How You Can Use an LLC to Avoid Paying Capital Gains Tax on the Sale of Your Personal Residence

Many people are not aware of the benefits that an LLC can bring to reduce their taxable income on their personal residence that you intend to turn into a rental property. While this method can bring you some great capital gains tax savings, there are a few things to keep in mind before making the decision.

First, you’ll need to sell your primary residence to an LLC that you own on an installment note. This will allow you to recognize all the gain in the year of sale while exhausting your $250,000 or $500,000 capital gain exclusion. Then, you can rent out the property over time and pay the LLC back for the installment note. You’ll want to make sure that you’re entitled to the full benefit of the exclusion by accurately reporting the tax basis of the property when filing your taxes. This means that you’ll need accurate records to support mortgage payoffs and any other applicable closing costs or tax paid on the purchase, as well as renovations on the property, so good record-keeping is essential. 

There are a few things to keep in mind when using an LLC to avoid capital gains taxes on the sale of your personal residence. When you sell your primary residence to an LLC that you intend to use as a rental property, note that your property may be reassessed for property tax purposes, which may negate the capital gains tax savings. Also, the sale to your LLC essentially provides a step-up in basis for the property – the new tax basis of the property is the purchase price! This can save you a good chunk in capital gains tax if you decide to sell in the future. 

Also, if you are the only member of the LLC when you sell your primary residence, you will have no income or loss from the LLC due to the sale, and your capital gains and the rental income will be reported on your individual tax return.

Lastly, note that the LLC itself is not taxed. It files an information return annually to report its income and deductions to the IRS, but no taxes are due on the entity itself. Instead, any profits or losses will flow through to the members (owners) proportionately according to their membership interests. 

If you’re interested in using an LLC to reduce your taxable income on your personal residence that you want to turn into a rental property, it could be worth looking into. This can be a great way to reduce your tax liability while also earning some passive income from the property. However, it can be tricky to implement if you’re not familiar with these types of transactions. If you’re looking for further help in executing this for yourself, reach out to us via our website to schedule your consultation.

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