Selling a property to a LLC to take Section 121 exemption

Forum|Forum|3 years ago
May 31, 2022
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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?

Not A Product Question

Best answer by Anonymous_

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

Anonymous_Answer

Employee

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

Anonymous

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)?

Anonymous_

Employee

@4708667 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.