Three family members have owned a house for 10 years - always occupied by a family member. This year we placed it in a LLC (Limited Liability Company) in order to rent it for about 3 months of the year. Now we have decided to sell it. The question is: since there will be significant capital gains, will these gains flow to our individual returns? Or does the LLC have to pay the capital gains and the remainder flows to us. There is nothing else in the LLC except this house. Any info will be appreciated.
The tax burden for the gains in the LLC are really dependent on how you set up the company. What you need to do is bring all of your LLC documentation to a tax specialist and ask them.
If you set the company up as a generic LLC, it is most likely that all tax burdens are shifted to the partners. Once again, do not take my word on it, talk to a tax specialist.
@Norman Scott Duncan Generally, an LLC is treated as a Partnership by the IRS for tax purposes. This means that the income and tax consequences will flow directly to the members of the LLC in proportion to the their respective LLC membership interest. The LLC itself will not pay taxes on the gain from the sale of the property. This will require partnership accounting on your end (K-1 statements).
Thank you Naseer Khan for explaining that........two other questions: Even though we've owned the house for 10 years before putting it into the LLC, did we lose our long term capital gain status when we put it in the LLC? (it is a partnership LLC by the way)
In other words, if we sell the house within 12 months of putting it in the LLC, will it be Long Term or Short Term Capital Gains? If Short Term, I have read that these pass through as ordinary income instead of short term capital gains --- is that true?
@Norman Scott Duncan Transferring property to an LLC generally should not affect the holding period for long term capital gain status, unless the property was sold to the LLC (vs, it being transferred).
If, for some reason, it is deemed short term capital gain, then it is treated as ordinary income that is taxed at the taxpayer's effective tax rate(s) because short term capital gains are treated as ordinary income. There is no special short term capital gain tax rate.
This response neither constitutes legal or tax advice nor establishes an attorney-client relationship. Inquirers must seek the advice of their own legal counsel prior to undertaking any course of action related to this inquiry.
Naseer Khan.....thank you again for the explanation.
When you say that short term capital gains are treated as ordinary income, I assume you are saying that those gains are taxed the same as if they were ordinary income. Correct?
If the gains in the LLC were to be classified as short term (for whatever reason), would I still be able to negate some of those gains with the short and long term losses I'm carrying over from previous years tax returns?
@Norman Scott Duncan Yes, you are correct - short term capital gains are taxed as ordinary income, as if it were wages earned at a job.
I am not an accountant and I am not completely certain with this information You should seek the advice of an accountant before acting. With that said, generally taxpayers are allowed to deduct up to $3,000 of their capital losses from ordinary income, every year until the losses are used up. But to offset larger amounts, there must be a long term capital gain in excess of capital losses for that year. Short term gain will not offset capital losses.
However there is a distinction if the capital losses came from the sale of real estate vs. other property. The IRS provides favorable tax treatment on the sale of real estate, which treats capital losses as ordinary losses, allowing the taxpayer to deduct the entire loss from ordinary income (see IRC Sec. 1231). Note that there is a 5 year lookback rule that will affect your future capital gains if you treated a capital loss as an ordinary loss and subsequently had a capital gain within 5 years. It can get complicated but take a look at this article I wrote regarding Capital Gains and Losses from Real Estate It explains it in more detail with examples.
Thank you again Naseer Khan.......all this has been extremely helpful.
Create Lasting Wealth Through Real Estate
Join the millions of people achieving financial freedom through the power of real estate investing