An LLC itself usually does not pay capital gains tax. The question of when LLCs pay capital gains tax turns on one thing: how the LLC is taxed. By default, an LLC is a pass-through, so capital gains land on the members’ personal returns and are taxed at their individual rates. The only LLC that pays capital gains tax at the entity level is one that has elected to be treated as a C-corporation.
Who Actually Pays: Entity or Member
An LLC is a state-law business form, not a tax category. The IRS taxes it under one of four classifications, and the classification decides who writes the check.
A single-member LLC is a disregarded entity by default. Capital gains show up directly on the owner’s Form 1040.1Internal Revenue Service. Single Member Limited Liability Companies
A multi-member LLC is taxed as a partnership by default. It files Form 1065 for information only and pays no federal income tax. Gains flow to the members through Schedule K-1, and each member reports their share on their personal return.2Internal Revenue Service. Partnerships3Internal Revenue Service. Partners Instructions for Schedule K-1 (Form 1065)
An LLC that elects S-corporation status is also a pass-through. Capital gains run through to the shareholders and are taxed on their individual returns.
An LLC that files Form 8832 to be treated as a C-corporation is the exception.4Internal Revenue Service. About Form 8832, Entity Classification Election A C-corporation pays tax on all its income, including capital gains, at the flat 21% corporate rate.5Internal Revenue Service. Limited Liability Company (LLC) If the corporation then distributes the proceeds as dividends, the members pay a second layer of tax on the dividend income. For a high-income member in the 20% qualified-dividend bracket plus the 3.8% net investment income tax, the combined effective rate on a capital gain can approach 40%.
2026 Capital Gains Rates for LLC Members
For pass-through LLCs, the member’s own tax rate applies. Short-term gains, on assets held one year or less, are taxed as ordinary income, which can reach 37%. Long-term gains, on assets held more than one year, qualify for the preferential rates of 0%, 15%, or 20%.6Internal Revenue Service. Topic No. 409, Capital Gains and Losses
The 2026 long-term thresholds are:7Internal Revenue Service. Revenue Procedure 2025-32
- Single filers: 0% on taxable income up to $49,450; 15% from $49,451 to $545,500; 20% above $545,500.
- Married filing jointly: 0% up to $98,900; 15% from $98,901 to $613,700; 20% above $613,700.
- Head of household: 0% up to $66,200; 15% from $66,201 to $579,600; 20% above $579,600.
- Married filing separately: 0% up to $49,450; 15% from $49,451 to $306,850; 20% above $306,850.
Members with modified adjusted gross income above $200,000 (single) or $250,000 (married filing jointly) owe an additional 3.8% Net Investment Income Tax on their capital gains.8Internal Revenue Service. Net Investment Income Tax These thresholds are not indexed for inflation. The practical ceiling on a high-income member’s long-term capital gains rate is therefore 23.8%. The NIIT applies to the lesser of your net investment income or the amount by which your modified adjusted gross income exceeds the threshold.9Internal Revenue Service. Questions and Answers on the Net Investment Income Tax Capital gains from selling assets or a membership interest are generally included regardless of how actively the member participates in the business.
When the LLC Sells an Asset
For a pass-through LLC, gain is calculated at the entity level, then allocated to members. The holding period for long-term treatment is measured at the LLC: the entity must have owned the asset more than one year.6Internal Revenue Service. Topic No. 409, Capital Gains and Losses A partnership-taxed LLC reports the total on Form 1065, allocates it per the operating agreement, and sends each member a K-1. Members then report their share on Form 8949 and Schedule D.10Internal Revenue Service. About Schedule D (Form 1040)
Depreciation Recapture
Selling depreciated business property adds a wrinkle. Internal Revenue Code sections 1245 and 1250 require depreciation recapture, which converts part of the gain back into ordinary income up to the depreciation previously claimed.11Office of the Law Revision Counsel. 26 U.S. Code 1245 – Gain From Dispositions of Certain Depreciable Property For equipment and similar tangible personal property, Section 1245 recaptures the full depreciation amount as ordinary income. For depreciable real property, the “unrecaptured Section 1250 gain” is taxed at a maximum rate of 25%.12Office of the Law Revision Counsel. 26 USC 1 – Tax Imposed The recaptured piece is reported on Form 4797.13Internal Revenue Service. Instructions for Form 4797 – Sales of Business Property Whatever gain remains after recapture is generally Section 1231 gain, which flows through as long-term capital gain at the preferential rates.
Self-Employment Tax Does Not Apply
Capital gains from selling assets are excluded from self-employment tax under IRC Section 1402(a)(3).14Internal Revenue Service. Self-Employment Tax and Partners An active member pays SE tax on operating income but avoids the 15.3% hit on a capital gain. The exception is a sale of inventory or property held for sale to customers in the ordinary course of business, which is ordinary income rather than capital gain to begin with.
When You Sell Your Membership Interest
Selling your stake in the LLC is a separate transaction from the LLC selling its property. Under IRC Section 741, selling a partnership interest produces capital gain or loss.15Office of the Law Revision Counsel. 26 USC 741 – Recognition and Character of Gain or Loss on Sale or Exchange You subtract your adjusted basis from the sale proceeds. Held more than a year, the gain qualifies for long-term rates. You report it on Form 8949 and Schedule D.
The Hot Assets Rule
IRC Section 751 blocks members from converting ordinary business income into capital gain by wrapping it in a membership interest sale. The statute targets “unrealized receivables” and “inventory items,” known informally as hot assets.16Office of the Law Revision Counsel. 26 U.S. Code 751 – Unrealized Receivables and Inventory Items When you sell, the portion of your gain tied to those assets is recharacterized as ordinary income no matter how long you held the interest. On a $100,000 gain where $30,000 relates to the LLC’s unrealized receivables, that $30,000 is taxed at ordinary rates and only the remaining $70,000 gets capital gains treatment. You will need information from the LLC to run the split, and the LLC must file Form 8308 with the IRS and furnish copies to the buyer and seller.17Internal Revenue Service. Instructions for Form 8308
Why Basis Decides the Number
Every gain calculation starts with your tax basis in the LLC, and basis moves every year. Initial basis is the cash you put in plus the adjusted basis of any property you contributed. From there it increases for your share of the LLC’s taxable and tax-exempt income and any additional contributions, and it decreases for your share of losses and deductions and for distributions you receive. Your K-1 gives you the inputs, but you keep the running total, not the LLC. Understate basis and you overpay. Overstate it and you underreport, with penalties waiting.
One trap: a cash distribution that exceeds your remaining basis is immediately taxable as a capital gain. A $10,000 distribution to a member with $2,000 of basis left creates an $8,000 gain, even though nothing was sold.
LLC Debt and Your Basis
Partnership taxation gives members something S-corporation and C-corporation shareholders do not get: your share of the LLC’s liabilities adds to your basis. Recourse liabilities, where a specific member bears the economic risk of loss, are allocated to that member. Nonrecourse liabilities, where the lender can look only to the collateral, are shared among members based on their interests. When your share of LLC debt drops, whether because the LLC paid down a loan or your allocation changed, the reduction is treated as a deemed distribution. If it exceeds your basis, you have a capital gain. Members joining an LLC that carries real debt should look at how liabilities are allocated in the operating agreement before signing.
Ways to Defer or Reduce the Gain
The tax code offers several routes for pushing capital gains into the future, and one for excluding them outright in a narrow set of cases.
Section 1031 Like-Kind Exchanges
Section 1031 lets an LLC swap real property held for business or investment use for other real property of like kind without recognizing gain at the time of the exchange.18Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment The gain is deferred until the replacement property is eventually sold in a taxable transaction. The timing is strict: the replacement property must be identified within 45 days and the exchange completed within 180 days.
Two limits matter. Only real property qualifies after the 2017 tax law changes; equipment, vehicles, and inventory do not. And partnership interests are specifically excluded, so a member cannot 1031-exchange their membership interest.19Internal Revenue Service. Like-Kind Exchanges Under IRC Section 1031 If some members want 1031 treatment and others want cash, the LLC typically has to restructure around the deal, which carries its own tax risks and needs careful planning.
Installment Sales
When an LLC sells property and receives at least one payment after the end of the tax year, the sale can qualify for installment reporting. Rather than recognizing all the gain in the year of sale, the LLC spreads the gain across the years payments come in.20Internal Revenue Service. Publication 537 (2025), Installment Sales Each payment splits into return of basis, capital gain, and interest income. Installment reporting is automatic unless the seller opts out, but it does not apply to inventory, dealer dispositions, or publicly traded securities. The LLC reports on Form 6252, and each member’s share flows through on the K-1.21Internal Revenue Service. About Form 6252, Installment Sale Income For a large sale, spreading the gain can keep members out of the 20% bracket in any single year.
Section 1202 for C-Corporation LLCs
An LLC that elected C-corporation treatment may qualify for one of the most generous provisions in the code. Section 1202 allows a shareholder to exclude 100% of the gain from selling qualified small business stock, potentially making the gain entirely tax-free at the federal level.22Office of the Law Revision Counsel. 26 USC 1202 – Partial Exclusion for Gain From Certain Small Business Stock The requirements are strict. For stock issued after July 4, 2025, the corporation must have aggregate gross assets of no more than $75 million at issuance, at least 80% of its assets must be used in a qualified trade or business, and the shareholder must hold the stock for at least three years. Several industries are excluded, including consulting, financial services, health care, restaurants, and real estate. The maximum excludable gain per issuer is the greater of $15 million or ten times the shareholder’s adjusted basis in the stock. Section 1202 does not apply to pass-through LLCs; it is a C-corporation provision only.