If a Trust sells a home, can the Trustee take the $250,000 capital gain exemption if the Beneficiary lived in the home until the sale?

[Critter1]

Revocable trust?

[tonybono]

Irrevocable Trust

[tagteam · Accepted solution]

In the instance of an irrevocable trust where a taxpayer is not treated as the owner of the trust, or the owner of that portion of the trust that includes the residence, no capital gain exemption (Section 121 exclusion) shall be allowed. 

Treas. Reg. § 1.121-1(c)(3)(i):

If a residence is owned by a trust, for the period that a taxpayer is treated under sections 671 through 679 (relating to the treatment of grantors and others as substantial owners) as the owner of the trust or the portion of the trust that includes the residence, the taxpayer will be treated as owning the residence for purposes of satisfying the 2-year ownership requirement of section 121, and the sale or exchange by the trust will be treated as if made by the taxpayer.

[Critter1]

The exclusion is generally $250,000 but can be increased to $500,000 if the sellers are married and file a joint tax return for the year of the sale, and both have met the use test for the house. Generally the exclusion is available only to an individual, because an entity, such as a trust, cannot use a house as a principal residence.

[randy2]

1. If the grantor has died and the home is being sold by the trust after their death (and the trust has become irrevocable at this point), does Section 121 exemption still apply?
2. If Section 121 exemption does apply, does that prevent the preparer from claiming a capital loss if the sales price is less than basis?
3. If the price is discounted by 25% off of FMV by a sale to the surviving significant other (not a spouse, not a beneficiary of the trust, and not a community property state), does this prevent taking a capital loss if answer to 2 above is "no"? 4. Does the trust use FMV on date of death for basis?

[mbatson13]

This maybe too little too late, but upon death of the owner, the property gets a step-up in basis equal to its FMV at the date of death of the grantor of the trust. This effectively makes the cost basis the same as the sales price so there's no gain.  You wouldn't use or need to use Section 121 to eliminate the capital gain because of this act of law.

[Mike7388]

What if the home deposited into the trust, and occupied by the depositor, can be removed (reacquired) from the trust by the depositor and replaced by replacing it with property of similar value?  In that case, is the $250,000 preserved?

[tagteam]

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@Mike7388 wrote:

What if the home deposited into the trust, and occupied by the depositor, can be removed (reacquired) from the trust by the depositor and replaced by replacing it with property of similar value?  In that case, is the $250,000 preserved?

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No, that would be a sham transaction and quasi fraudulent. 

[ronlevy111]

 "Depositor" isn't a valid term. You mean Grantor, which, if deceased, can't do anything.

No I believe it wouldn't be a sham if, as a Trustee,  you simply did the transactions through a 1031 exchange. No real way of "removing" it from the (now irrevocable) trust without considering it a sale, so just sell it and buy another ("replace") property within the 1031 time constraints.

[tagteam]

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@ronlevy111 wrote:

No I believe it wouldn't be a sham if, as a Trustee,  you simply did the transactions through a 1031 exchange.

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The Section 121 exclusion is what was under consideration and, of course, personal use property (such as a main residence) would not qualify for a 1031 exchange.

Further, somehow having a grantor trust acquire title to a main residence for the sole purpose of disposing of it shortly thereafter in order to qualify for the Section 121 exclusion could most definitely be considered a transaction the substance of which was solely to avoid taxation.

[Billramsey53]

The original question did not specify whether the trust was revocable or irrevocable. Thus, the reply only provides a partial answer to the question and is correct in stating that an irrevocable trust does not qualify for a Section 121 capital gains exclusion. However, if a house is held by a revocable trust and served as the principal residence for at least 2 out of the preceding 5 years as the tax filer’s (trust owner’s) principal residence, it fully qualifies for the Section 121 exclusion ($250,000 for single and $500,000 for married filing jointly). The grantors of a revocable trust are considered the owners of the property for Federal tax purposes.

[tagteam]

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@Billramsey53 wrote:

....The grantors of a revocable trust are considered the owners of the property for Federal tax purposes.

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You have to read the relevant treasury regulation more closely (Section 1.121-1(c)(3)(i) (below)).

The Regulation only requires that the property held by the trust be treated as owned by the grantors (per Sections 671-679), not that the trust be revocable since even irrevocable trusts can be treated as grantor trusts.

(3) Ownership -

(i) Trusts. If a residence is owned by a trust, for the period that a taxpayer is treated under sections 671 through 679 (relating to the treatment of grantors and others as substantial owners) as the owner of the trust or the portion of the trust that includes the residence, the taxpayer will be treated as owning the residence for purposes of satisfying the 2-year ownership requirement of section 121, and the sale or exchange by the trust will be treated as if made by the taxpayer.