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 gains tax.
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 time after a homeowner stops using property as a primary residence, but before the 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.
Determining tax liability can be complex, and it requires specific knowledge of your unique facts and circumstances. 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.