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I am a Trustee. My mother left her house valued at $300,000

I am a Trustee....
I am a Trustee. My mother left her house valued at $300,000 (rounded for ease of math). Four years later we sold the home for $450,000. We put $75,000 into improvements and the sales cost was $25,000. Is the $50,000 gain taxable? We live in Virginia. Does the Trust then file a 2013 tax return? There is no other income to the Trust. We want to pay out the inheritances and close down the Trust in early 2014 but need to understand what if any taxes are due.
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Answered in 7 minutes by:
10/10/2013
Lev
Lev, Tax Advisor
Category: Tax
Satisfied Customers: 30,692
Experience: Taxes, Immigration, Labor Relations
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Lev :

Hi and welcome to our site!
I assume that was a living trust set by your mother and you became a succeeding trustee after your mother passed away.
If that is correct - the trust became irrevocable just after your mother (the grantor) died - and as such it is treated as a separate legal and taxing entity.
According to filing requirements - see instructions page 4 Who Must File - http://www.irs.gov/pub/irs-pdf/i1041.pdf
The fiduciary (or one of the joint fiduciaries) must file Form 1041 for a domestic trust taxable under section 641 that has:
1. Any taxable income for the tax year,
2. Gross income of $600 or more (regardless of taxable income), or
3. A beneficiary who is a nonresident alien.
Thus because the gross income realized from the sale of the house is above $600 - the tax return is required.

Lev :

To determine the capital gain realized by the trust we need to start with the basis. For inherited property - the basis is the fair market value of the property at the time the decedent passed away.
If the house was valued $300k when she died - that is your basis.
The basis should be adjusted by selling expenses and improvement expenses - so your adjusted basis will be $400k as you estimated.
That will be $50k gain - which is classified as long term capital gain. I assume that proceeds are to be distributed to beneficiaries - thus the trust will pass taxable gain to beneficiaries as well - so beneficiaries will include their share of taxable income into individual tax returns
The trust should issue schedule K1 to each beneficiary - www.irs.gov/pub/irs-pdf/f1041sk1.pdf‎
If that is the only property held in the trust - and all funds are distributed - the trust would be dissolved.

Customer:

When I typed in my question, I was unaware where this was going, so I made up numbers. We estimate the actual gain to be about $100K, if that makes any difference. The two main questions we have right now are:

Customer:

1. How much to we need to allocate for the Capital Gain tax payment? We hear 15% and 10%.

Customer:

2. Because the total estate was under $1M, I have issued no Schedule K1 documents. Many small payouts have been made. Am I now in a bind?

Customer:

I just intended to file one 2013 federal tax return, pay the CG tax and that's all. I know about the K1, but declined to issue any. We have made smaller payouts (Trust included $150K or so in cash) for four years.

Lev :

How much to we need to allocate for the Capital Gain tax payment? We hear 15% and 10%.
As I mentioned above - the gain most likely will be passed to beneficiaries - so the tax rate will be determined by each beneficiary based ion his/her taxable income, filing status, deductions, etc.
The tax rate will be determined individually.

Customer:

3. Can I file to pay the CG taxes with no K1s issued?

Customer:

Also:

Customer:

4. Is there any State tax (VA)?

Customer:

thanks...

Customer:

So, you are saying the Trust does not pay any CG tax?

Lev :

Because the total estate was under $1M, I have issued no Schedule K1 documents. Many small payouts have been made. Am I now in a bind?
I think you meant estate taxes - there is NO estate taxes. But if the trust has income above filing requirements - INCOME tax return is needed. K1 is to report distribution of taxable income to beneficiaries - thus - if there is taxable income and it is distributed - K1 is required as well.

Customer:

OK, but if the gain is all distributed, the Trust effectively has no 2013 income? Can I just issue a K1 specific to the gain?

Lev :

Can I file to pay the CG taxes with no K1s issued?
If none of income was distributed to beneficiaries and if the trust is not required to distribute income to beneficiaries (that should be verified with trust's documents) - then no K1 is required and income taxes are paid by the trust.

Lev :

Is there any State tax (VA)?
Yes - because the house is in VA - the gain is considered income from VA sources - and it is taxable for the state regardless where beneficiaries are residents.
Same tax treatment as on the federal level - the gain is passed to beneficiaries - and the tax liability is determined based on the total income.

Customer:

I'm trying to determine how the federal government would be able to determine what distributions reported on K1s is taxable. If only the portion of the distribution that is capital gain is in fact taxable and those funds are mixed into the Trust account, who can tell what porting of the Trust is taxable? Why not distribute the taxable amount to the children who will pay no taxes?

Customer:

(porting = portion)

Lev :

OK, but if the gain is all distributed, the Trust effectively has no 2013 income? Can I just issue a K1 specific to the gain?
If the house was sold in 2013 - that means - the trust has gross income more than $600 in 2013 - and is required to file the tax return.
When the gain is distributed to beneficiaries - it is deducted on the trust's income tax return (form 1041) - so the trust will not have any taxable income - still the tax return is needed.
K1's are not issues separately - they are issued as part of the tax return and sent to the IRS as attachments to 1041. In additional - copies of K1's are sent to beneficiaries - so they will use them for individual tax returns.

Customer:

The process is starting to make sense, but I still see no way the government (IRS) can possibly determine what distributions are taxable. Forget for a second that we have been distributing funds over four tax years. If a Trust has a total value of $600K and out of that total $100K was capital gains, then the entire $600K is distributed to seven people (in varying amounts) how on earth would the government determine who of these seven people received a portion of the capital gains and who got only the untaxed inheritance?

Lev :

First of all - having taxable income and required to file - are different issues.
Then - if the GROSS income is above $600 - not $600k - the trust is required to file the tax return.
Second - the taxable income is calculated on the tax return - in the same manner as for individuals. So you will identify the gain $100k as in your example - as taxable long term capital gain.
Then - you deduct the distribution to beneficiaries - and attach K1 with their names and SSN's - so the IRS will track that taxable income to to these individuals.
After that deduction - the trust will not have any tax liability.

Another issue - there are two types of distribution - the distribution of the income and distribution of the corpus. Income is generally distributed first - so if there is any income and any distribution - it is assumed that income is distributed.
Distribution of the corpus doesn't generate any taxable income for beneficiaries - as as such is not required to be reported on K1. You may mention such distribution as other information on K1 or in additional statement to beneficiaries - but because that is not taxable - the IRS would not worry about that.
The proportion of the distribution is based on the trust document - according to grantor - as a trustee you should follow grantor's wishes.

Customer:

I appreciate the information. I'm still not clear on all of this, but I have taken enough of your time. I was not anticipating a dialog or I'd be a little better prepared. This service is new to me. When we close this are further questions allowed or is that a new exchange?

Lev :

My intention is to provide EXCELLENT service - and I appreciate if you take time and rate my work accordingly.
You may come back to this page any time
Here is the address - http://www.justanswer.com/tax/81puz-trustee-mother-left-house-valued-300-000.html
I might be not immediately available - but surely will address all your tax related issues.
You are welcome to come back and ask for clarification.

Customer:

Thank you.

Lev
Lev, Tax Advisor
Category: Tax
Satisfied Customers: 30,692
Experience: Taxes, Immigration, Labor Relations
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