Over the past two weeks, I’ve looked at the insurance, tax, and asset protection considerations involved in transferring real estate into a trust.
This week, I’ll touch on funding issues unique to irrevocable trusts, as well as those unique to revocable trusts.
Irrevocable Trusts
Typically, there are two categories of issues to consider when deciding whether to transfer real estate into an irrevocable trust. Both stem from the fact that, under normal circumstances, the purpose of these transfers is to get the value of the property out of the grantor’s estate for estate tax purposes.
- Transfer Tax Issues: In order to get the property out of the grantor’s estate, the grantor needs to make a completed gift to the irrevocable trust. This usually means filing a gift tax return. Also, beware of the grantor retaining too much control over the disposition of the property once in the trust, such as a sprinkling power – this could cause the property to be included in the grantor’s estate. (See IRC § 2038).
- Income Tax Issues: Assuming the gift into the trust is complete and the property is not included in the grantor’s estate, there will be no step-up in the property’s basis when the grantor dies. Think carefully about the loss of this step-up in basis before deciding to transfer real estate into an irrevocable trust. This is a very fact-intensive decision. For example, if the property is a vacation home which the client intends to stay in the family for generations, the basis may make little difference. Essentially, the present value (at the decedent’s death) of the future capital gains tax should be compared with the presumed estate tax savings.
Revocable Trusts
When deciding whether to fund property into a revocable trust, you should take into account the impact of any property agreement on the transfer into the trust.
Once your clients’ real estate is funded into the trust, will it be tenancy in common property, community property, or some other form of property? If community property is available in your jurisdiction, it is typically the best option (assuming your clients are a married couple, of course).
Community property qualifies for a step-up in basis on the entire property at the death of the first spouse, not just the decedent’s half. Tenancy in common property, on the other hand, only qualifies for a step-up in basis only on the half included in the predeceasing spouse’s estate.
Believe it or not, there are still a few more issues to think about when funding real estate into a trust. Next week, I’ll have a bonus blog for you with several additional considerations of which you’ll want to be aware before deciding to make a transfer.
Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (800) 846-1555
www.aaepa.com
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if parent is placing second home in irrevocable trust, what is cost basis (value)? Is it the original cost to the grantor, or the present fair market value? This is not clear in your discussion.
Gail,
Thanks for following the blog. The income tax basis of property acquired by gift or transferred in trust is set forth in section 1015 of the Internal Revenue Code. The basis is ordinarily the basis in the hands of the transferor, i.e., carryover basis. However, if the fair market value at the date of transfer is lower than the transferor’s basis, then the basis may be different. In such a case, for gain purposes, the basis would be the fair market value on the date of transfer. For loss purposes, the basis would be the transferor’s basis. This is all set forth in section 1015.
Again, thanks for following the blog.
Steve
when property is put into a revocable trust and then transferred to a irrevocable trust at the death of the grantor, does that property go into the irrevocable trust with a stepped up basis?
Linda, Thanks so much for following the blog. If the asset is included in the taxable estate of the decedent, it gets a step up in basis. Thus, where the asset eventually winds up is not relevant. Only whether the asset was taxable in the decedent’s estate. Also, it is not relevant whether an estate tax was paid or payable as a result. Again, thanks for following the blog. I hope you have a great 2015!
Steve
I have an Aunt who recently passed away. When her husband passed 15 years ago the house was, for some stupid reason, put into an irrevocable trust. I know the step up from her husband’s passing is included in the basis. Do we get a step up in basis for her passing? What IRC is it covered under? Thanks.
Frank,
Thanks for reading the blog. A step-up (or –down) in basis occurs because of Section 1014 of the IRC. That section provides that if the asset is included in the taxable estate of the decedent, it gets a change in basis to FMV on date of death (or alternate valuation date). Of course there are exceptions, such as a property received by gift and going back to the donor within 1 year. The irrevocable trust may or may not be included in the taxable estate of the decedent, depending upon its provisions. For example, some irrevocable trusts are designed to remove the assets for the purpose of obtaining Medicaid, yet are designed to cause inclusion in the taxable estate in order to receive a step-up in basis. One way of doing this is the inclusion of a testamentary limited power of appointment. As the grantor of the trust, retention of a testamentary LPOA would cause inclusion under section 2038 of the IRC.
Again, thanks for reading the blog.
Steve
If a 1041 Estate Tax Return is filed with several rental properties of the deceased and then those properties are probated and transferred to a Revocable Realty Trust, what basis should they have, and what put into use date? I believe the basis w depreciation should carry over to the Trust return, but am unsure of the date. Estate tax return used date of death Aug of 2012. Also, does this Trust become irrevocable and the properties gifts, requiring gift tax?
Lisa, thanks for following the blog.
Generally, if the property was included in the taxable estate, its basis will be the fair market value on the date of death as reflected on the return. Normally, with the step up in basis, the depreciation “clock” will start over as of the date of death, as well. As for the trust, from the title, it appears to be revocable, but that would depend upon the terms of the trust. Normally, there would not be a gift tax return for a trust set up at death as it would have been a transfer at death and the estate tax return would have reported the transfer. I suggest you contact a member of the American Academy of Estate Planning Attorneys in your area who can help you with the specifics of your situation. Here is the directory of members of the American Academy of Estate Planning Attorneys.
Again, thanks for following the blog. Steve
Good morning, Mr. Hartnett. I will be inheriting my mother’s townhouse and would like to know if it is better to take title in the new irrevocable trust my mother’s will specifies that I set up (for the portion I am inheriting from her irrevocable trust, which the home is not in), or is it better to take title in my own personal revocable trust (I will also be inheriting a portion from her estate that was not in an irrevocable trust). My plan is to one day move into her house and I want to be able to sell it one day when I retire and be able to use the one time property tax base transfer that California allows.
I guess the real question is can my irrevocable trust transfer title to my revocable trust without triggering a step up in basis?
Sheryl,
Thanks for reading the blog. To address specifics of your situation, it would be best to see a practitioner in your area who can review your mother’s will and provide you with legal advice based upon his or her review of your mother’s documents and your situation.
Again, thanks for reading the blog.
Steve
My mother created an irrevocable trust and placed her residence in it back in 2007. Both her and I were named trustees. No gift tax return was ever filed. She passed in 2015. My understanding is that assets in an irrevocable trust are normally excluded from the estate and do not receive a step up. However, there is a provision in the trust that says my mother had a limited power of appointment. The attorney, who has not been cooperative, will only say that a life estate was set up. Based on these facts, can you tell if the trust assets should receive a step-up, and if so, do you recommend that we file an estate tax return showing the residence (even though her estate was under the filing threshold).
Also, I’ve read that the life estate can cause issues with medicaid, where the government can attempt to reacquire any benefits from the life estate assets.
Thank you.
Doug, I’m sorry for the loss of your mother. However, you would need to contact an attorney in your locale who could look at the trust and the circumstances to make this determination. If you let me know your location, I might be able to suggest someone who might be able to help. Again, I’m sorry for the loss of your mother.
Steve
My husband’s grandmother passed away recently. Years ago, she set up a revocable trust for her descendants with the only assets being real estate (family farm, which has been in the family for a few generations & other property). The farm was sold by the trust and the assets are being distributed to the beneficiaries. How do we determine the cost basis for the farm for tax purposes?
Christina, thanks for reading the blog. Assets in a revocable trust receive a step up in basis to fair market value at the date of death or alternate valuation date. However, the basis could have been adjusted since date of death for improvements or depreciation. I would ask the trustee or trustee’s attorney for more information. Thanks again for reading the blog.
Steve
Grandfather creates irrevocable trust with no “grantor trust” characteristics, with granddaughter as beneficiary.
Grandfather purchases residential real estate “A” for lease and later transfer same into granddaughter’s irrevocable trust.
Granddaughter’s trust leases “A” in 2010.
Granddaughter’s trust allows granddaughter to live in “A” rent free in 2011, 2012, 2013.
Granddaughter buys separate property “B” independent of trust in 2014.
Granddaughter’s trust sells “A” in 2014.
Granddaughter’s trust buys property “B” from granddaughter early in 2015, and simultaneously pays off third-party loan ostensibly using funds realized from sale of property “A” (substantiated by total amount of assets in Trust).
-It is not yet known how much grandfather paid for property “A”
-It is not yet known if grandfather filed a gift tax return when he transferred property “A” into granddaughter’s trust.
-It is not yet known what the value of the property was when transferred into granddaughter’s trust.
-The proceeds from the sale of property “A” were very near the payoff of the loan on property “B”.
* What facts are essential to the proper filing of 1041 for granddaughter’s 2014 trust?
* What facts are essential to the proper filing of 1041 for granddaughter’s 2014 trust?
Charles,
Thanks for following the blog. You will need the adjusted basis of the property, distributions made to beneficiaries, etc. Here is a link to the instructions for Form 1041: https://www.irs.gov/pub/irs-pdf/i1041.pdf. I suggest you bring all relevant information to a CPA or tax attorney in your area to assist in the preparation of the return. Again, thanks for following the blog.
Steve