1041 Estate Income tax return

[Stevehofwa]

If the deceased final tax return resulted in a liability paid by the estate, can that be deducted on the estate income tax return(and the loss passed on to a beneficiary via k-1)?  If so, where does the deduction go?

[tagteam · Accepted solution]

The only expenses that can be deducted by the estate (on an estate income tax return, Form 1041), are liabilities incurred (and paid) by the estate. 

Federal income taxes incurred by the decedent prior to death are not typically liabilities of the estate. 

Regardless, federal income tax can be deducted as an expense on neither an individual nor an estate income tax return.

[Stevehofwa]

Thanks-so any cost incurred prior to death has to be either included in the final year return(if deductible) or in the estate tax return, if that applies.  The estate income tax only applies to costs or income incurred by the estate, like administration or legal costs, and income prior to distribution.  Is that right?

[tagteam]

@Stevehofwa That is correct.

[Mike9241]

Thanks-so any cost incurred prior to death has to be either included in the final year return(if deductible) or in the estate tax return, if that applies. The estate income tax only applies to costs or income incurred by the estate, like administration or legal costs, and income prior to distribution. Is that right?

expenses incurred prior to death and paid after would be deductible only on the estate income tax return if they're deductible. they are referred to in tax literature as expenses in respect of a decedent. income earned prior to death but paid after such as unpaid wages, dividends declared, interest income accrued, unpaid rental income, etc. would be reported on the estate income tax return if taxable. they are referred to as income in respect of a descendant

there are exceptions to the above but certain rules must be followed. read the instructions to Form 1041 start with page 19. they should give you guidance on what can and can't be reported on the 1041. then if you have further questions post back in this thread. 

https://www.irs.gov/pub/irs-pdf/i1041.pdf 

[Stevehofwa]

If you have rental property in the estate, does the net rental income(not considering depreciation) and depreciation pass through to the beneficiary?  If there is a rental loss due to depreciation, can this be used to offset estate income and reduce pass through income(even if it’s not passive to income, like dividends) to the beneficiary?  I realize that would reduce pass through depreciation, but that might not be useful to the beneficiary.

[RobertB4444]

All income net of expenses passes through to the beneficiary on the K1 unless the taxes are paid at the estate level.  

The rental loss will reduce pass-through income to the beneficiary.

@Stevehofwa

[tagteam]

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@Stevehofwa wrote:

If you have rental property in the estate, does the net rental income(not considering depreciation) and depreciation pass through to the beneficiary? 

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The depreciation is passed through to the beneficiary in proportion to the income passed through from the rental activity. 

If all of the income is passed through to the beneficiary, then all of the depreciation is passed through to the beneficiary. Conversely, if all of the income is retained by the estate, then so is all of the depreciation. If 50% of the income is retained by the estate and 50% of the income is passed through to the beneficiary (an unusual scenario), then 50% of the depreciation is allocated to the beneficiary and 50% is allocated to the estate.

[Stevehofwa]

So, still a little bit confused here. The estate has a rental activity which shows income, but has depreciation losses which make the rental  actvity an overall loss. If the fiduciary elects to allocate all of the rental income to the estate, can the estate then use the rental loss to offset other income, such as dividend, interests, etc., up to $25000, so the income to the beneficiary on their K-1 is reduced, and non of the depreciation is passed on?  In general, can I allocate the income any way I wish in order to minimize taxes all around?  Is there any way to utilize the exemption to reduce the pass through income?

[tagteam]

A qualifying estate can take advantage of the $25,000 special allowance.

See https://www.irs.gov/instructions/i8582#en_US_2022_publink1000278150

A qualifying estate is the estate of a decedent for tax years ending less than 2 years after the date of the decedent's death if the decedent would’ve satisfied the active participation requirements for the rental real estate activity for the tax year the decedent died.

[Stevehofwa]

Ok so in that case I allocate all rental income to the estate,  and so the all of the depreciation as well, and take the loss as a deduction against any other income, and the beneficiary gets their taxable K-1 income reduced(and I can choose what income is passed on, like dividends rather than interest, since the tax rate is lower).  Better than passing on the depreciation to a beneficiary who can't use it(due to income) until the house is sold, if ever.  

[Stevehofwa]

Regarding the $600 exemption, I guess that cannot be used on a final return to reduce taxable income to the beneficiary?  So its just shows up as a $600 loss?

[tagteam]

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@Stevehofwa wrote:

Regarding the $600 exemption, I guess that cannot be used on a final return to reduce taxable income to the beneficiary?  So its just shows up as a $600 loss?

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No. The exemption does not apply for a complete distribution (i.e., such that would create a net loss).

[Stevehofwa]

Thanks for the info.  The irs instructions are rarely very clear.   Final year DNI(taxable income to the beneficiary), is gross income -allowed deductions(like rental loss, attorney fees, etc), where the income distributed can be chosen by the fiduciary for maximum tax benefit.  In the final year, the estate cannot have any taxable income, as all was distributed, thus the exemption is not allowed.  Is it true that if this wasn’t the final year that you wouldn’t be able to use the rental loss(assuming the estate income was low enough) to offset DNI?( but you would be able to use the deduction)

[Stevehofwa]

Meant use the exemption.  In the final year, I take it then that you can't have a taxable income to the estate?  So for example, can I not distribute the taxable income and leave it in the estate and pay taxes there?  If it wasnt a lot it might be at a lower rate, and not taxable in the beneficiary's state.