Trust issue

[Consultant]

Grandmother formed Trust in 2000. Grandson is Trustee. Only item to Trust was her house. She passed away in 2005.
Grandson rented property until May 2021 when he sold it. Grandson's two children are the beneficiaries. Using basis set
up in 2005 a gain of 50-60 K is apparent from the sale. My somewhat limited knowledge of this situation tells me that
2 K-1's at 50-50 capital gain profit will be issued via the Trust. However, client has insisted that he was told by an attorney
during another issue that the Trust proceeds are NOT taxable because this is an inheritance.
1. Who is correct?
2. Does a step up basis apply to this situation?
3. Form 1041 should be filed since the 1099-S is in Trust's ID?
4. Would a will have been better?

[Lion]

First, read the trust document.

[New York Enrolled Agent]

1. Who is correct?

Not the attorney.

[ATSMAN]

Not the attorney.

Correct. As Lion suggested you will need to review the trust document first to determine what type of Trust you are dealing with.

Just based on what you described in the initial post it appears the house was a personal residence that was re titled under the trust and the owner continued living in that until her death. Then after her death the trust becomes irrevocable automatically and the Grandson rented it out until 2021. How was the rental income reported? What tax returns were filed for that period? Look at the depreciation schedules to see what value they used to depreciate and how much depreciation was already taken prior to sale. Is the 2 K-1 correct to report out income and deductions?

If it was not in a trust then the beneficiary would inherit a step up up in basis. That would be much advantageous.

[TAXNJ]

……My somewhat limited knowledge of this situation tells me that
2 K-1's at 50-50 capital gain profit will be issued via the Trust. However, client has insisted that he was told by an attorney
during another issue that the Trust proceeds are NOT taxable because this is an inheritance.
1. Who is correct?……..

Could be the attorney, you and/or the reply posters are incorrect. As you say with your limited knowledge of the facts you are presenting hearsay of the situation.

You should talk to the attorney as to what the attorney addressed. Also, read the Trust document to get the facts and create a timeline of all facts.

Is this scenario related to a Federal and/or State tax? Was the attorney talking about State inheritance and/or Federal?

You need to present the correct facts otherwise you may be getting useless reply information.

[ATSMAN]

Trust returns can be very complicated so if this is your first trust return may I suggest you partner with another experienced professional.

[TAXNJ]

…..If it was not in a trust then the beneficiary would inherit a step up up in basis. That would be much advantageous.

? Will you provide a cite? Think there is a “stepped up” basis.

e.g.,
https://www.nolo.com/legal-encyclope...exclusion.html

[ATSMAN]

? Will you provide a cite? Think there is a “stepped up” basis.

e.g.,
https://www.nolo.com/legal-encyclope...exclusion.html

I am not in my office now but going strictly from memory I believe if the property was transferred to the trust while the owner was alive and the trust owned the property at the time of death there is no step up in basis. The trust's basis is the value when the property was originally transferred.

Your cite refers to primary residence CG exclusion, I was not talking about that.

[TAXNJ]

I am not in my office now but going strictly from memory I believe if the property was transferred to the trust while the owner was alive and the trust owned the property at the time of death there is no step up in basis. The trust's basis is the value when the property was originally transferred.

Your cite refers to primary residence CG exclusion, I was not talking about that.

Correct, but 1st paragraph talks about “stepped up basis” of article which states, “If you inherit a home do you qualify for the $250,000/$500,000 home sale tax exclusion? The answer is no. However, you benefit from the stepped-up basis rules for inherited property. As a result, you might not need the exclusion when you sell the home.”

So look forward to your response when back in your office.

[ATSMAN]

Correct, but 1st paragraph talks about “stepped up basis” of article which states, “If you inherit a home do you qualify for the $250,000/$500,000 home sale tax exclusion? The answer is no. However, you benefit from the stepped-up basis rules for inherited property. As a result, you might not need the exclusion when you sell the home.”

So look forward to your response when back in your office.

Section 1015(b), the assets of a grantor trust after death have the same basis. IRS views that grantor trusts do not qualify for a step-up in basis at death, section 1015(b) imposes a carryover basis.

[New York Enrolled Agent]

Section 1015(b), the assets of a grantor trust after death have the same basis. IRS views that grantor trusts do not qualify for a step-up in basis at death, section 1015(b) imposes a carryover basis.

ATSMAN - you are correct that it appears the IRS views section 1015(b) to control even after the death of the grantor. Many commentators suggest that the sub-section applies to situations prior to death. It is an issue open to "discussion".

Interestingly, the Treasury Department's 2018-2019 Priority Guidance plan included that topic (see below) given what seems to be a bit of a conflict between sections 1014 and 1015. Despite being a "priority" I have not seen any result regarding this issue.

GIFTS AND ESTATES AND TRUSTS
1. Guidance on basis of grantor trust assets at death under ?1014.

[TAXNJ]

Section 1015(b), the assets of a grantor trust after death have the same basis. IRS views that grantor trusts do not qualify for a step-up in basis at death, section 1015(b) imposes a carryover basis.

Did not see in the Original Post that it is a “Grantor” trust. Where was it shown? Thanks in advance.

As far as Grantor trust here is some interesting reading.

https://www.kmgslaw.com/knox-law-ins...you-cant-trust

[ATSMAN]

Did not see in the Original Post that it is a “Grantor” trust. Where was it shown? Thanks in advance.

As far as Grantor trust here is some interesting reading.

https://www.kmgslaw.com/knox-law-ins...you-cant-trust

OP did not say positively that it was a Grantor Trust, but he did say it was formed in 2000 while the taxpayer was alive and that was the only property transferred to the trust and she died in 2005. Then Trusttee rented it out.

I may be wrong but the OP has to read the trust document and how it has been reported all these years.

[Scarecrow]

An estate attorney once told me it is very rare to set up an irrevocable trust before death. It is usually some type of revocable trust, because people have a habit of changing their minds before they die.

With that in mind, I am going to offer a straight forward guess that is more than likely to be true.

Grandmother forms a trust in 2000 and puts her house in it as the only asset? Why? Most likely to avoid probate, NOT to avoid estate tax, because estate tax would not be a factor if the house was her only asset. Thus, it is more likely than not that this was a grantor trust.

Grandmother dies in 2005.

Grantor trust turns into irrevocable trust upon death. House basis is stepped up to fair market value on the date of death.

Grandson starts renting the house in 2005, using fair market value as of 2005 for depreciation purposes.

Grandson sells rental property in 2021. Gain is 50K - 60K, meaning the difference between selling price in 2021 and FMV in 2005 minus depreciation recapture equals 50K - 60K.

The attorney is correct that there is a step up in basis. Only the step up in basis is based on 2005 FMV, not 2021 FMV. Thus, the reason for the 50K - 60K gain that must be split 50/50 on the 2 K-1s.

[ATSMAN]

Assuming the actual facts are as you described, I will agree with you "Only the step up in basis is based on 2005 FMV, not 2021 FMV."