is an IRS rule that allows you to exclude from taxable income a gain of up to $250,000 from the sale of your principal residence. A couple filing a joint return gets to exclude up to $500,000.
What is a simple trick for avoiding capital gains tax on real estate investments? ›
You can avoid paying this tax by using the 1031 deferred exchange or tax harvesting. Alternatively, you can convert your rental property to a primary residence or invest through a retirement account. Don't forget to insure your property with Steadily to avoid making losses after investing in real estate.
How are capital gains taxed in an LLC? ›
First, the 21% corporate tax must be paid, and second, the shareholders must pay individual income tax on their dividends at capital gains rates, which range up to 23.8%.
Using a real estate LLC can come with disadvantages such as tax complexity, setup challenges, transferred tax obligations, lack of guaranteed asset protection, financing difficulties, and increasing expenses.
How are capital gains treated in an LLC? ›
LLC With Multiple Owners, Taxed as a Partnership and General Partnership. The rules that apply to a corporation would be identical in this scenario: any long-term capital gain would be taxed only within the LLC.
Why do rich people buy houses under LLC? ›
Advantage #1: Protect Assets and Limit Liability
The primary reason one might use an LLC or trust to purchase a residential property is to protect their assets and limit their liability. By forming an LLC, the homeowner separates their personal assets from those associated with the property.
How can an LLC avoid property tax reassessment in California? ›
Forming an LLC Can Help Avoid Property Tax Reassessment
So, for example, a parent can form an LLC and transfer real estate into it. No reassessment occurs because – as a sole-member LLC – no change in ownership occurred. From the LLC, the parent can then transfer a 50% ownership interest to one of their children.
Can I live in a house owned by my S Corp? ›
Having the S corp own your residence may sound like a great way to get free housing, but it's likely to attract attention from the IRS. Whether you are the only shareholder or one of many (up to the limit of 100 allowed) living in a house owned by the company is reasonably construed as income.
How are capital gains taxed on an LLC? ›
If an LLC is listed as a C Corporation, the LLC must file corporate income taxes. In 2022, the federal corporate income tax rate is 21%, with many states adding their own taxes on top of that. Along with the corporate income tax, any profits or dividends distributed to members are subject to capital gains tax.
How do I avoid capital gains on sale of primary residence? ›
You can avoid capital gains tax when you sell your primary residence by buying another house and using the 121 home sale exclusion. In addition, the 1031 like-kind exchange allows investors to defer taxes when they reinvest the proceeds from the sale of an investment property into another investment property.
