Sale of contract for deed by trust

[Gretel]

Mom died last year, had income from contract for deed from sale of home. All assets went into irrevocable trust. Now, in order to pay some heirs right away, one heir (my client) purchased the contract for 200,000 and put funds into trust account. 200,000 is what the bank figured, which includes interest of $5,000 (very low interest rate). Normally one purchases a note at a discount, which I believe is treated as OID.

I am not sure how to treat this interest for either, the trust tax return or the 1040. Maybe the trust just has a capital gain of $5,000 for last year and my client has a basis of $200,000?

[Burke]

You say she died "last year" but you don't say when the home was sold on contract, nor when note was purchased. Interest received prior to her death would go on her 1040. Since the cost of the note your client purchased from the trust included interest, that should be reported on 1041 as interest income. There is no capital gain on a note nor does it receive stepped-up basis. Interest received after son purchased the note goes on his return, and there is no "basis" for tax purposes. It's principal.

[Gretel]

You say she died "last year" but you don't say when the home was sold on contract, nor when note was purchased. Interest received prior to her death would go on her 1040. Since the cost of the note your client purchased from the trust included interest, that should be reported on 1041 as interest income. There is no capital gain on a note. Interest received after son purchased the note goes on his return, and there is no "basis" for tax purposes. It's principal.

Thanks, Burke, I didn't think it was that easy. Home was sold 2013, mom died 10/2016, note was purchased 12,2016. You say, since the interest is stated interest by the bank it is interest income to the trust. On the flip side the son can take this interest as investment interest deduction (has enough other investment income). Somehow I looked at it as prepaid interest, making things too complicated. Not that is matters, since gain/loss is zero but why would a purchased C4D not be a capital asset?

[Burke]

Technically, a note is considered a capital asset which can be bought and sold, just no gain or loss in this case for the trust. And since the son paid the $5K interest, he can deduct it as investment interest deduction, IMO. He now has the legal right to collect the principal and lets hope it is recorded as a lien on the property.

[Gretel]

...lets hope it is recorded as a lien on the property.

Thanks again, the lien was actually the main issue that the kid bought the note. They were told that a trust cannot own such a contract for deed.

[Burke]

Never heard of that and can't find any reference or cite, but don't know why it would not be treated as any other asset she owned at her death. Was that from an attorney?

[Gretel]

Never heard of that and can't find any reference or cite, but don't know why it would not be treated as any other asset she owned at her death. Was that from an attorney?

I am not sure but I believe it was from the bank that processes this contract. They are known to do and say a number of wrong things around estates/trusts.