How to report transfer of rental property into a trust for grantor and beneficiary

[cc063854]

My parents set up an irrevocable trust for a rental property that they had been reporting on Form 1040 Schedule E. After transferring to the trust, the rental property will continue to be rented out.
1. Do my parents have to file a gift return for the transfer? If yes, should they report the gift value using cost basis with depreciation adjustment OR FMV?  
2. How do my parent report the rental property under the trust? Do my parents continue to file Schedule E on Form 1041 Trust Return? What basis to use and how to report the rental income?
3. Is there any impact to my own personal return?  

[tagteam]

Is this a grantor trust? Are you a beneficiary? Are your parents beneficiaries as well?

If you are a beneficiary, then whatever share you received as a beneficiary would be a gift to you (as a beneficiary). A gift tax return would need to be filed if the value was greater than $17,000 (for 2023) or $18,000 (for 2024).

The gift would be based on the fair market value of the property on the date of the gift. The trust's basis would be a carryover basis (essentially, your parents' adjusted basis). 

If the trust, as a nongrantor trust, files an income tax return, you should receive a K-1 (1041) from which you would report your share of the income, gain, deductions, etc.

[cc063854]

Yes, it is a grantor trust. I am both the trustee and beneficiary of the trust. I am the only beneficiary so my parents are not the beneficiaries.

I understood that a gift tax return is needed if it's over $17,00 (2023), but what confuses me is the basis to report on the gift tax return and the trust return.

You mentioned that "The gift would be based on the fair market value of the property on the date of the gift. The trust's basis would be a carryover basis (essentially, your parents' adjusted basis). "
For example, if the rental property was $1M when my parents bought it, and at the time it was transferred to the trust, the FMV was $1.5M.
Does it mean that my parents should report $1.5M on gift tax return AND $1M basis on the trust return?

Thank you for answering my question!

[tagteam · Accepted solution]

Yes, the gift tax schema and income tax schema are different.

The amount of the reported gift would be the fair market value on the date the gift was made.

The basis would be a carryover basis (adjusted for any gift tax paid, which is likely to be none) assuming the donor's basis is lower than the fair market value.

Note that the trust appears to be a  grantor trust, meaning that it is disregarded for federal income tax purposes.

[cc063854]

If it’s non-grantor trust, how is the treatment different? Thanks!

[tagteam · Accepted solution]

The actual treatment is not different with respect to the basis (assuming typical trust terms) but the trust would issue a K-1 to the beneficiary (rather than a grantor information statement or, alternatively, no statement whatsoever if the trust does not have an EIN).

Note that any gifts made to the trust would be considered to be gifts made to the beneficiary(ies).