This 2000 letter ruling says the partnership is not a problem, since those taxpayers didn't rent it.  So does that mean it is a problem for your taxpayers, because they did?

https://www.irs.gov/pub/irs-wd/0004022.pdf

I would argue substance over form.  The substance is that the taxpayers are idiots who went to a seminar and were convinced by some promoter that LLC's are great protection (maybe from Covid and STD's?).  They should qualify for Section 121 exclusion even if they are stupid.  But I'm not sure how you would show that on a 1065.