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I live in Georgia and my sister lives in California. We have

I live in Georgia and...

I live in Georgia and my sister lives in California. We have just inherited 50% each of our parent's house located in San Diego, CA. It was placed into a trust in the early 90s. Our mother passed in 1997 and our father passed in December 2012. We plan to sell the house and are worried about Long Term Capital Gains - specifically, what values are used to determine the amount of the gain to be taxed. Is it the value of the house as of her death in 1997 or our father's death in 2012? I've heard that, due to the trust, it is based on the date of our mother's death. I can't believe this is right as it would seem to greatly increase the basis for determining our capital gains. We're both dirt poor and are trying hard to do this without a lawyer. Also, as a resident of Georgia, am I liable for any state taxes (California or Georgia)? Help! 

I should also add that our father made his second wife the trustee of his estate and that we are not on good terms at all. She has elected not to file an estate tax return for the trust after my father passed and we do not believe one was filed when my mother passed in 1997. She is represented by an attorney and we cannot afford one. The house is being distributed from the trust to my sister and I at the end of August.

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8/21/2013
jgordosea
jgordosea, Enrolled Agent
Category: Tax
Satisfied Customers: 3,161
Experience: I've prepared all types of taxes since 1987.
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Greetings,

Sorry to hear of the loss of father and your tax issues.

First, please know that there is not any income tax on the inheritance but only on the income from the house, if you rent or when you sell.

As to state taxes, you will include the gain from sale of the house in your Georgia return since you have to include income from all states in your resident return. You will also file a California return since the property is located in California.
But you will not have to pay double because with your Georgia return you will get credit for the California tax paid on Form 500 Schedule 2 line 1.

In almost all cases, a personal residence that is held in a trust still gets the increase to the value at the date of death. When the trust is revocable during his life, your farther was deemed the owner of the house and the trust did not file any tax returns itself. Your father included the income from any trust items just as if there was no trust for tax purposes.
Even with an irrevocable trust that had to file trust tax returns during his life, there is still increase in basis to fair market value when the house is included in the estate of the deceased.
So, the gain will most likely only be any change in value between the date of death and the date of sale.

Also, you may be aware that the gain on a primary residence is not included in income when the property is owned and occupied for two years out of five prior to the sale of the residence.
See http://scholarship.law.marquette.edu/cgi/viewcontent.cgi?article=1221&context=elders
"Under new Section 121(d)(9), an estate or heir can exclude $250,000 of gain if the decedent used the property as his or her principal residence for two or more years during the five-year period prior to the sale.

In addition, if an heir occupies the decedent's home as his or her principal residence, the decedent's period of ownership and occupancy can be added to the heir's subsequent ownership and occupancy in calculating the two out of five years ownership and use test.

Under Section 121(d)(9)(C), the $250,000 exclusion is also extended to property sold by a trust provided that the trust was a qualified revocable trust, as defined under Section 645(b)(1), immediately prior to the decedent's death. Any period of occupancy and ownership of the decedent can be extended to an heir's subsequent ownership and use regardless of whether the principal residence was owned by a trust established by the decedent."

If you do not plan to sell the house soon you may want to consider making it your primary residence and then selling as your father's ownership and occupancy can be added to your subsequent ownership and occupancy for the two of five year test for excluding any gain on sale.

When you state that "She has elected not to file an estate tax return for the trust after my father passed" that likely means that your father did not have an estate large enough to be subject to estate tax and that there was less than $600 income in the estate for the year following his death. Estate tax returns, like others, are not optional or by choice.

Without access to the trust agreement and all the facts in your situation it is not proper for me to guarantee you have no gain but the rules do allow for exclusion and for the increase in basis on the inherited property in almost all cases.


Hopefully this gives you good general information to begin to consider the tax issues. Although you can inherit without a lawyer it is probably well worth getting an enrolled agent, or other experienced tax professional, to properly apply the tax rules to your specific situation and the terms of the trust agreement that your father had.

Please do ask if you need more discussion or clarification.
Thank you.
jgordosea
jgordosea, Enrolled Agent
Category: Tax
Satisfied Customers: 3,161
Experience: I've prepared all types of taxes since 1987.
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Customer reply replied 4 years ago

Thank you for your reply. I do have some followup questions and a few additional facts that may help you.


 


We do plan to sell the house immediately and neither my sister or I will be taking up residence there at all.


 


The house was placed into the family trust via quitclaim deed in 1998.


 


You stated: "In almost all cases, a personal residence that is held in a trust still gets the increase to the value at the date of death. So, the gain will most likely only be any change in value between the date of death and the date of sale."


 


This sounds correct, but I am being told that the value of the house (for the purposes of determining the amount of gain) is computed from the date of our mother's death in 1997 and not my father's day in 2012. This sounds wrong and, if true, I believe would greatly increase the gain and therefore our tax liability. Is there anything in the tax code or that is common in trust law you are aware of that would trigger a calculation of the taxable gain from any point other than the date of my father's death in 2012?


 

Hello again,

There are literally thousands of ways to write the terms of a trust and there are some provisions that will cause the not to be a step up in basis for the second spouse's death.

The key fact is if the trust and not the spouse (your father) is considered the owner of the house. When the spouse is the owner there is increase and when the trust is the owner there is not an increase in the basis.

Without analyzing the specific terms of that particular trust (or consulting with the attorney that drafted it) it is impossible to give a definite answer for whether the trust is the owner.

What can be looked for in the trust agreement is if the second spouse (your father) only had the ability to obtain principal needed to maintain his quality of life (often stated as for health, education, maintenance, and support needs). Some trusts that commonly use that language are called B” Trust, Family Trust, or Credit Shelter Trust.

Even when that was true of the trust agreement it is possible if an estate tax return was filed at the death of the first trust than an election was made (called the Qtip Election; but details are way beyond the scope of this discussion) that would have made him the owner for income tax purposes.
In some cases if no estate tax return was filed that can still be done and the election still made (but that avenue may not be open as the trustee would control that decision).

Please do understand that even if the increase was only earlier then to that value at the first death will be added the cost of any improvements since then to the cost basis (roof, remodel,additions, etc. but not repairs).

Also amount of tax on capital gain may not be as much as you think for a sale this year because there is a zero rate of tax on long term capital gain for amounts up to the top of the 15% bracket.
That basically means there will not be tax on gain until your income (the gain plus other income) is more than $72,500 for a married filing joint couple and the rate for gain above that amount is 15% unless your total income is more than 400,000.

For example you could have 22,500 of other income and 100,000 if gain but there would be only about 7,500 tax on that gain (since the first 50,000 of gain would get the zero rate). The same other income and 200,000 of gain would be about 22,500 of tax on the gain. So after federal tax net income on the sale would be about 92,500 and 177,500.

There will be state income tax as well but that hopefully gives you a better idea of how much of the gain needs to be used for tax and that the gain will be reduced by any improvements even if the trust was such that the trust was the owner and their is no increase in basis.

So, it could be correct that the trust was the owner even though there was a chance to make a QTIP election on the mother's estate return and have the father be the owner for income tax purposes.

Please do ask again if you need more help even though the only way to be certain is to provide all the information and documents to an experienced practitioner to apply these rules to this specific trust.

Thank you for the opportunity to be of service.
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