Again, thanks to those who responded. I pulled out the Trust documents and the Trustee may distribute the trust principal for support and maintenance. If the Trust distributes the house to my brother and then my brother sells it as an individual, there should be no problem with him taking the primary residence exemption (he has certainly lived there long enough and has paid real estate taxes). I think that might be the easiest way to handle it. He takes the principal, in this case, the house at the trust's basis or the date of death basis. Then when my brother sells, he will have a capital gain for appreciation over the trust's basis, but can use the primary residence exemption. As far as I know doing the K-1 for the trust, there's no reporting of principal distribution as it's not an income event for the trust or beneficiary.
