Client's brother established an irrevocable inter vivos trust several years ago, funding it with $1000. Since then, the trust corpus has grown to a value of roughly $85000, due to additional contributions of assets by the original grantor (my client's brother) and other family members, and also due to investment income.
My client is the only beneficiary of the trust as long as she is alive. After her death, any remaining assets in the trust go to a charitable educational entity. However, this is not a charitable remainder trust. It appears to be a spendthrift trust, originally intended to prevent my client from squandering the money, and to shield the assets from creditors.
The trustee is my client's same-sex partner. The terms of the trust give the trustee absolute and total discretion as to when or whether to make any kind of distribution; no distribution is ever required. The only real requirement is that the trustee act in the best interest of my client, and the terms prohibit any distribution to the educational institution as long as my client is alive.
Yes, the trust has its own TIN and has been filing Form 1041.
The issue:
My client wants to put a rental property that she owns into the trust. The property consists of three rental units, and she has owned it for about 15 years. She currently holds title to it as an individual.
Superficially, this looks totally clean and uncomplicated. She has been reporting the rental income, expenses, and depreciation on her personal Schedule E for the last 15 years.
But it gets really complicated really fast. The property has an estimated FMV of $140,000, a mortgage of about $80,000, and a basis of.... well, let's just say that the basis is probably well below the FMV because of all those years of depreciation on Schedule E and appreciation of the property itself.
Her motives for transferring the property into the trust are not entirely clear to me. It appears that she wants to prevent the property from going to family members, and give her partner control over the property and its equity and income, thereby shielding it from creditors but nevertheless remaining available to her down the road if she becomes incapacitated, mentally or physically, and begins to incur massive medical expenses. I'm not absolutely certain of this, but it sounds like she wants to shield the asset from attachment or inclusion for purposes of Medicaid eligibility. But she may have other motives as well. Most of her family is hostile to her partner.
My client has envisioned three different mechanisms by which the property could be transferred into the trust:
(1) She transfers the property into the trust with a quit-claim deed. This will trigger the due-on-sale clause in the mortgage, and the trust will simply pay off the mortgage with its current liquid assets.
(2) She pays off the mortgage with her own money first, then transfers title to the trust.
These two scenarios have the same outcome: my client is making an outright gift to the trust. The only difference is the value of the gift. If she pays off the mortgage first, the value of the gift is much greater.
(3) She sells the property to the trust at its fair market value, determined by a competent appraisal. The trust purchases the property in an arms-length transaction, using part or all of the trust's current assets to make a downpayment, and then taking a mortgage for the rest of the purchase price. My client would not sign the mortgage note. She believes that the trust may be able to borrow on its own, because of the trust's assets and the rental income generated by the property. Alternatively, the trustee might agree to accept personal liability on the mortgage note, to get a better interest rate.
The questions:
(a) If my client gifts the property, as described in scenarios (1) and (2), does this successfully avoid any capital gain until the trust sells the property? Does the trust use her basis? Does the trust start depreciation all over?
Or is the gift disregarded because she is the beneficiary of the trust?
She appears to be retaining a beneficial interest, although this isn't crystal clear to me because the trust itself is irrevocable. She can't get the property back unless the trustee decides to make a distribution and transfer title back to her. We're assuming that will never happen. Even if it did, it would not be at her direction; she is giving up complete control of the property. She will certainly continue to receive some income from it, but only if and when the trustee decides to make distributions.
(b) What happens if my client sells the property to the trust, as described in scenario (3)? This would appear to be a full blown final disposition, with all the consequences of capital gain.
But is the sale disregarded because the property was sold to a related party? Once again, she is the beneficiary of the trust. And this appears to meet the definition of a related party.
(c) If my client gifts the property to the trust, she becomes a grantor to a trust of which she is also a beneficiary. The trust is not a grantor trust, because the original grantor was not a beneficiary, and the trust is irrevocable. But the fact remains that if she makes the gift, there will be an individual who is both a grantor and beneficiary of this trust.
Does this poke a hole in the shield they are trying to create with respect to Medicaid and other hypothetical creditors? Or will the trust survive an attack if they can get past whatever "look-back" period applies to "self-settled" trusts?
This is an Ohio affair.
TIA
Burton
My client is the only beneficiary of the trust as long as she is alive. After her death, any remaining assets in the trust go to a charitable educational entity. However, this is not a charitable remainder trust. It appears to be a spendthrift trust, originally intended to prevent my client from squandering the money, and to shield the assets from creditors.
The trustee is my client's same-sex partner. The terms of the trust give the trustee absolute and total discretion as to when or whether to make any kind of distribution; no distribution is ever required. The only real requirement is that the trustee act in the best interest of my client, and the terms prohibit any distribution to the educational institution as long as my client is alive.
Yes, the trust has its own TIN and has been filing Form 1041.
The issue:
My client wants to put a rental property that she owns into the trust. The property consists of three rental units, and she has owned it for about 15 years. She currently holds title to it as an individual.
Superficially, this looks totally clean and uncomplicated. She has been reporting the rental income, expenses, and depreciation on her personal Schedule E for the last 15 years.
But it gets really complicated really fast. The property has an estimated FMV of $140,000, a mortgage of about $80,000, and a basis of.... well, let's just say that the basis is probably well below the FMV because of all those years of depreciation on Schedule E and appreciation of the property itself.
Her motives for transferring the property into the trust are not entirely clear to me. It appears that she wants to prevent the property from going to family members, and give her partner control over the property and its equity and income, thereby shielding it from creditors but nevertheless remaining available to her down the road if she becomes incapacitated, mentally or physically, and begins to incur massive medical expenses. I'm not absolutely certain of this, but it sounds like she wants to shield the asset from attachment or inclusion for purposes of Medicaid eligibility. But she may have other motives as well. Most of her family is hostile to her partner.
My client has envisioned three different mechanisms by which the property could be transferred into the trust:
(1) She transfers the property into the trust with a quit-claim deed. This will trigger the due-on-sale clause in the mortgage, and the trust will simply pay off the mortgage with its current liquid assets.
(2) She pays off the mortgage with her own money first, then transfers title to the trust.
These two scenarios have the same outcome: my client is making an outright gift to the trust. The only difference is the value of the gift. If she pays off the mortgage first, the value of the gift is much greater.
(3) She sells the property to the trust at its fair market value, determined by a competent appraisal. The trust purchases the property in an arms-length transaction, using part or all of the trust's current assets to make a downpayment, and then taking a mortgage for the rest of the purchase price. My client would not sign the mortgage note. She believes that the trust may be able to borrow on its own, because of the trust's assets and the rental income generated by the property. Alternatively, the trustee might agree to accept personal liability on the mortgage note, to get a better interest rate.
The questions:
(a) If my client gifts the property, as described in scenarios (1) and (2), does this successfully avoid any capital gain until the trust sells the property? Does the trust use her basis? Does the trust start depreciation all over?
Or is the gift disregarded because she is the beneficiary of the trust?
She appears to be retaining a beneficial interest, although this isn't crystal clear to me because the trust itself is irrevocable. She can't get the property back unless the trustee decides to make a distribution and transfer title back to her. We're assuming that will never happen. Even if it did, it would not be at her direction; she is giving up complete control of the property. She will certainly continue to receive some income from it, but only if and when the trustee decides to make distributions.
(b) What happens if my client sells the property to the trust, as described in scenario (3)? This would appear to be a full blown final disposition, with all the consequences of capital gain.
But is the sale disregarded because the property was sold to a related party? Once again, she is the beneficiary of the trust. And this appears to meet the definition of a related party.
(c) If my client gifts the property to the trust, she becomes a grantor to a trust of which she is also a beneficiary. The trust is not a grantor trust, because the original grantor was not a beneficiary, and the trust is irrevocable. But the fact remains that if she makes the gift, there will be an individual who is both a grantor and beneficiary of this trust.
Does this poke a hole in the shield they are trying to create with respect to Medicaid and other hypothetical creditors? Or will the trust survive an attack if they can get past whatever "look-back" period applies to "self-settled" trusts?
This is an Ohio affair.
TIA
Burton
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