Sale of an inherited primary residence by an irrevocable trust

[M-MTax]

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.

[JFW3]

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!

[M-MTax]

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@JFW3 wrote:

........somehow the K-1 of the trust needs to transfer that capital gain to.....

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You can stop right there; grantor trusts do not issue K-1s.

[M-MTax]

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@JFW3 wrote:

.....I read this as saying, "the sale or exchange by the trust will be treated as if made by the taxpayer."...

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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.

[JFW3]

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.  

[M-MTax]

.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.

[JFW3]

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.

[M-MTax]

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....just transferred some of the corpus to himself....  

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I understand what you are getting at but he doesn't have to transfer anything to himself for federal income tax purposes; the trust's assets are his assets.