Capital Gains on Real Estate Held in an LLC

A single-member LLC is invisible to the tax return, so nothing changes

Reg. section 301.7701-3(b)(1) classifies a domestic LLC with one owner as 'disregarded as an entity separate from its owner' unless it elects otherwise. The rental income went on the owner's Schedule E while the property was held, and the sale goes on the owner's Form 4797 and Schedule D exactly as if the deed had been in the owner's name.

That means every rule on the owner's side applies unchanged: the 0%, 15% and 20% breakpoints of Rev. Proc. 2025-32 at $98,900 and $613,700 for a joint return, the 25% ceiling on unrecaptured section 1250 gain, and the 3.8% surtax above $250,000 joint or $200,000 single of modified adjusted gross income. How a rental gain is layered and taxed is on the recapture page.

A married couple's LLC in a community property state can also be treated as disregarded, but a two-member LLC elsewhere is a partnership, which is the next case. Whether an LLC can do a 1031 exchange covers the same-taxpayer rule for each form.

A multi-member LLC passes the gain through member by member, character intact

A domestic LLC with two or more members is a partnership by default under the same regulation. The LLC files Form 1065 and issues a Schedule K-1 to each member. Section 702(a) requires members to account separately for their shares of long-term capital gain and section 1231 gain, and section 702(b) provides that the character of each item is 'determined as if such item were realized directly from the source from which realized by the partnership'. A long-term gain at the LLC is a long-term gain on the member's return.

Shares follow the operating agreement under section 704(a), provided the allocation has substantial economic effect under section 704(b). One allocation is mandatory: section 704(c)(1)(A) requires gain on property a member contributed to be shared 'so as to take account of the variation between the basis of the property to the partnership and its fair market value at the time of contribution'. A member who put in a low-basis building is allocated the gain that was already built in when it came in.

The rate is then set member by member. The same $600,000 gain can be taxed at 15% to one member, 20% to another and partly 0% to a third, with the 25% depreciation layer and the surtax also tested on each member's own return. Members in another state may also face that state's non-resident filing or withholding on the sale; the state pages cover each state.

An LLC taxed as an S corporation keeps the rates but adds two traps

An LLC that elected S status is also a pass-through. Section 1366(b) determines the character of each item 'as if such item were realized directly from the source from which realized by the corporation', so a long-term real estate gain reaches the shareholders as long-term gain and each shareholder's bracket applies.

The first trap is getting property out. Section 311(b) treats a corporation that distributes appreciated property to a shareholder as if it 'were sold to the distributee at its fair market value', so moving a building out of the S corporation into the members' names before a sale or exchange is itself a taxable sale. A partnership can usually distribute property without that result, which is one reason real estate rarely belongs in an S corporation.

The second trap is history. If the entity was ever a C corporation, section 1374 imposes a corporate-level tax at the highest rate in section 11(b), 21%, on net recognized built-in gain during the five-year recognition period after the S election. 1031 planning for S and C corporations works through both.

An LLC taxed as a C corporation has no capital gains rate at all

A C corporation pays the flat 21% rate of section 11(b) on every dollar of gain, with no 0%, 15% or 20% band and no 25% ceiling. Section 291(a)(1) adds a corporate-only recapture: 20% of the excess of what section 1245 would have recaptured over what section 1250 actually recaptures is treated as ordinary income, which for a straight-line building means 20% of the depreciation is converted to ordinary income before the rest is taxed.

The proceeds are then taxed again when distributed as a dividend, and a distribution of the property itself triggers section 311(b) at the corporate level. A corporation can do its own section 1031 exchange, which defers the 21% and the section 291 amount, but the two-layer problem remains whenever cash comes out.

A hypothetical three-member LLC: the same sale, three different bills

Hypothetical: an LLC taxed as a partnership sells a rental at a $600,000 gain, of which $120,000 is depreciation, and allocates it equally. Each member reports $200,000 of gain including $40,000 of unrecaptured section 1250 gain. Ignore state tax and selling costs.

• Member A, a retired couple with $30,000 of other taxable income: the $40,000 depreciation layer is taxed at 12%, about $4,800; about $28,900 of the appreciation fits under the $98,900 zero-rate amount and the rest is at 15%, about $19,700. Roughly $24,500, plus a few hundred dollars of surtax because the sale lifts modified adjusted gross income just past $250,000.
• Member B, a couple with $300,000 of other taxable income: the depreciation layer at 24%, $9,600; the appreciation entirely inside the 15% band, $24,000; surtax 3.8% on $200,000, $7,600. Roughly $41,200.
• Member C, a single filer with $700,000 of other taxable income: the depreciation layer at the 25% ceiling, $10,000; the appreciation all above $545,500 at 20%, $32,000; surtax $7,600. Roughly $49,600.
• Three members, one sale, bills from about $24,500 to $49,600 on identical K-1 numbers. Run your own numbers with your CPA.

A 1031 exchange happens at the LLC level, and the members' choices must be made before closing

Section 1031 requires the taxpayer that sold to be the taxpayer that buys. For a disregarded LLC that is the owner; for a partnership or S corporation it is the entity, so the LLC sells, the LLC's qualified intermediary holds the funds, and the LLC takes title to the replacement. A member cannot take a share of the proceeds and exchange it alone, because an interest in a partnership is not real property under section 1031(a)(1).

When members disagree, the usual answer is to change the ownership before the sale so that each member holds an undivided interest in the real estate directly. Drop and swap strategies explains the timing and the risks, and options when one owner wants cash and another wants to defer covers the alternatives, including a partial exchange at the entity level.

An LLC that exchanges can take its replacement as a Delaware Statutory Trust interest, and how a DST interest is held through an LLC or trust sets out the mechanics.