Grantor Letter from REL Liquidating Trust

[peggysioux]

Taxpayer has a grantor letter for trust and it shows a loss for section 1231 from passthrough activity however, there is not a place on the fiduciary K-1 to input data for a section 1231 loss. There is a place to enter info in the partnership K-1. Can someone provide some direction.

[Koss]

Grantor Letter

A grantor trust is a disregarded entity. Income is reported on the grantor's tax return as if the trust did not exist.

Report the loss directly on the grantor's tax return, as if it were his, and not in the trust. A loss on Section 1231 property would be reported on Form 4797.

BMK

[peggysioux]

Grantor Letter

The grantor trust was created by the courts pursuant to bankruptcy by R.E.Loans and the taxpayer (as previous investor) is now a beneficiary of the REL liquidating trust and the letter is a replacement of a K-1. The letter shows there is a loss for Section 1231 and there is also an ordinary business loss from partnership. Being the trust states the letter is a replacement of a K-1, shouldn't the information be input in tax software through a K-1 input. The letter also provides the taxpayers basis or "beneficial interest" in the trust. The information that the letter is providing seems like a partnership K-1, but letter states "Liquidating Trust". Being there is both partnership loss and 1231 loss, would it be incorrect to use the Partnership K-1 input?

[Koss]

Schedule K-1

Entering the data into a K-1 for a partnership may or may not produce the correct output.

My previous reference to Form 4797 may be an incomplete explanation.

Keep in mind that Schedule K-1 is not transmitted as part of an electronic return. Furthermore, if the return is filed by mail, Schedule K-1 is not attached. The software carries data from the the K-1 screen to the appropriate sections of the tax return.

Your approach is not irrational, but it may have unintended consequences. For example, I would be willing to bet that if you use the partnership K-1 screen, your software is going to identify the trust, with its EIN, as a partnership on page 2 of Schedule E. This would not be accurate.

With that being said, you are probably on the right track. Your client is not a partner. But somehow he has to report a section 1231 loss that has been passed through to him as the beneficiary of a trust.

I encourage you to read the Partner's Instructions for Schedule K-1 (Form 1065), with attention to Box 10, which is used to report section 1231 gains and losses. This type of loss is generally a passive activity, so it has to be reported first on Form 8582. The amount of the loss that is allowed is then carried to Form 4797. Good luck trying to determine how much of the loss is allowed. The question that is going to arise is whether the taxpayer has disposed of his entire interest in the passive activity. If your client still holds a beneficial interest in the liquidating trust, i.e., he is still waiting to see if he ever recovers any money from the crooks, then he has not yet disposed of his entire interest. That may mean that the entire section 1231 loss is suspended. (Unless he has passive income, from the trust or from some other source...)

Entering the data on a partnership K-1 screen may in fact produce a return that is mathematically accurate. Misidentifying the trust as a partnership is a fairly harmless error.

But I probably wouldn't do it that way myself. In a case like this, you really can't rely on the software to put things in the right places, especially if you are using fields that are meant for something different than what you are actually reporting.

I know this isn't the answer you are looking for. But if you want to be certain that you are accurately reporting this stuff, what you really need to do is figure out how you would report it if you were doing the return by hand. Once you know what the correct output is, then you can play around in your software and figure out how to get the information to show up where it needs to be.

I still think the answer may be to enter it on Form 4797. But if you try that, make sure you indicate that it is a loss from a passive activity, and whether the interest has been fully disposed of.

BMK