House in trust - tax implications

[ilovetaxes]

Our father put his house into an irrevocable trust. The members of the trust are my two siblings and me.  My father has passed away, and one of us will pay the other two siblings each one-third of the current value of the house, and become the owner of the house.

What are the tax implications for each of us?

Thanks!

[ScruffyCurmudgeon]

@ilovetaxes

TO READERS IN GENERAL, SEE WHAT FOLLOWS AT Inherited House previously Personal Residence of Decedent is sold by the Beneficiary or Heir - and the attachment pdf.

@ilovetaxes Read what follows as it describes the general conditions that apply to a beneficiary receiving the inheritance of a Decedent's house.   See the attachment on how to enter in to TurboTax. 

The inheritance to the three siblings does not result in a Form 1099-S as there is no sale immediate upon the death of your parent nor upon transfer of ownership in thirds to each of you. In your specific case, unless the deed is immediately titled in each of the three names, there will be no Form 1099-S reported unless you formally sell a share in the house to each sibling, in which case each sibling has the obligation to file as described here, but each dividing the selling price and the total selling expenses by three - that is reporting the respective third of net proceeds.  Note that each will then have to report the capital gain or capital loss as described.  This would be the simpler case for you in one way but not another.  If you were not becoming the owner/occupant, then you, and they, would report the effective sale as indicated in the attachment, with the numbers reported being 1/3 each.

However, since you are "buying" the shares of the house from your siblings and IF you will be the only named party on the Form 1099-S when you subsequently sell the house in the future, then the issue is more complex because you and they probably have different personal tax situations.  Most simplisticly, your siblings have a right to the 1/3 of the net proceeds.  In that case, when you at some point in the future sell the house, your cost basis would still be the FMV as of the date of your father's death.  The question between you and your siblings should be if there is a need to adjust for the implicit fact of imputed gain or loss that will at some time in the future be your liability or your write-off. It's complicated! You will need to discuss this with your siblings to reach an amicable agreement as to the amount that you and they recognize as the selling price of the share.
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Inherited House previously Personal Residence of Decedent is sold by the Beneficiary or Heir

Two Common and Different Tax considerations of which to be aware and one rare tax consideration as well:

1. Inheritances (or Gifts) are Not Subject to Income Tax. The recipient (Heir or Beneficiary) has no income tax liability in obtaining the house.
   
   
2. When sold, if the house has never been subsequently occupied by the beneficiary, then the house is not a personal residence but an investment property.  The sale is typically (supposed to be) reported by the real estate broker or conveying attorney on Form 1099-S, showing only the gross proceeds of the sale.
   See the attached PDF File to see how to report this in TurboTax.  Note that as investment property, there is no personal residence capital gain exclusion, and a net capital loss or a net capital gain is reportable, depending on whether or not the net proceeds are greater than or less than the inherited value of the house at date of death (the "Fair Market Value" or "FMV").
   ATTACHMENT: 2019 Sale of Decedent's House by Benficiary - LOSS or GAIN Scruffy.pdf
   If the house has been subsequently occupied by the beneficiary and becomes the beneficiary's personal residence, then the allowable capital gain exclusion on the sale of a personal residence ($250.000/$500,000) may apply but no capital loss can be reported whereas a capital gain after exclusion must be reported.
   
   
3. Rare circumstance:
   Six states which are listed below collect an inheritance tax from the beneficiary if residency applies and relationship is as stated in the conditions for taxability at the state level, and two of the states listed below collect both an estate tax and an inheritance tax:
   -   Iowa 
   -   Kentucky 
   -    *Maryland 
   -   Nebraska 
   -    *New Jersey 
   -   Pennsylvania
             * State collects both estate and inheritance tax

[Anonymous_]

I agree with @ScruffyCurmudgeon. 

One additional point @ilovetaxes is that you need to determine the basis in the property. If this happened to be a trust that only became irrevocable upon the death of your father (i.e., it was formerly a revocable living trust, aka grantor trust, then most likely the basis is the fair market value on the date of death of your father.

If, on the other hand, the trust was initially set up as an irrevocable trust such that your father had no control over the corpus (i.e., it was not a grantor trust, the property would have not been included in his gross estate but was, instead, a gift to the beneficiaries of the trust), then the basis would be the fair market value on the date the property was deeded into the trust (or, the lesser of the fair market value on the date of the gift or your father's adjusted basis if figuring a loss).

[Carl]

As you can see @ilovetaxes this has the potential to get rather complex. It could also be extremely simple too. It just depends on the type of trust. (There are four basic types of irrevocable trusts that I am aware of, and their may be more I'm not aware of.)

Basically, the first thing that "must" happen is probate on the estate. Nothing matters until probate is completed in it's entirety. Period.

If (and that's *ONLY* if) upon completion of probate, all three of you are listed as owners of the house, then what each of you do with your 1/3 share is your business. If two owners want to sell their share to the remaining owner, they most certainly can.

One thing that "MUST" be done though, and preferably done yesterday if not sooner, is to determine cost basis of the house. Is it the FMV of the property upon the passing of your father? Or is it the FMV of the property at the time it was transferred and titled to the trust? It depends on the type of irrevocable trust. This matters big time, as each of you will get 1/3 of that cost basis.

Then when each member sells their 1/3 share, any amount of gain over that cost basis is taxable income to the seller and must be reported on the seller's personal tax return for the tax year of the sale.

[Anonymous_]

@Carl Trusts that are established inter vivos essentially bypass the entire probate process, which is one of the primary reasons they are widely used. 

[Carl]

@Anonymous_ I forgot to mention my reasoning for waiting for probate to complete. Basically, when dealing with such large value items that are inherited, I always recommend folks wait for "at least" 6 months after the passing of the deceased before they make any decisions concerning that property or item inherited. That's because for up to 6 months after their passing, folks are still in the grieving process and for many it can and will affect their decisions. Decisions they may regret later.

But after six months folks will tend to have adjusted enough to their "new normal" and can make better and more sound decisions. The average probate can take six months. It just depends on the will and whats in the estate. I know when my grandmother passed back in the early 90's, probate on her very simple will was completed in about 5 weeks. But my dad still waited before he sold her house.

[ilovetaxes]

Thanks to both of you!

[spittybug]

I have read the above answers and wish to confirm that I have understood and applied it to my situation properly....

House purchased in 1989.  House was put into IRREVOCABLE living trust in 2007, but no appraisal done.  House was sold in early 2019.   No distribution made to beneficiaries (children of owner) as owner was still alive until end of 2019.  I Have received interest income 1099-Int.  I must file a return for the trust for the first time, so I need to calculate gain on sale of the house.  I have receipts for improvements since 2007, but don't have an appraised value of the house at the time it was put into trust.  Is there a means to estimate it without running afoul?    Also, once these gains have been taxed and we divide the trust up among beneficiaries (only the house sale proceeds are in it), do the beneficiaries have a tax liability for this inheritance since it is from a trust not an individual?  This tax stuff is enough to make a sane person crazy...   Thank you!!

[rd57]

So what happens after the sale of the house and the money is distributed to the beneficiaries?  Do the beneficiaries get taxed on the money as income?

[spittybug]

Update> I had a professional do her taxes as recommended.  Turns out that since it was a living trust and the house was sold prior to her death, the trust didn't file any taxes for 2019.  The gain (which was excluded by using the one time gain rule) and the accrued interest were reported on her taxes; the last to be filed for her.  For 2020 the trust will file a return for simply the income on the interest it is earning in 2020.  It will be the last one it files too because it will be distributed prior to the end of the year.  Hope this helps someone else in the same boat and prevents them having to spend the >$700 for the professional....... that's why I use Turbo Tax.

[Anonymous_]

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@rd57 wrote:

So what happens after the sale of the house and the money is distributed to the beneficiaries?  Do the beneficiaries get taxed on the money as income?

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Yes, that is generally what occurs; any gain on the sale is passed through to the beneficiaries on their K-1s (although there typically is little, if any gain, assuming the house is sold shortly after death).

[Anonymous_]

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@spittybug wrote:

The gain (which was excluded by using the one time gain rule)....

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Of course, it should be pointed out that the Section 121 exclusion ("gain rule") can only be used when the house is in a trust under these circumstances; i.e., where the trust is a grantor trust (aka revocable living trust) and not treated as a separate entity for federal income tax purposes.