home sale exclusion and husband and wife LLC

[Nat Hussey]

I think I'm seeing that the home sale exclusion is entirely unavailable to couples owning their home in an LLC where they are both members. It looks as though trusts work and single member LLCs work, but not husband/wife LLCs. This is counterintuitive in situations where couples do not operate any business or take deductions with the LLC entity. It also doesn't seem like a recipe for abuse. Is this correct? Thank you!

[dkh]

What is the advantage of having your principal residence in an LLC? 

[TaxGuyBill]

I think you are correct.  That is because the multi-member LLC is a completely separate entity, essentially a third-party, similar to how a corporation is a third party.

[Nat Hussey]

It can be convenient for asset management and for situations where there are privacy or security concerns. 

[Nat Hussey]

Thank you! I get that conceptually, but where there was no enterprise activity or deductions, the entity was really just a form for holding a marital residence, which seems as though it should not affect tax treatment. 

[TaxGuyBill]

But it is putting it in the Multi-Member part that screws things up.  They are creating a separate taxable entity.  People often don't think things through when then do such things.

[IRonMaN]

"It can be convenient for asset management and for situations where there are privacy or security concerns"

But it kinda sucks when you sell the house for a gain.

[BobKamman]

And exactly where are you seeing that?  Or maybe you are hearing it, at the barber shop from the guy in the next chair who has a cousin  . . .

Sometimes the IRS audit tool of "substance over form" can be used to the taxpayers' favor.  Of course it's stupid for them to play this LLC game, but they still put their pants on one leg at a time.  I suspect.  To be on the safe side, I would deed it out of the LLC and to their individual names before the sale.  

[Nat Hussey]

I saw it in a revocation of a PLR 200004022. The PLR said where there was no business activity carried on by spouses and no deductions taken, the sec 121 exclusion still applied. The revocation just said something like 'not in line with IRS' current thinking.' I couldn't find much/any follow-up IRS guidance on the point. 

Taking the property out of the LLC is tempting, but the ownership requirement wouldn't be satisfied for the required time period. I also thought about having one spouse surrender their membership interest, making it a disregarded entity under 26 CFR 1.121-1(C)(3)(ii), but I think it presents the same problem.

[BobKamman]

So you are referring to PLR 200119014 published more than 20 years ago, which revoked PLR 200004022 published less than two years earlier. The reason given by IRS? “Because it is not in accord with the current views of the Service.”
Since these PLR’s apply only to the one taxpayer who asked, and they just reflect the IRS position and not any clear guidance from statutes, regulations or courts, I would advise clients that it’s a gray area and if they want to pay a lot of tax just to avoid resolving it, you will follow their instructions. First, though, I would research the dozen or so amendments to Section 121 since the revocation was issued. There may be some court cases that are relevant, also. IRS might have changed its mind again, maybe several times, or the law might have changed it for them.

[BobKamman]

Also, those PLR's involved a partnership, not an LLC, and the partnership also owned some rental properties.  

[Nat Hussey]

Not seeing any relevant litigation or amendments. Partnership tax treatment would be the framework for analyzing an LLC Case. Thanks. 

[BobKamman]

Partnership tax treatment, when the partnership also owns income properties, is not the appropriate framework for analyzing an LLC.

[Nat Hussey]

Not relevant to my case. I think the bottom line is that a multi member LLC can't take the exclusion and deeding out of the LLC can't retroactively satisfy the ownership prong of the eligibility test unless of course it's on the market for 2 years. I'd love to be wrong.

[BobKamman]

I'd love it if people didn't have their mind made up before asking.