federal estate tax question

[leslie1983]

My situation is a woman died ten years ago and left her 2 young children her residence in her will. It was placed in the estate of the deceased until it was sold in 2006. Ten years in the estate! The funds were placed into a money market fund and earned in excess of $1,100.00 in 2006. The estate was shut down at the end of 2006 and the funds were placed in a trust for the childrens education. Do I have to file a 1041 for the interest earned, the sale of the house or does the sale go on the individual returns of the children.

[Roland Slugg]

File F-1041

Dear leslie

That's a long time for an estate to be deemed open for tax purposes. After about two years it should probably be treated as a de-facto trust.

The interest earned in 2006 and the LTCG on the sale of the house (assuming there was a gain) will be taxable on a fiduciary return, F-1041. I would prepare that return as a trust's return, not as an estate's return. However, since the first estate was distributed to the children's respective estates in 2006, all the income will pass through to those trusts, and the old estate/trust gets a distributions deduction. This return is nearly a year late, so there may be penalties and interest on any tax due.

Did the children continue to live in the house the whole time? Could they somehow be treated as its owners and eligible for the §121 exclusion? From the facts you presented, it looks doubtful, but it could be worth discussing with the lawyer.

[Kram BergGold]

The answer depends

Whose name was on the settlement statement as the owner of record, the estate or the beni's. Let's assume it was the estate and the interest earned on the sales proceeds was in the name of the estate. Then the estate needs to file a 1041 to report the gain on the house (the difference between the sale price less expenses of sale and less the date of death value and to report the interest income. If the beni's were listed as the owners then they report the same things on their 1040 returns. I hope they realize they have 10 years of appreciation to pay tax on.

[leslie1983]

The children lived in the house the entire time up until the sale of the house. The owner of record on the settlement statement and the 1099-S was estate of the deceased.

[leslie1983]

The advice I was given on another site was to record the increase in the value of the house, add the interest earned and then distribute the income to the kids because their tax rate will be lower. What do you think?

[BOB W]

Do you have a "substance" vs "form" issue here? In essence this house was inherited by the children at the time of death. "Form" was violated, but sometimes "substance" can prevail. You may want to look into who "substantly" owned the house at the time of sale????

How old were the children at time of death and who stayed with the children that allowed them to stay in the house? Who paid the RE taxes and provided utilities and such?

If it is determined that the children are the "substantial" owners, they would be allowed the 121 exclusion.

[leslie1983]

The children were young (6 & 8) when their mother died. They lived in the house with the ex-husband who moved back in to the house to care for them. Her family (the deceased) decided that he could stay and maintain the house for the children. He fell behind on the real estate tax payments ($56,000.00) and that's why the house was sold. Do you think that is enough to show the children as owners?

[BOB W]

Substance over Form, as far as the IRS goes, seems to be a one way street in the IRS eyes. They do what is best for the IRS $$$$ wise. But I think you have a strong case, especially since there are young children involved. The lack of adult guidance is obvious here, with their do nothing attitude. If everything was done at the proper time, who would be the owners when the sale took place?

If it were my case, I would proceed as if the children were the owners. But you need to research this futher, possibly with a tax attorney. Based on the total assets of the mother, there may not of been any estate tax filing requirements. This case seems to be low income people?

[leslie1983]

Not necessarily low income, just not enough to file a 706 in 1996 (under $600,000)