Section 121 exclusion

[Jesse]

My client and his sister inherited a house many, many years ago from their parents. My clients sister has lived there for decades and has decided to sell the house and downsize with all sales proceeds split 50/50.

Sis thought the house was still in both names so I thought we could use the section 121 exclusion for her 1/2 of the sale and Bros would have to pay capital gains on his 1/2 of the gain.

Just found out that they forgot that in the 90's, because of some legal problems Bros was going through, they put the house in a living trust in Sis' name. Does this VOID the section 121 exclusion? Or would he still be considered as owner of the home and primary res for 2 out of 5?

And, now that Bros name is not on the house, just Sis' in the living trust, is the entire gain passed to Sis?

[Bees Knees]

A living trust in reality serves no purpose other than to avoid probate and determine who gets the property at death. If the property is sold prior to the death of the person who gave it to the trust, it is as if the trust never existed. The reason is because in order for bro and sis to sell the house, the living trust has to be a revocable trust, meaning the grantor (bro and sis) have the power to take back the property at anytime and sell it. That is basically what happened here. Brother and sister revoke the trust, make it go away, and then turn around and sell the property, taking personal responsibility for whatever tax consequence results from the sale.

It would be no different than if bro and sis put $100,000 cash in the bank and then transfer the account to a revocable trust. The interest income would still be taxed to bro and sis on their individual 1040s as if the trust did not exist. Bro and sis have the power to revoke the trust at anytime, cash in the account, and spend the money. The only thing the revocable trust does is avoid having to go through probate and set the terms of where the money goes if either bro or sis died before taking the money out of the trust bank account.

On the other hand, if the house were put into an irrevocable trust, then we wouldn’t be having this conversation as bro and sis would have no right to decide to sell the house. Only the trustee of the trust could do that. A grantor in an irrevocable trust cannot take back the property that has been transfered to the trust and sell it.

[DaveO]

Sis should get entire Section 121 exclusion.

Since she is the sole owner of the house. A gift tax return should have been filed when Bro signed over his 1/2 to Sis. Another should be filed when Sis "gifts" 1/2 of the proceeds to Bro.

[Bees Knees]

Since she is the sole owner of the house. A gift tax return should have been filed when Bro signed over his 1/2 to Sis. Another should be filed when Sis "gifts" 1/2 of the proceeds to Bro.

TTB, page 21-24, "A transfer to a revocable trust that allows the donor to take back the property is not a completed gift."

Since brother and sister have the ability to sell the house, the trust had to be a revocable trust. It is possible, however, that two separate trusts were set up, but I doubt it: 1)Bro setting up an irrevocable trust with Sis as beneficiary of his 1/2 interest, and 2) Sis setting up a revocable trust with Bro as beneficiary of her 1/2 interest. In that case, what you describe would be correct. However, I doubt two separate trusts were set up here. It sounds to me like they both put their share in a revocable trust with Sis as the beneficiary thinking creditors could not touch it, and now they want to, and have the right to take it back and sell it.

[DonPriebe]

Better check the title and trust

Just found out that they forgot that in the 90's, because of some legal problems Bros was going through, they put the house in a living trust in Sis' name. ... And, now that Bros name is not on the house, just Sis' in the living trust ...

Lots of people are casual about using terms like "living trust" - after all it's a trust and the sister is living. But if the brother's name is not on the house, just the sister's, then he doesn't own it! If they were effective in shielding the house from his "legal problems", then almost by definition he doesn't have an ownership interest in the house. If his name is not on the trust, only sister's, then why do you think his signature is necessary to sell the house?

Time to read the underlying documents and hope they were prepared by an attorney, not just something off an internet site somewhere.

[Jesse]

A living trust in reality serves no purpose other than to avoid probate and determine who gets the property at death. If the property is sold prior to the death of the person who gave it to the trust, it is as if the trust never existed. The reason is because in order for bro and sis to sell the house, the living trust has to be a revocable trust, meaning the grantor (bro and sis) have the power to take back the property at anytime and sell it. That is basically what happened here. Brother and sister revoke the trust, make it go away, and then turn around and sell the property, taking personal responsibility for whatever tax consequence results from the sale.............

TTB, page 21-24, "A transfer to a revocable trust that allows the donor to take back the property is not a completed gift."

Since brother and sister have the ability to sell the house, the trust had to be a revocable trust. It is possible, however, that two separate trusts were set up, but I doubt it: 1)Bro setting up an irrevocable trust with Sis as beneficiary of his 1/2 interest, and 2) Sis setting up a revocable trust with Bro as beneficiary of her 1/2 interest. In that case, what you describe would be correct. However, I doubt two separate trusts were set up here. It sounds to me like they both put their share in a revocable trust with Sis as the beneficiary thinking creditors could not touch it, and now they want to, and have the right to take it back and sell it.

Only one trust was set up and I understand that the only purpose the living trust really serves is avoiding probate but I'm still confused as to whether the section 121 will apply.

Is the living trust the "owner" of the home unless it is revoked? If this is the case it appears that Sis did not own the home even though it was her primary residence for 2 out of 5 years.

Or is Sis really the owner until the trust is revoked or death occurs in which case section 121 will apply?

[Bees Knees]

Only one trust was set up and I understand that the only purpose the living trust really serves is avoiding probate but I'm still confused as to whether the section 121 will apply.

Is the living trust the "owner" of the home unless it is revoked? If this is the case it appears that Sis did not own the home even though it was her primary residence for 2 out of 5 years.

Or is Sis really the owner until the trust is revoked or death occurs in which case section 121 will apply?

Did both bro and sis have the power to revoke the trust? Or only sis?

It makes a difference. Sis gets section 121 if she had the power to revoke the trust. For federal tax purposes, a revocable trust is taxed to the grantor, and if she is the grantor, she pays tax (or receives the benefit of the exclusion) on property held by the trust.

Bro would also be subject to tax on the sale if he had the power to revoke the trust and take his share back. Since he never lived in the home for the last 2 out of 5 years, he gets no 121 exclusion.

[Jesse]

Thanks all for your help.

From what Bros said only Sis was listed on the living trust, but he had Power of Attorney for Sis so he signed the documents "Bros XXX, POA". Before I go any further I'll get more documentation from him to see what actually transpired.