121 Excl US Ion: Main Home To Llc Rental

Los Angeles County, California
Tax, SDIRAs & Cost Segregation
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121 Excl US Ion: Main Home To Llc Rental

Evelia Loera
Member since 2025 · 1 post · 1 vote

Does couple qualify for capital gains exemption? 

Clients (married couple) purchased and lived in main home/residence from 2019 through mid 2022. Mid 2022 placed as a rental property under LLC (treated as an S-Corp/1065). Now they want to sell and would like to benefit from the 121 exclusion capital gains. They are inquiring about transferring the deed back to their names, before selling the property. I've read through the IRS publication 523.

Do they even qualify? 

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Aaron ZimmermanBusiness Member
Accountant · Chicago, IL · Member since 2018 · 2k+ posts · 1k+ votes
11mo

@Jason Malabute 100% agreed with this and in alignment. 

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  • Jason MalabuteBusiness Member
    Accountant · Los Angeles, CA · Member since 2016 · 2k+ posts · 904 votes
    11mo

    They can only claim the §121 exclusion if the property is titled in their personal names or a disregarded single-member LLC, not an S-Corp or multi-member LLC. They must have lived there for at least two of the past five years to qualify, and any depreciation claimed during the rental period is taxed separately at up to 25%. If the property was transferred from an entity they control, that can trigger related-party issues

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  • G. Brian DavisPro Member
    Investor · Hatboro, PA · Member since 2016 · 3k+ posts · 866 votes
    11mo

    They might qualify if they lived there 2 of the past 5 years, but having it in an S-Corp complicates things. A real estate CPA should confirm before they transfer the deed.

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  • Ashish AcharyaBusiness Member
    CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
    11mo

    @Evelia Loera, that's a great question, which comes up a lot. Since the home was moved into an LLC and taxed as an S-Corp/Partnership, it's technically no longer owned personally, so the IRS usually won't allow the Section 121 exclusion. Even if you transfer it back now, it's tough to qualify because the ownership wasn't in your personal name during that period. It's one of those situations where timing and structure really matter, so definitely talk it through with a CPA before selling. I sent you a quick DM with a helpful resource on this too.

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  • Sean Culloden
    CPA · Member since 2025 · 8 posts · 6 votes
    10mo

    Sadly they don't qualify for the 121 exclusion anymore. Once they transferred the home into an LLC taxed as an S-corp or partnership they broke 121 rules.

    Section 121 only applies when the individuals own and sell the home. A corporation or an LLC taxed as an S-corp/1065 cannot have a "principal residence," so the ownership and use tests both fail. The seller has to be the same taxpayer who lived in the home. Here, the seller would now be the entity, not the couple.

    The moment they deeded the property into the S-corp/1065, they no longer personally owned the house. Even though they previously met the 2-of-5-year use test, they no longer meet the ownership test because the entity owns it, not them.

    Transferring it back now doesn’t help. When an S-corp or partnership distributes appreciated real estate, that’s treated as if the entity sold the property at fair market value. They would trigger the gain inside the entity and still wouldn’t qualify for 121, because the property still wouldn’t have been owned and used by them as individuals for the required periods prior to “their” sale.

    Some options are to sell it inside the S-corp/1065 and pay the tax, or if the property has been legitimately used as a rental/investment property, the entity could potentially do a 1031 exchange. But 121 is gone and cannot be restored once the home is placed inside an S-corp or partnership.

    So no, the 121 exclusion is no longer available and transferring the deed back won’t fix it.

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  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    10mo

    The whole discussion is missing the timing problem. Even if the property was not moved into another entity, the window got closed mid-2025. Too late anyway.

    So we have TWO reasons why it does NOT work:
    - it has been transferred into another entity AND
    - too late

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