No Capital Gain Exclusion for Residence that is Held in Family Trust
IRS recent ruling shows unintended consequence of trusts used to hold personal assets. This ruling reminds us that tax rules change after a trust can’t be changed, making trusts sometimes inflexible in dealing with changing tax opportunities.
In this case the sale of a home, in which an individual resided for many years but to which title was legally held by a family trust, did not qualify for the Tax Code’s new capital gains exclusion on the sale of the house. The exclusion would for most home owners provide a $250K per person tax free gain. The IRS concluded that the individual’s inability to control the assets of the trust prevented her from being deemed an owner of the trust for tax purposes. The intention was that her largest asset held in a revocable trust would give her ultimate tax advantage while protecting her on the downside – the reality is that if her trust converts to a irrevocable trust she is no longer able to sell her property and obtain the $250K tax free gain.
Family trusts are a common estate planning tool and often place assets, such as a home, into a trust. The income beneficiary has rights to any income from the trust and may even have use of the assets but has no control to sell, mortgage or dispose of the assets of the trust. Since only the trust’s designated trustees have the power to make decisions related to the encumbrance or disposal of the trust’s assets then the IRS deems that the beneficiary has preferential estate tax treatment only if they have the ability to continue living in the home.
Planning for the smooth transition of your assets to your family upon death can be complicated and can have serious tax ramifications. ALWAYS review all tax documents with financial advisor, estate planner and tax advisor.
Edi Alvarez, CFP®
BS, BEd, MS