Do I need to pay the capital gains tax on a house I inherited and sold through an irrevocable trust or does the trust pay?

[sugarandspice486]

My father left me his house at time of death but the house remained in a trust until it was sold. I lived in the house for a year and invested money to fix it up to sell. What taxes need to be paid if it was an inheritance though the house wasn't put in my name?

[DianeW]

If the house was sold while in the trust, the trust will report the sale. Unlike a revocable trust, an irrevocable trust is treated as an entity that is legally independent of it's grantor for tax purposes. Accordingly, trust income is taxable, and the trustee must file a tax return on behalf of the trust. 

Distributions to beneficiaries of an irrevocable trust, are taxable to beneficiaries at ordinary income tax rates.

When a grantor -- a living-trust creator -- dies, the trust becomes irrevocable. An irrevocable trust is an independent taxpayer in the eyes of the IRS, required to file its own tax return. Responsibility for completing the paperwork falls to the trustee appointed by the grantor. If you're the trustee, you must file the final trust return.

For more information about the trust return you can use this link: Instructions for Form 1041.

If you find that you should report the sale on your tax return (the trustee should be able to tell you or if you are the trustee, you can check with the attorney who helped with the estate or set up the trust) here is the information about how you, as an individual would report the sale of inherited property.

Inherited property receives a stepped up basis in the hands of the beneficiaries, and is always considered to be held long term. This means that the "cost basis" to each beneficiary is the value of the home on the date of death.  If the sale occurs close in time to the inheritance, then the result of the sale would be little to no gain.  This means little to no tax.  

Example: The house value on the date of death is $100,000, plus the cost of the capital improvements you made after the date of death ($5,000 estimated), then it was sold by you for $115,000.  The selling expenses ($3,000) would be also reduce the gain.  The result in this scenario is a $13,000 gain.

The maximum tax rate for long term capital gain (LTCG) is 20%, however it is lower based on your marginal tax rate. LTCGs are taxed at rates of 0%, 15%, or 20%, depending on your tax bracket.

This TurboTax article will help you decide whether you need to file the trust return.  Click the blue hyperlinks for more detail.

https://ttlc.intuit.com/replies/3302186

[Mghenderson]

What about when the house is sold and the grantor is still alive? My Dad setup an irrevocable trust for his 3 kids, me and my 2 siblings. We sold the house, and the house is in the trust. The mortgage was paid off so it was a large cash amount that went into a trust savings account. Will the Trust have to pay capital gains on that entire amount?

[TomYoung]

@Mghenderson 

Asset transferred to an irrevocable trust retain the donor's basis, though you need to know the FMV of the house at the time of the transfer.   Basically dad made a gift to you and his basis carries over to the trust but "FMV" plays into the basis you'd actually use on the tax return.  The tax won't be levied against the entire proceeds, just the profits.

[Mghenderson]

Thank you. That’s a big relief!

Marty

[Schmidt0505]

Do you know what the percentage could be selling through the Trust.  We have a very complicated issue; but, the percentage might determine if we want to deal with adjusting a cost basis figure...if that is even possible.  We have issues that might make this possible; we hope.

[RalphLS]

Further question...

I have the same setup... father has irrevocable trust with me as trustee and 2 siblings as additional beneficiaries. The FMV assessment that was done when the house was put into the irrevocable trust in 2013 was really low.  Didn't realize that would come back to bite me.  Had no idea the $250K single/$500k married capital gain exemption would be lost. Can a FMV estimate be done instead of supplying the assessment - based on the 2019 selling price?

Thanks in advance!

Ralph

[MikeP3]

I do not agree with the example $100000 stepped up value with $5k improvements and $3k selling expenses. Sale at $115k.

Gain would be $115k less $105k (incl $5k improvemnts) less selling exp $3k leaves $7k cap gain. Prior response even said selling exp would reduce gain.

[tagteam · Accepted solution]

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@MikeP3 wrote:

I do not agree with the example $100000 stepped up value with $5k improvements and $3k selling expenses. Sale at $115k.

Gain would be $115k less $105k (incl $5k improvemnts) less selling exp $3k leaves $7k cap gain. Prior response even said selling exp would reduce gain.

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This thread is actually ancient and should be closed (or archived), but it appears as if the math is simply wrong in the post to which you referred.

Sales price LESS selling expenses LESS Cost basis PLUS improvements EQUALS gain/loss. So, your math is correct ($115,000 less $3,000 expenses = $112,000 less $105,000 adjusted basis = $7,000 gain).

In addition, as a sidebar, it should be noted that an irrevocable trust can also be a grantor trust. At least one of the posts above appears to indicate (or at least imply) that irrevocable trusts can never be grantor trusts.

[oldcheme]

A reply stated that distributions from an irrevocable trust are ordinary income not inheritance, surely this is NOT correct.

[tagteam]

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@oldcheme wrote:

A reply stated that distributions from an irrevocable trust are ordinary income not inheritance, surely this is NOT correct.

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It is not correct, at least not as a general rule. The nature of what is being distributed controls the tax treatment.