Revocable trust and sale of rental property after death

[GaryFNC]

Planning time - revocable trust that owns a rental property.    3 children to inherit the asset/proceeds at death.  Property is worth more than its original basis from years ago.

My understanding is that the property gets a step-up in basis at death. 
    
1. I believe that passing the trust to the 3 children means that they all receive their portion of that new basis..

2. I think that if the trust instead sells the property, it has to report the capital gains (presumably very small if sold quickly) on Form 1041 - is that correct?

3. My main question is what happens after that.  The trust then distributes the net proceeds of the property sale to the children.    I think that distributed trust income is taxed for the children, but distributed principal is not.   So, are the proceeds from sale of the property considered income or principal when distributed to the children

Thanks in advance - having trouble finding anything completely clear on all this in the IRS docs or prior questions

[GaryFNC]

2 notes..

1. The property is not worth anywhere near enough to trigger estate taxes

2. We didn't want all the children to inherit the property together - one is still young and it is very awkward to have 3 owners who would need to agree on what to do with it, etc.

[Mike9241]

if the only beneficiary died, there would be a step up to FMV on the date of death.  if the property is then sold by the estate, any gain would be reported on the estate 1041.  The executor generally must follow the provisions of the trust as to what happens to the assets of the estate.  However, most state laws give the executor some discretion. Thus the executor may have the option of paying the taxes on the gain at the estate level (form 1041) and distributing the remaining proceeds tax-free to the beneficiaries or distributing the gain by distributing the proceeds to the beneficiaries and issuing each a k-1.

.   

you need to read and understand the trust agreement. 

[GaryFNC]

Mike,  thanks much......

A follow-up question to be sure I have this right...
1. "if the only beneficiary" - I assume you mean the grantor in our very simple case, but I will verify how the trust is written.    It is basically just a trust to handle the property and nothing else or more complicated.
2. "remaining proceeds tax-free" - I assume that means that the net proceeds from the sale (after any capital gain taxes which will be small if sold quickly) are treated as principal...

I will look into the question of distributing by K-1 to the beneficiaries.

Basically, we are reworking the trust (for various reasons) and I want to make sure we have constructed things properly from the standpoint of taxes.   If we simply sell the house earlier, the capital gains are sizable, so far better to have it inherited.

[Critter-3]

I highly recommend you seek local professional guidance on this matter as the state you live in and the state the beneficiaries live in could come into play.  Seek someone who understands trusts & income taxes for the best advice. 

[GaryFNC]

At some level, always the right answer..  BUT that guidance is often quite expensive if I don't know exactly the questions I want answered - so trying to get as far as I can from IRS docs, internet, and this very useful community before engaging an expensive (and not always useful, unfortunately) pro.