How to remove rental property from old revocable living trust (under SS#) schedule E upon death of one trustee and enter asset into new sub trust with EIN?

[Cindy10]

My husband died on 3/26/17. A rental property (RP) was held in our Living Trust (LT) (under our SS#) which created a new sub trust C at DOD with it’s own EIN. RP was placed in TR C. I believe the RP’s basis is now 100% of FMV less land on DOD. How do I close out the RP Sch E/Asset Depreciation in the orig. LT so there is no tax liability on depreciation?  There will be income and expenses to report for the first 3 months. There doesn't appear to be a place to indicate property was inherited and not sold.

[pk · Accepted solution]

without reading through the details of the trust document, it is impossible to tell you with any degree of certainty how you should proceed. Sure we can tell you the mechanics of fixing the schedule E but that would be too risky. Please consider seeing a professional tax preparer in your locality. How the property was held, what state do you live in, which state is the property held etc. all play into this. Please consider the suggestion

[Cindy10]

The state is CA both for living and holding property.  The rental property before death was recorded in the name of our revocable Living Trust with both my husband and myself as Trustees under our SS #.  Upon his death a new irrevocable sub trust of the original living trust (marital deduction trust C - community property) under an EIN was formed that gives me the right to income from it and will be divided upon my death - 50% to my heirs, 50% to his heirs.  We had no common children.  I believe the property has a 100% step up to FMV at DOD.  It has been appraised and recorded in the name of the C Trust with me as sole trustee.  I am fairly sure how to enter this in the 1041 tax filing so to begin depreciation at the new appraisal with a new 27.5 year term.  It is removing the rental property as being inherited in 2017 from the 1040 that escapes me.  In the asset worksheet pre death under dispositions, I entered the DOD as the sales date (no place to show property was inherited), balance of non depreciated property as the sales price and value of land as land sales value.  It created a zero gain for line 14 (1040) from form 4797.   Am I on the right path?

[pk]

If the trusts were not there and this was a simple case of (a) husband and wife residents of community property state; (b) jointly owning a rental property with right of survivorship, then what you are doing is correct i.e. achieve a basis change in the property for depreciation purposes. But in doing so you have also unduly changed the useful life of the property, when all you wanted to achieve is to record and affect recognition of basis change. I agree with all your other statements as to step-up basis adjustment. Think a different way to do this is to show a disposition at DOD adjusted basis -- from Trust-A ( husband's trust / estate ) to Trust-C ( Family Trust ). Then start a new asset representing the rental property with the new basis ( note that FMV is total asset value including land ) and use this for depreciation. Since this is owned by the irrevocable trust-C, the income reporting is at the trust level and not at your individual level. The income that you get from the trust is the inheritance for you and therefore is not taxable to you. So this would mean that evrey year you will have to file a trust return and your own individual return --- for both Federal and CA. Does that make sense ?

[Cindy10]

Thank you for your sharing your knowledge of this unusual situation.  I will take some time to absorb your statements and respond again.  Your help is greatly appreciated.

[Cindy10]

Thank you so much for taking an interest in my question and providing an answer parts of which were very helpful.  Question about the statement, "the income you get from the trust is the inheritance for you and therefore not taxable to you."  I really don't understand this.  In Trust C, this first year with the new stepped up basis on the rental home, depreciation creates a negative net income for the trust and no tax is due.  I believe I can't transfer this to me to use with my income tax  (Will it carry over year to year so I can distribute it upon termination of the trust (of course I will be dead then!)?)  Perhaps next year there will be income which I assume will be distributed via the K-1 to me.  Are you telling me this income is not taxable to me?  Will the trust have paid taxes on it before distribution?  I hope not because the tax rate is high?  Your help clarifying this would be greatly appreciated.
Here's another problem.  Exemption Trust B holds my husband's separate property - the monies from an payoff of an installment sale of a rental home that we held the mortgage which is, at this time, nearly all capital gains that requires taxes to be paid, and stock which after transfer to the trust has been sold with a capital gains.  Is the rental home capital gains a passive or non-passive income item?  Where do I enter it in the 1041 estate/trust return?  I assume the stock is entered under Schedule D?  Is the stock a passive or non-passive income item?  There are two separate income items here, stock sale capital gain and payoff capital gain from installment sale of rental property.  This trust will use a fiscal year of 4-1-17 to 3-31-17 as it's initial and final year.  All proceeds will be distributed to heirs (not me, but to his family).  Our state is CA.  Anything else you need to know? Hope this has not given you a headache as it has for me!  I look forward to your reply.

Cindy