Trust for disable person

[BOB W]

Mother dies in 1986. Will created a Trust for Daughter who is a challenged person. Daughter has lived in inherited house since 1986. Trust is in Daughter's name and trustee is brother of daughter (sister). Trustee needs to sell house in order to get needed cash to continue the needs of the mother's daughter. Will Sect 121 apply when the house is sold in the trust?

[Lion]

I'm thinking NO. The trust does not live in the house even though it owns the house. The mother that lived there is deceased and lives there no more nor owns the house any more. The daughter who lives there now does not own the house. No one meets both the ownership and use tests.

[Kram BergGold]

Depends

For the Trust to qualify for Section 121, there has to be Five by Five Powers. I don't fully understand 5 by 5 powers but I researched this a few years ago and that is what I learned. If anyone could explain Five by Five Powers that would be great.

[New York Enrolled Agent]

Mother dies in 1986. Will created a Trust for Daughter who is a challenged person. Daughter has lived in inherited house since 1986. Trust is in Daughter's name and trustee is brother of daughter (sister). Trustee needs to sell house in order to get needed cash to continue the needs of the mother's daughter. Will Sect 121 apply when the house is sold in the trust?

I agree with Lion and don't believe under your fact pattern that the §121 exclusion is available.

From the regulations:
(i) Trusts.
If a residence is owned by a trust, for the period that a taxpayer is treated under sections 671 through 679 (relating to the treatment of grantors and others as substantial owners) as the owner of the trust or the portion of the trust that includes the residence, the taxpayer will be treated as owning the residence for purposes of satisfying the 2- year ownership requirement of section 121, and the sale or exchange by the trust will be treated as if made by the taxpayer.

The exclusion is available if there is a grantor trust in place - that is not your situation.

[BOB W]

In clarification with client, the trust was set up 2 years after mother's death. The trust was not created by the mother's will. The daughter inherited money and the house, where she lived for 30 plus years, which was then put into the trust by the brother, as trustee. The name of the trust is, "Trust u/w Jane Smith Doe". Does this change anyone's mind?

ADDED: just found out that U/W means "Under Will" but it is the name of the Daughter with brother as trustee for Incompetent person.

Can anyone straighten this jumble out?

[New York Enrolled Agent]

The trust was not created by the mother's will.

The name of the trust is, "Trust u/w Jane Smith Doe".

Those two statements seem to be contradictory.

I would suggest you get a copy of the trust document and read it.

[BOB W]

The ADDED statement was a correction.

[Gary2]

A web search for special needs trusts 121 suggests that it may be possible, but I couldn't easily find anything that spelled out the details. Perhaps the attorney who drafted the trust document could advise.

[Burke]

If the trust was not created by specific instructions of the will, then (I am assuming) the daughter inherited the house outright? What about the brother? Was it left to them jointly? He could not "put it into a trust" without her signing off on it if this is the case, unless he went to court and got legal guardianship for his sister. I think you need to converse with the client further about this. You may want a copy of that will. (It is not unusual for it to take 2 years to settle an estate and set up a trust.) If the daughter and the son (brother) together set up a trust for the house on their own then it may be a grantor trust. You need to determine how the ownership passed. Get a copy of the will and the trust document. Also, determine if a new deed was written for the real estate and how it is titled. Otherwise, if the house passed to the trust under the will with the daughter as beneficiary and the brother as trustee, then the trust owns the house and there is no 121 exclusion. I would refer your client to an attorney for an opinion.

[BOB W]

The Trust was setup by the Will upon mother's death. Daughter was left all of her estate, house and large some of money 30yrs ago. Brother has his own assets but was made trustee by mother's will. Money ran out now and needs to sell house. All assets were in the trust and distributed thoughout the years to daughter. Daughter filed personal income tax return from K-1 for taxable income from trust. Only the house is left to sell for the continued support of Daughter.

[Burke]

Well, that's it then. The Trust owns the house, its basis is the FMV at Mother's death (30 yrs ago) + improvements, and the Trust will report any long-term capital gain on the sale. It will retain the proceeds inside the Trust for the daughter's continued care.

[BOB W]

Burke....

Did I fail to mention that the daughter lived in the house for all that period? Sounds like she is not the beneficial owner of the trust based on your reply. Thank you for your time and everyone elses.

[Burke]

The fact that she lived in the house (you did mention that) is really immaterial. The trust owns the house and paid all the expenses.

Also, one addition to my previous post. IF the trust established under the will (you will have to review) gave the trustee discretion about the allocation of capital gains to the beneficiary, then it is possible to pass those through to such beneficiary on the K-1. You don't often see this; however, it is a very good thing to have established in a trust document. If it is not addressed, or silent on the matter, cap gains stay inside the trust.

[BOB W]

I see nothing talking about Capital Gaines. But over the years all taxable income was put on a K-1 and made taxable to the beneficary. The Trust never paid tax during the years when it had income.

Does that allow for Capital Gaines to follow the way the trust was being handled?

[Burke]

No. All that was done correctly according to the Internal Revenue Code. The trust document would have to specifically state the allocation of cap gains to the beneficiary, or allow the trustee to elect it at his discretion. Besides, in order for it to be taxable to the beneficiary, it would have to be distributed to the beneficiary, and they might not want to do that. It can cause problems with other government benefits, Medicaid, etc. etc.

How old is this disabled person? Is she receiving SSI? Is Medicaid going to take over when her money runs out? The rules for special needs trusts can be complicated when integrating with other benefits. I would recommend the TP contact an attorney who specializes in this field to see what options he may have.