1041 Irrevocable Trust: Basis for Home

[gregt75]

I have a client who last year put his house in an irrevocable trust in his son's name. It is a two family house. He rents one floor. I am assuming now that he is considered a tenant. Will the basis of the house be the original appraisal that he had back in 1991? He did not have it re-appraised. I am assuming the depreciation will be reset as though it is starting from the beginning. Please advise. Thanks.

[Koss]

Not enough info

gregt75 wrote:

put his house in an irrevocable trust in his son's name

Who is the trustee and who is the beneficiary? And what happens to the corpus of the trust if the beneficiary dies?

These things matter. You gotta read the trust instrument. Here's one reason why:

It is a two family house. He rents one floor.

It's not entirely clear what this means. But just for fun, I'm going to assume that it means that one floor is really rented, at fair market value, in an arm's length transaction, to a real tenant, who is not related to your client, or to his son... and that your client lives on the other floor, but is not paying rent.

I am assuming now that he is considered a tenant.

He's not really a tenant if he's not paying rent. And even if he pays rent, who would he pay it to? Brings us back to the question of who is the trustee and who is the beneficiary...

If he really put the house into an irrevocable trust "in his son's name," then that means that his son is the beneficiary. So where is the son living? Is the son even an adult? And why is your client still living in the house, if he gave it away?

What do you mean he didn't give it away? That's what irrevocable means. If he's still living in the house, and he still has the right to use it and control it, then he didn't really give up ownership. If he really gave up ownership, then why is he still living there?

First you gotta get a copy of the trust agreement, and figure out who are the beneficiaries, and who is the trustee. It may not really be irrevocable, even if it uses that word. If your client can change the trustee, or he still has the right to use the house, then he has retained an interest, and the trust may be a disregarded entity for tax purposes.

Better hope this isn't some "trust package" that be bought online or at a seminar. Those things are tax evasion schemes. Does he think that this is going to allow him to take tax deductions for repairs, utilities, insurance and depreciation on the house that he lives in? Without paying fair market rent that is reported as income?

Be very careful with this thing.

If your client won't produce a copy of the trust agreement, you should walk away, and tell him to go see a tax lawyer.

No joke.

BMK

[gregt75]

Burton,

I will get more info but it is all legit. It is my friend's father. He went through a lawyer to set this up. It is not a scheme. My friend does not live in the house. His father lives on the first floor and tenant lives on the second floor. His father bought the house in 1991 and has been renting the second floor to a tenant ever since. I believe my friend's father is the trustee and his son is the beneficiary. Lets go on this assumption but I will confirm. Please advise. Thanks.

[mastertaxguy]

Gift tax issues

I have a client who last year put his house in an irrevocable trust in his son's name. It is a two family house. He rents one floor. I am assuming now that he is considered a tenant. Will the basis of the house be the original appraisal that he had back in 1991? He did not have it re-appraised. I am assuming the depreciation will be reset as though it is starting from the beginning. Please advise. Thanks.

There may also be a gift tax issue. An appraisal at the time of transfer to the irrevocable trust (if it is really irrevocable) would be nice. The value of the property likely exceeds the gift tax exclusion in the year of gift, and thus, a gift tax return (even if no gift tax is due) is required. A valid appraisal should consider the property's current FMV, cost of replacement, and value as an income property over 27.5 years.

Depending on the State, the transfer may affect property tax assessments (personal residence vs. non-personal residence property as father no longer owns the property). What you describe, though, is more likely a revocable trust, with the father the current income and asset beneficiary, with the son the residual beneficiary upon father's death.

These are likley issues more for the lawyer. If a lawyer was involved initially, he/she can advise the son on the basis of the building, which is likely the father's basis (reduced for allowable depreciation attributable to the upper unit). Son will receive the property via the trust if irrevocable at father's basis, thus avoiding the step up in basis upon father's death.

As for a tax return, if an irrevocable trust, that entity needs to file a tax return. if irrevocable. the son is "gifting" the FMV of father's rent, and the son may be denied rental (Schedule E) deductiosn based on personal use of the property. See The Tax Book, (deluxe) Page 7-7, top right column, and IRC 280(A) and regulations thereunder. Also, The Tax Book (deluxe) Pp. 21-24-26. Your facts do not indicate the upper and lower units are separate property tax units, such as a condo or perhaps a duplex.

[gregt75]

The son is the trustee and beneficiary.

[gregt75]

It is an irrevocable trust.

[Koss]

Trust

Okay, let's make sure I've got the facts:


(1) Father lives in one unit.
(2) The other unit is occupied by a tenant paying fair market rent.
(3) Father was the owner of the house.
(4) Father transferred ownership of the house into an irrevocable trust.
(5) His adult son is the trustee.
(6) His adult son is also the beneficiary.
(7) The son/trustee/beneficiary is not living in the house.
(8) Father is still living in the house.
(9) Father is not paying rent to the trust.

All these things matter.

Mastertaxguy is also correct that a gift tax return may have to be filed, but that's a separate issue. And he is correct that the new ownership of the home may have an impact on property taxes.

Questions:

Is the son the only beneficiary?

What happens if the son dies before the father?

Does the father have the power to change the trustee or the beneficiary? Is there someone else who can make these changes?

I'll stay with you on this. If it was done by a competent estate planning attorney, then I'm sure it's legit. But there's still a lot of variables you have to account for.

BMK

[gregt75]

Questions:

Is the son the only beneficiary? Yes, but his wife is contigent.

What happens if the son dies before the father? His wife would become the beneficiary and trustee.

Does the father have the power to change the trustee or the beneficiary? Is there someone else who can make these changes? No, only the son.

Also, the father does deposit some extra money into the trust bank account beyond the rent from the upstairs tenant. He is only depositing. He does not have rights to withdraw.

Can you expand on the gift tax return and property tax affect. I am meeting with the father and son tomorrow. I am talking to my friend today so I can respond throughout the day. Let me know what else you need.

[mastertaxguy]

gift tax-property tax issues

1. Don't get in beyond your abilty and authority to act. Some of this is legal stuff which may have been considered, and done, or should have been considered, by the attorney who set this up. Not you. This sounds like a "medicaid planning" trust and transfer set up to improverish the father so he qualified for medicaid nursing home payments in the future, or maybe to set up a 1031 exchange at some point, but that is NOT YOUR CONCERN.

2. For what purpose are you meeting with these folks? Father may, or may not, have an individual tax return, the trust will have a 1041 to do with a K-1 of some amount out to the son. Son likely will need a tax return. If you get three+ returns out of this, you should send the lawyer a referral fee or something. Don't be shy about charging for the 1041 either. IT IS NOT A 1040EZ!

3.Gift tax: see The Tax Book cites earlier. Remember the value of the property on the date of transfer to the irrevocable trust (which is a gift to the beneficiary/ies) determines the value of the gift, not the basis. The value of the gift may be the value of the income steam over the son's or his spouse's lifetime (and possibly more than the value of the building and land), but that is up the appraiser who needs to be IRS qualified. The value of the property is the basis for the trsut for deprecation, subject to the related party/personal issues on rental property mentioned earlier. Assuming the paying tenant is paying FMV rent, Dad is getting a gift of the FMV of the rent each month. Also, the annual exclusion may not apply to the initial transfer to the irrevocable trust since the only present beneficial interest, based on your facts, is the right to receive rents for the son. Annual exclusion does not appy to gifts of future interests.

4. Property Tax issue: some states or localties re-assess real property when there is a transfer, and in such cases a transfer to an irrevocable trust (your situation) is a transfer which may result in a higher (or lower) property tax assessment depending on valuation. This is not really your issue. You know the local situation.

Have fun!

[gregt75]

I am friends with them. The father will have a tax return. He owned the house for half of the year. The son is a working adult so he has to file a tax return. I was assuming all the rental revenue will be taxed through the trust and not flow through to the son's return.

[Burke]

I have a client who last year put his house in an irrevocable trust in his son's name. It is a two family house. He rents one floor. I am assuming now that he is considered a tenant. Will the basis of the house be the original appraisal that he had back in 1991? He did not have it re-appraised. I am assuming the depreciation will be reset as though it is starting from the beginning. Please advise. Thanks.

Your OP concerned the basis for the home in the trust. It will be the donor's original basis, which is what he paid for it, plus any improvements made since purchase. (If it was jointly owned with a spouse in the beginning, and that spouse is deceased, it would have received stepped-up basis of 1/2 its FMV at her death). And if the father/owner has been depreciating it as rental property (or a part of it) then that accumulated depreciation reduces his basis. It does not get "reset as though it is starting from the beginning" just because it was transferred into a trust. It will be treated as a gift as others have mentioned above.

[gregt75]

Your OP concerned the basis for the home in the trust. It will be the donor's original basis, which is what he paid for it, plus any improvements made since purchase. (If it was jointly owned with a spouse in the beginning, and that spouse is deceased, it would have received stepped-up basis of 1/2 its FMV at her death). And if the father/owner has been depreciating it as rental property (or a part of it) then that accumulated depreciation reduces his basis. It does not get "reset as though it is starting from the beginning" just because it was transferred into a trust.

When you say it does not get reset, you mean I continue the depreciation where I left off? The house will be fully depreciated soon.

[Burke]

Yes, that is correct.