I am using TT to do my brother's irrevocable Trust (formed at my parents' death) and his personal tax return. From what I can tell, an heir can get the $250/$500k exclusion for a primary residence if they lived in the house for two of the last five years. The Trust owns and will sell the house in 2024. My brother (an adult) is the trust beneficiary and has lived in the house for the required years. House has appreciated since parents' death so there will be a gain on sale (above stepped-up inheritance basis). Will the trust be issued a 1099-S or my brother? Does the trust report the gain on home sale on the K-1 and my brother then report on his individual tax return with the exemption? If the trust has been distributing capital gains, does it need to distribute the capital gains on the sale of the house to my brother? If so, how does that work in TT? I don't see anything on the K-1 other than a regular capital gains tax. Or do I have the taxes completely wrong on this, and somehow my brother does not get the primary residence exception even though he has lived there for 20+ years since it is owned by his irrevocable trust (I hope not)?
@JFW3 , please can you clarify somethings :
(a) Are you saying that the revocable trust of your parents became irrevocable on the passing of your parents OR that your parents set up an irrevocable trust with assets ( house ) and the only beneficiary is your brother ?
(b) if the latter, and the house has been your brother's abode for all these years -- the irrevocable trust acting as a conservatorship for the benefit of your brother -- and trust has and still owns the house -- true ?
(c) what I am trying to get to is that if the trust owns the house and sells it -- there is no step-up and/or " main residence" gain exclusion --- therefore the questions to understand the situation.
Champ, Thanks for the interest and questions. My mother had a revocable trust, which owned my folks' home after my father passed. The house was transferred to a new (irrevocable) trust in my brother's name upon my mother's death. My brother is the only beneficiary of that Trust. It's not a conservatorship. My brother lived with my parents in the house when they were alive and continued to live in the house after they died. His trust (created when my Mom died) currently owns the house. I found an article online that indicates, "Section 121(d)(9)(C) stipulates that the (residency) exclusion also applies if a trust sells a property where the grantor or the heir uses the home as a primary residence." So say my folks paid $200k for the house; it was worth $275k when my mother passed, and it is now worth $300k. I believe my brother's basis is $275k, and he should get a residency exclusion for a $25k gain if sold at $300k. I was just trying to see if someone in the TT community had experience with this as I'm sure it's not unique.
Your brother's basis would be $275k and he would get the exclusion provided the trust was a grantor trust.....there is a specific exception for trusts in Reg Sec 1.121-1
@JFW3 be careful of who the owner of the house is. From the way you describe it, the irrevocable trust is the owner of the home- not your brother. he is a beneficiary of the Trust. He did not inherit the residence. The irrevocable trust became the owner per the terms of the revocable trust, right?
please reconfirm the IRC paragraph - I can't find the language you are stating in section 121. Can you please provide a link?
NCperson, Thanks for your reply and you are so right, it appears that the interaction between trusts and home sales seems very complicated. I'm not a tax accountant and perhaps I need a CPA to work rather than me finding the correct box in the TT income tax trust form. There are many rules, but it appears the end result is that a person (including the beneficiary of a grantor trust) can exclude the gain from the sale of a primary residence that is owned by a trust if they meet the two-year ownership criteria and the trust is correctly worded. I was wondering if folks had experience on how to make that happen in TT.
a person (including the beneficiary of a grantor trust) can exclude the gain from the sale of a primary residence
That is correct provided it is a grantor trust. I already gave the link in my previous post -
Reg. §1.121-1(c)(3)
@JFW3 I get all that, but I am not aware that an irrevocable trust can be a grantor trust. best to consult a lawyer and confirm whether the trust that owns the home meets the definition of a grantor trust or not. It would depend on how the document is written.
On the other hand, is it worth it. You state the capital gain is currently $25k. How much is your brother's income. for most the capital gains rate is 15% ($3750 in this case if no exclusion) and if his total income including the $25k is below $44k, there is no capital gains tax to be paid in any event. You could burn a lot up with lawyers figuring this out.
@JFW3 agreeing with my colleagues @NCperson and @M-MTax , just want to add :
(a) not knowing the antecedents ( why was the trust created , the actual language etc. ), where we are trying to go is ( and has been quite clearly articulated in section 121 of IRC ) to determine the extent of dominion of your brother ( beneficiary ) over the asset ( either declared at origination or after certain condition such as reaching an age etc. ). To the extent of the dominion over the asset , he is privy to the benefits of gain exclusion etc. This is why we have been going back and forth -- we do not know the extent of dominion.
(b) I agree with @NCperson that while a discussion with an attorney may be advisable but the cost may or may not be worth it for just this purpose ( sale of the asset and recognition of income). The language in the trust should be enough for you to determine the dominion question.
Is there more one of us can do for you ? As always if the question does not lend itself to general interest, you can always PM one of us and keep it reasonably private.
pk
I am not aware that an irrevocable trust can be a grantor trust.
Yet it can.......just because a trust is irrevocable does not mean it cannot be a grantor trust either in whole or in part.
Again, thanks to those who responded. I pulled out the Trust documents and the Trustee may distribute the trust principal for support and maintenance. If the Trust distributes the house to my brother and then my brother sells it as an individual, there should be no problem with him taking the primary residence exemption (he has certainly lived there long enough and has paid real estate taxes). I think that might be the easiest way to handle it. He takes the principal, in this case, the house at the trust's basis or the date of death basis. Then when my brother sells, he will have a capital gain for appreciation over the trust's basis, but can use the primary residence exemption. As far as I know doing the K-1 for the trust, there's no reporting of principal distribution as it's not an income event for the trust or beneficiary.
@JFW3 , generally agreeing with your conclusions ( i.e. the understanding of the rules / text of the Trust docs & conditions ). Where I have an issue is that for your brother to meet the gain exclusion, he must have owned the property ( for 2 years) and used as main residence ( for 730 total days ). If you transfer/distribute the asset to him, his ownership comes into being ONLY after transfer ( he would have dominion ).
You are also correct that the distribution of the corpus of a trust is generally not income to the beneficiary.
Does this make sense ?
Thanks. I think he might be considered a substantial owner for the time the house was owned by his Trust. I'm now looking at the Federal Tax Coordinator Analysis (RIA), which observed that "any person (beneficiary or a grantor) who is treated as the owner of the trust under the grantor trust rules could exclude the gain from the sale of a residence" if they satisfied the ownership and use test described. And "for purposes of determining whether the ownership test is satisfied, presumably, the person treated as owner of the trust could combine any period that he owned the residence individually with the period of time that the trust had owned the residence." I just need to get a little more into the tax code and the revenue rulings (assuming they are still good after the Chevron decision). This is not my area of expertise (took one tax class in getting a Masters degree) .... I just know enough to research items to be dangerous.
@JFW3 I agree that the trust rules matter here ( how it is exactly worded --- this could be treated as a case of equitable ownership ( think there was case in California where Person A lived in the house , paid all the dues as if he owns the place, He had person B buy the house for him because he could not qualify for the loan. It was always understood that B was owner on paper but the house was for benefit / use of Person A. I brought this because of this -- can he claim to be the equitable owner ?
presumably, the person treated as owner of the trust could combine any period that he owned the residence individually with the period of time that the trust had owned the residence.
Yeah, that's called "tacking" and it is allowed for other purposes but NOT for the purposes of complying with the ownership requirements of Sec 121.
You might want to read Reg. Sec 1.121-1. I'll copy and paste it below.
(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.
Then read sections 671-679 which outline the grantor trust rules particularly Sec 678....substantial owners.
Thanks, M-MTax; you clearly know more about taxes than I do. Maybe I'm not reading the regs correctly, but the house has been in my brother's trust for 5 years, and he has lived in it for those five years. Assuming a grantor trust and he meets the criteria in sections 671 through 679 (which I will look at), I read this as saying, "the sale or exchange by the trust will be treated as if made by the taxpayer." So, let's say he keeps ownership of the house in the trust, and the trust sells the house. Is the 1099-S issued to the trust's tax-paying ID or my brother's SSN? If the trust reports the gain, somehow the K-1 of the trust needs to transfer that capital gain to my brother and indicate it as from a home sale that will be treated as if made by my brother. The IRS will want either the trust or my brother to include the capital gain, and those tax returns need to know what the other is doing. Otherwise, it risks both reporting or neither reporting the gain. That's why I was thinking if he moved the house out of the trust into his name, it's clear that the sale is treated as made by the taxpayer. There is nothing more confusing than trying to read the source tax regulations!
@JFW3 wrote:........somehow the K-1 of the trust needs to transfer that capital gain to.....
You can stop right there; grantor trusts do not issue K-1s.
@JFW3 wrote:.....I read this as saying, "the sale or exchange by the trust will be treated as if made by the taxpayer."...
Except with a grantor trust, the trust and the taxpayer (grantor) are one and the same; the trust is disregarded for federal income tax purposes.
A nongrantor trust is treated as a separate entity.
This trust started its life as a grantor trust by my Dad. That trust owned the house. When my father died, the trust specified creation of a successor trust for my brother with my brother's share of the inheritance. One of the assets moved into the successor trust was the house. My brother is a successor trustee and has power to control or direct the successor trust's income and assets. The successor trust has never paid income tax because it distributed all the income. Are you saying the successor trust is not a grantor trust? If it's not a grantor trust, he should probably distribute the house as principal to himself and then own it for two years before selling it. Or he could put the house title in a newly created grantor trust in his own name and sell it from there after two years. Key is that he would need two more years ownership to qualify for cap gains exemption as a primary residence.
.has power to control or direct the successor trust's income and assets
If he has that much control, then he would most likely be treated as the owner of the assets in the trust and be treated as a grantor (substantial owner) per Sec, 671-679 and as such would qualify for the Sec 121 exclusion.
Thanks. Section 678 seems to say that if a person has a "power exercisable solely by himself to vest the corpus or the income therefrom in himself," that person can be treated as the owner of the trust. I believe my brother, as beneficiary and trustee of his trust, can do that. So he can count the time his trust owned the house towards the ownership requirement for a residency exclusion. So I'm back to my thinking to transfer the ownership of the house from his trust to my brother as an individual to sell the house (which incidentally also supports that he has the power to call himself the owner of the trust because he would have unilaterally just transferred some of the corpus to himself). He gets the 1099-S issued to his SSN and handles it as if he owned the house since it was first transferred to his trust when my parents died. It seems reasonable with the quoted tax provisions. Again, thanks. I'll let you know if this is correct if we go to a lawyer or a CPA.