When Converting Primary Home to Rental, How Can You Realize Capital Gains

[JamesofDC]

My question is essentially the same as one posted a few years back. Here's the link: http://www.expertlaw.com/forums/show...546#post364546


There was not a good response so I am reposting the same question.

My wife bought her own home in 1997 and, even with the market dip in 2006-2011, still has significant capital gains in the house. We moved into a new home in 2010 and have been renting the old home. I know if we sold it now or by 2013 we'd qualify for the 121 exclusion. But we'd rather keep it. Is there a way to do this but nonethless lock in our 121 exclusion, e.g. by selling it to a trust or s-corporation with us as beneficiaries?

[Mr. Knowitall]

You cannot "sell" to an alter ego - if you sell to a trust you control, unincorporated entity you control (e.g., a partnership comprised of you and your wife), single member LLC (or dual, you and your wife), etc., you should anticipate that the IRS is going to disregard the transaction as a sham.

Although a corporation is a separate legal entity, and you may be able to secure the Sec. 121 exclusion if you otherwise qualify, you probably do not want to transfer your real estate to a corporation. There are a lot of tax disadvantages. You would want to talk to your accountant to make sure you are properly structuring the transaction and to discuss the tax consequences of the transfer (difficulties with claiming depreciation, inheritance, getting financing, tax deductions for rental properties, the transaction costs....)

[JamesofDC]

Can you explain what you mean by not being allowed to “sell” to an alter ego? Because you seem to be saying two different things in that you suggest the transaction would be regarded as a sham by the IRS but that we may nonetheless qualify for the 121 exclusion.

If we’d qualify for the 121 exclusion, how would it be treated as a sham? I am wondering if you are assuming, incorrectly, that the transfer would be at an artificially low price or something similar like that to generate a loss where none exists. That is not my intent.

[Bubba Jimmy]

There are complex rules that apply to the sale of property to related parties or controlled entities. They are structured to prevent nonsensical transactions that have no business purpose except to avoid taxation. They address every conceivable scheme and while I'm not inclined to do large amounts of research for free to answer a message board question, I'm very confident that this kind of scheme is covered. To be sure you should pay someone to research the question, or research it yourself. Just know that the normal tax rules are suspended in the case of sales between related parties and controlled entities. It is not easy to find unintended loopholes. Otherwise, they would be commonly used, common knowledge, and then they would be addressed by the congress.

[Mr. Knowitall]

Alter ego: A person's secondary or alternative personality. You can't call yourself a LLC or partnership and magically stop being you.

If you properly structure a corporation and "do everything correctly", your scheme may be possible - but for reasons previously discussed it would probably be a bad idea from the outset. If you want to have the issue fully researched and the tax consequences analyzed, work with your lawyer and accountant.

[llworking]

Alter ego: A person's secondary or alternative personality. You can't call yourself a LLC or partnership and magically stop being you.

If you properly structure a corporation and "do everything correctly", your scheme may be possible - but for reasons previously discussed it would probably be a bad idea from the outset. If you want to have the issue fully researched and the tax consequences analyzed, work with your lawyer and accountant.

And just to be clear, a corporation is a different entity than an LLC, partnership or trust.