Irrevocable Trust: How To File

[gregt75]

Here are the details

(1) Father lives in one unit.
(2) The other unit is occupied by a tenant paying fair market rent ($1000/month).
(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 supposed to pay 837 a month in rent but paid about $600/month.
(10) The trust started in April 2012.
(11) It was transferred on the deed at a price of $1
(12) The father has no power to change anything.
(13) There is a bank account and federal ein for the trust.
(14) The house was not appraised after the transfer.

I am assuming I would file a 1041 with a schedule e and K-1 but nothing would flow through to the son's income tax return. The trust would pay all the taxes. I would fully depreciate the house but at what value? Someone had said I continue the depreciation from where it was left off. It has been rented to an upstairs tenant since 1991. It is approaching full depreciation. Please advise.

[Koss]

Basis

Because the father is not paying FMV rent, you have a complex problem as to how to deal with the unit where the father lives. I need to think about that some more.

I do not agree with a comment in the earlier thread that suggested that the two units were somehow not "divided," and that the father's use of one unit would disqualify the entire property from being treated as a rental property. It doesn't matter if it is a single parcel of real estate. It is multi-family housing. You are clearly dealing with two different residential units in one building. The unit occupied by a tenant will continue to be treated as a rental property. The treatment of the father's unit is not clear. There are complex rules involving related parties that may come into play.

All of this affects the question of basis, because before you determine the depreciable basis, you have to determine whether you are depreciating both units or only one.

I don't have a complete answer on that question.

I do have an answer on the basis, generally. But that won't help until you figure out whether you are depreciating the entire building or only one unit...

The property was transferred into the trust as a gift. The figure of $1.00 is a legal fiction that is commonly used in real estate transfers. There is a good reason for it under state law; it is irrelevant to federal tax law. The property was a gift.

The basis of a gift is donor's adjusted basis.

You can start depreciation from the beginning, as a new asset, because the property has a new owner (the trust). But there won't be much of a basis to depreciate. The new owner's basis is the father's adjusted basis. That means the father's original basis (probably cost basis), minus all depreciation that has been taken so far, plus any improvements.

I don't think "continuing" the depreciation schedule of the previous owner is the correct way to do it. But it would have almost the same effect.

If you do it the way I suggested, you'll have to take the new basis and depreciate it over 27.5 years--not the number of years remaining for the previous owner.

Hope this helps.

BMK

[gregt75]

I would take his original cost minus all the depreciation he has accrued so far. That depreciation was based on half the value of the house since only half of the house was rented. In the trust agreement, was the rental amount of 837 for the father. That is not considered FMV since it is less than the tenant upstairs? It was mentioned earlier about the gift tax return. Does my client need to file that now? I appreciate all your help on this. By the way, this is in NJ.

[Koss]

Rental Income

You wrote:

In the trust agreement, was the rental amount of 837 for the father.

Not clear what you mean here.. is this a question?

That is not considered FMV since it is less than the tenant upstairs?

837 is not too far away from 1000. If there are qualitative differences in the two units, e.g., age of appliances, carpet, etc., then 837 might be FMV for one unit while 1000 is the FMV for the other one.

But you said the father actually paid only 600 or so...

It was mentioned earlier about the gift tax return.

The father should probably file a gift tax return to report the gift of the entire building to the trust.

One earlier comment suggested that the son may now be giving the father a gift each month, which would be the difference between FMV rent and what the father is actually paying. That probably won't require a gift tax return, because the total amount for the year will be under the annual exemption amount...

I'm still not sure whether the unit occupied by the father should be treated as a rental.

Is the father writing rent checks to the trust? This is actually pretty important...

Does the trust explicitly allow the father to continue living in the house? At a particular rate of rent? For a certain period of time? Or indefinitely?

BMK

[gregt75]

There is a rental contract with the trust that says the father should pay $837/month. He actually only paid $600/month in cash which was deposited in the trust. The units are essentially the same. The trust does not say that he is a tenant. It does not say anything about him having to live in the house.

The lawyer drafted a rental agreement between the trust and the father. I would consider him a tenant. He will in the future start paying by check the amount that was agreed to.

[Koss]

Rental Property

There is a rental contract with the trust that says the father should pay $837/month. He actually only paid $600/month in cash which was deposited in the trust. The units are essentially the same. The trust does not say that he is a tenant. It does not say anything about him having to live in the house.

The lawyer drafted a rental agreement between the trust and the father. I would consider him a tenant. He will in the future start paying by check the amount that was agreed to.

The IRS would likely take the position that because the father paid less than FMV ($600 vs. $1000), the expenses of that unit are not deductible.

But since there is a contract that calls for $837, and $837 could arguably be the FMV...

If the father paid up the difference, i.e, the amount he owes as back rent, maybe you could just treat the father's unit as an ordinary rental.

Either way, going forward, if he starts paying fair market rent (however you ultimately choose to define that), the taxpayer (which is the trust) will be able to depreciate both units, and deduct expenses for both units.

That's going to make a big difference in the depreciation, because the unit occupied by the father has no accumulated depreciation, and therefore has a much higher basis...

The related-party rules are not the issue that I thought they were. In this context, a related party is defined by certain biological relationships. The father is not "related" to the trust, in this context, for purposes of determining whether the rental property is "personally used" by the taxpayer.

The problem is the issue of FMV. If the unit is rented at less than FMV for more than a certain number of days, then the trust cannot deduct expenses (or depreciation) for that unit, for that year.

BMK

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[gregt75]

If we could not deduct the father's unit, then how would the money be treated that he is depositing into the trust? I would think I would have to count him as a tenant since there is a rental agreement. Would the IRS question this since the rents are close in value?

That's going to make a big difference in the depreciation, because the unit occupied by the father has no accumulated depreciation, and therefore has a much higher basis...

Would there be a separate basis for his unit?

[Koss]

You wrote:

If we could not deduct the father's unit, then how would the money be treated that he is depositing into the trust? I would think I would have to count him as a tenant since there is a rental agreement. Would the IRS question this since the rents are close in value?

If you decide that the rental expenses are not deductible (because the father is not paying FMV rent), then the rental income is still income to the trust. You just don't take any expenses or depreciation.

The rents are close. $837 could in fact be FMV rent. In an audit, the real problem would be trying to explain why he only paid $600 when the rental agreement says $837. If the other unit is renting for $1000, then $600 is definitely way below FMV.

Would there be a separate basis for his unit?

If you treat the father's unit as below FMV, so that expenses and depreciation are not deductible this year, then, yes, you better track each unit separately, in a separate column on Schedule E.

If you decide that the father is paying FMV, then you could just treat it as one rental property.

You've indicated that you know how to determine the basis of the unit that has been rented at FMV for years. For the father's unit, you have to determine the basis and add that to the basis of the other unit, and then you have the basis for the whole property. It's probably his cost basis in that half, without any depreciation, plus any improvements over the years.

It might be easier to just treat it as two separate rental properties either way.

BMK

[gregt75]

You wrote:



If you decide that the rental expenses are not deductible (because the father is not paying FMV rent), then the rental income is still income to the trust. You just don't take any expenses or depreciation.

The rents are close. $837 could in fact be FMV rent. In an audit, the real problem would be trying to explain why he only paid $600 when the rental agreement says $837. If the other unit is renting for $1000, then $600 is definitely way below FMV.



If you treat the father's unit as below FMV, so that expenses and depreciation are not deductible this year, then, yes, you better track each unit separately, in a separate column on Schedule E.

If you decide that the father is paying FMV, then you could just treat it as one rental property.

You've indicated that you know how to determine the basis of the unit that has been rented at FMV for years. For the father's unit, you have to determine the basis and add that to the basis of the other unit, and then you have the basis for the whole property. It's probably his cost basis in that half, without any depreciation, plus any improvements over the years.

It might be easier to just treat it as two separate rental properties either way.

BMK

I think we will put down the rent at 837 a month. I think I could argue he is on a fixed income if that makes sense. As far as basis I was going to take what he paid originally for the house and then back out the accumulated depreciation on the upstairs unit. That would be the basis for the entire house. That would also be the amount for the gift tax return. Nothing will flow through to the son's return right?