How Do I Sell a Home in an Irrevocable Trust?

POSTED ON: November 5, 2021

I’m a trustee selling a home in irrevocable trust for a parent who died. There are two beneficiaries who will get the sale proceeds with a stepped-up basis. I’m filing Form 1041 but do I still have to file a Form 1040 to report anything for the beneficiaries?

How Do I Sell a Home in an Irrevocable Trust?

There is often a misconception by some clients that if they transfer their home to an irrevocable trust, that they would never be able to transfer that home during the remainder of their lives.  This couldn’t be further from the truth.  If the client is the trustee of the trust. the client is free to sell the home, collect the proceeds from the sale of the home, and purchase a replacement home, as long as both the sales proceeds of the home stay in the trust and the replacement home is purchased with the proceeds in the trust.  An irrevocable trust can be a much more flexible estate planning document than most people realize.

A trustee who sells a home in an irrevocable trust for a parent who died should know that often (depending on how the trust is drafted), assets transferred to an irrevocable trust will be deemed a completed gift and will not be included in an estate for estate tax purposes.

Lehigh Valley Live’s recent article entitled “What happens to tax on a home sold from a trust?” explains that this means there wouldn’t be a step-up in basis to the fair market value upon the decedent’s death.

Remember that an irrevocable trust is a type of trust in which its terms can’t be modified, amended, or terminated without the permission of the grantor’s named beneficiary or beneficiaries.

Irrevocable trusts have tax-shelter benefits that revocable trusts to don’t.

However, an irrevocable trust can be created so that the settlor (the creator) of the trust keeps certain rights and powers, so that gifts to the trust are incomplete for estate and gift tax purposes.

In that instance, the assets are included in the settlor’s estate upon death and obtain a step-up in basis upon the decedent’s death.

If the trust sells the asset in the trust, the trust may need to file Form 1041, U.S. Income Tax Return for Estates and Trusts, and the trust may be required to pay a tax.  However, if the trust has been properly established by a qualified estate planning attorney, the property in the trust should achieve a step up in basis, and that tax should be minimal (if any).

If the trust distributes any income to the beneficiaries in the same tax year it receives that income, the income is passed through to the beneficiaries, and the beneficiaries must report it on the beneficiaries’ individual tax returns (Form 1040) and pay any tax due.

It’s generally a good idea to report and pay tax at the individual rate instead of at the trust or estate level.

That’s because the trust or estate will begin to pay tax at the highest rate at only $13,150. In comparison, an individual doesn’t pay tax at the highest rate until his or her income exceeds over $440,000.

Note that an irrevocable trust is a more complex legal arrangement than a revocable trust. As a result, there might be current income tax and future estate tax implications when using this type of trust. It’s wise to seek the assistance of an experienced estate planning attorney.

You may also like to review these blog posts on the proper use of irrevocable trusts: Do You Need a Revocable Trust or Irrevocable Trust? and Can Estate Taxes Be Avoided with a Trust? and What Kind of Trust Is Right for You?

Reference: Lehigh Valley Live (Aug. 16, 2021) “What happens to tax on a home sold from a trust?”

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