Tax on gifted land in a trust

[Jerry1]

Hoping to get some help with a gift situation that may include a capital gain.

Background: DW and her two siblings were gifted some land from their mother. It was put into an irrevocable trust in 2019. The original land was bought for $10K. The gift tax return says that the gift to each child was $30K which was what the land was worth at that time (about $90K).

Now, the mother died and the trust can be distributed. There is cash (no problem) and there is the land. The land will stay in an amended trust as it is the right of any of the three to use the land and as they die, their shares will ultimately go to my children (the only blood grandchildren). So there is no intention to sell the land.

At the time of the gift/setting up the trust, the lawyer said that they can pay the capital gain it the time of the gift or when distributed. It was not done when the trust was set up. I'm trying to figure out if I have a taxable event now that the mother died. It seems to rely on what it means to be distributed. Is it now distributed because the mother died? Or, can the gain be put off until the property is actually someday sold.

Any help on this would be appreciated. Unfortunately, I did not plan for a $30K gain this year. If it were taxed, how would it be taxed? I just crossed into the 22% tax bracket.

Thanks.

 

[cathy63]

I am not an expert in trust taxes and I recommend you consult someone who is, i.e. an accountant, not a lawyer. I don't think you'll need more than an hour of someone's time.

That said, I do not understand why there would be a taxable capital gain at any point in this process. The mother gave the land to an irrevocable trust. Since it was a gift, her basis went along with it. So even though the value of the gift was $90K, if the land had been sold at that time, the capital gain would have been $90K minus the basis, not $30K per child.

Moving to the present time, the death of the original grantor is irrelevant. The irrevocable trust continues to own the land and it continues to have the original basis (plus any improvements the trust has made during the time it has owned the property). There is no step up in basis and there is no transfer of ownership that might trigger a property tax reassessment. No sale has occurred, so there is no capital gain to pay tax on.

If the trust does sell the land in the future, then there will be a capital gain at that time. The trust will either pay the taxes and distribute the profits to the beneficiaries, or the trust will distribute the gains to the beneficiaries and they will pay the tax at their own rates.

The reason why the $90K is important is for the estate tax calculation. Your MIL's estate tax exemption is reduced by the amount of the gifts she made during her lifetime. Since the current exemption is over $12M and we're talking about $90K, I'm guessing it has no effect in this case.

 

[Sunset]

I'm no lawyer.

These Trust things are weird to me, but if the land is registered to the Trust, and the Trust is still "alive" , there is not any land transfer going on.
Only the person in charge of the Trust (the administrator) has changed.

I hope Trust experts here can tell us the details as this issue keeps cropping up in life.

< cross post with Cathy63 >

 

[OldShooter]

IANAL either, but I think this needs expert eyes. One question is whether there is anything going on with the trust where it will have taxable income at the trust rate. (IIRC federal something like 33%)

Another question is basis step-up. With the gift, I think the opportunity for a step-up on mom's death is gone but what about the transfer to OP's grandchildren? Is there a way to recapture the step-up option when that happens? Again IANAL

 

[Jerry1]

Thank you so much Cathy. I couldn’t understand how the mother could have gave more than her basis. If I understand correctly, she didn’t. All that was done was reported the gift against her life time exemption at market value. That makes more sense.

 

[pb4uski]

I am not an expert in trust taxes and I recommend you consult someone who is, i.e. an accountant, not a lawyer. I don't think you'll need more than an hour of someone's time.

That said, I do not understand why there would be a taxable capital gain at any point in this process. The mother gave the land to an irrevocable trust. Since it was a gift, her basis went along with it. So even though the value of the gift was $90K, if the land had been sold at that time, the capital gain would have been $90K minus the basis, not $30K per child.

Moving to the present time, the death of the original grantor is irrelevant. The irrevocable trust continues to own the land and it continues to have the original basis (plus any improvements the trust has made during the time it has owned the property). There is no step up in basis and there is no transfer of ownership that might trigger a property tax reassessment. No sale has occurred, so there is no capital gain to pay tax on.

If the trust does sell the land in the future, then there will be a capital gain at that time. The trust will either pay the taxes and distribute the profits to the beneficiaries, or the trust will distribute the gains to the beneficiaries and they will pay the tax at their own rates.

The reason why the $90K is important is for the estate tax calculation. Your MIL's estate tax exemption is reduced by the amount of the gifts she made during her lifetime. Since the current exemption is over $12M and we're talking about $90K, I'm guessing it has no effect in this case.

+1 that is what I was thinking... the basis for the land follows the gifting rules as if the mother simply gifted it to the three beneficiaries as joint owners and the trust is a bit of an unnecessary distraction.

I wonder if the amended trust is the best way forward. I'm not sure if it can me done in your state but could the trust transfer the land to the 2 grandchildren with the 3 current owners granted a life estate to use the land for the rest of their lives?

Our current real property is held in enhanced life estate deeds where our 2 kids are remaindermen and will own the property when the second of us dies but while we are alive we have an enhanced life estate and the right to use the propertes, rent the properties and keep the rent, or sell them and keep the proceeds from the sale... all of the rights and responsibities of joint ownership but it goes to the kids when the second of us dies outside probate much like a beneficiary designation on a financial account.

My parent's trust has two pieces of real estate with each trust owning 50% and 5 equal beneficiaries of the trust. I am exploring setting up an LLC for each property and having each of us own 20 shares of 100 shares in total. So if one sibling wants out they can easily sell or exchange their interests.

 

[Jerry1]

+1 that is what I was thinking... the basis for the land follows the gifting rules as if the mother simply gifted it to the three beneficiaries as joint owners and the trust is a bit of an unnecessary distraction.

I wonder if the amended trust is the best way forward. I'm not sure if it can me done in your state but could the trust transfer the land to the 2 grandchildren with the 3 current owners granted a life estate to use the land for the rest of their lives?

Our current real property is held in enhanced life estate deeds where our 2 kids are remaindermen and will own the property when the second of us dies but while we are alive we have an enhanced life estate and the right to use the propertes, rent the properties and keep the rent, or sell them and keep the proceeds from the sale... all of the rights and responsibities of joint ownership but it goes to the kids when the second of us dies outside probate much like a beneficiary designation on a financial account.

My parent's trust has two pieces of real estate with each trust owning 50% and 5 equal beneficiaries of the trust. I am exploring setting up an LLC for each property and having each of us own 20 shares of 100 shares in total. So if one sibling wants out they can easily sell or exchange their interests.

The trust is set up similar to as you describe. There’s three daughters and two granddaughters. Dad died before all of this. Mom established the trust and gifted the property and some cash to shield it from Medicare, which never became an issue. Each daughter owns 1/3’rd of the land (they’ll distribute the cash now that mom has passed). As each of the daughters pass, their share will pass to the granddaughters until ultimately, they own it.

There does now need to be an amendment because the trust said to distribute all the cash upon death. However, the daughters want to leave some cash in the trust to pay the taxes and any maintenance of the land (like having it mowed).

 

[Sunset]

.......

There does now need to be an amendment because the trust said to distribute all the cash upon death. However, the daughters want to leave some cash in the trust to pay the taxes and any maintenance of the land (like having it mowed).

Seems like they could just put the cash into a savings account and pay the taxes and maintenance out of that. Actually would save money.

Avoiding the ~30% tax rate the trust has to pay on earnings.

 

[Jerry1]

Seems like they could just put the cash into a savings account and pay the taxes and maintenance out of that. Actually would save money.

Avoiding the ~30% tax rate the trust has to pay on earnings.

Wouldn’t any earnings just pass to each individual?

Also, I think there would be little income. They’re not planning on leaving much in there and it’s raw land so the taxes are only about $600/yr. That should offset any earnings on a cash account for a net income of zero or less.

 

[Sunset]

Wouldn’t any earnings just pass to each individual?

Also, I think there would be little income. They’re not planning on leaving much in there and it’s raw land so the taxes are only about $600/yr. That should offset any earnings on a cash account for a net income of zero or less.

Maybe I wasn't clear.

I was suggesting that the trust pay out all cash to each individual, so as to not pay the high trust tax rate.

Not sure a trust can deduct expenses from income to arrive at net income like a business can.

But if people take all the money from the trust and then pay the trust bill for property tax there is zero income for the trust to pay taxes upon.

 

[pb4uski]

I noticed that a 1041 isn't required if the gross income is less than $600, so I would limit the cash in the trust so you don't exceed $600 of gross income and therefore don't have to file a tax return and K-1s for each beneficiary. Keep it simple.

 

[OldShooter]

Wouldn’t any earnings just pass to each individual? ...

Any income distributed would not be taxed at the trust level. Amounts distributed will depend on the terms of the trust and, possibly, the discretion of the trustee.

 

[38Chevy454]

I noticed that a 1041 isn't required if the gross income is less than $600, so I would limit the cash in the trust so you don't exceed $600 of gross income and therefore don't have to file a tax return and K-1s for each beneficiary. Keep it simple.

You can deduct trust expenses (such as property tax, fiduciary fees, and other fees) so the gross income can be higher; just want to keep the net trust taxable income to be $600 or less.

 

[cathy63]

Seems like they could just put the cash into a savings account and pay the taxes and maintenance out of that. Actually would save money.

Avoiding the ~30% tax rate the trust has to pay on earnings.

If the trust earns less than $2900, its tax rate is only 10%. If the family is just keeping enough cash in the trust to pay the property tax and maintenance, then the income is not likely to be even that high and the trust tax rate will be lower than their individual rates. As Jerry says in his OP, he and his wife are at 22%.

Just eyeballing the tax brackets, I think it's probably around $6K in trust income where you'd save tax by distributing it to beneficiaries who are in the 22% bracket. Less than $6K and you're better off paying taxes through the trust. That changes if the other beneficiaries have significantly higher or lower incomes.

 

[Jerry1]

Thank you all so much. This discussion will help DW be prepared when she meets with her sisters and the attorney.

 

[pb4uski]

You can deduct trust expenses (such as property tax, fiduciary fees, and other fees) so the gross income can be higher; just want to keep the net trust taxable income to be $600 or less.

No, you are incorrect . The instructions state gross income of $600, not net income. See Who Must File on page 5 of 1041 instructions.