Because a trust can help accomplish so many estate planning goals, it is common to find at least one trust agreement in the average estate plan. If you choose to establish a trust, that trust may own taxable assets, including real property. If so, you need to have a clear understanding of how trust property is taxed in the event it is sold or transferred out of the trust. The Grand Forks trust lawyers at German Law explain when capital gains taxes could be due upon the sale or distribution of rust assets.
Capital Gains Tax Fundamentals
Capital gains taxes are paid when you realize a gain on the sale of an asset. For example, if you purchased real property for $250,000 and sold it ten years later for $500,000, you would realize a gain of $250,000. Determining when capital gains taxes are due, how to calculate the gain upon which the tax is paid, and how much tax is due can be quite complicated because of the numerous and varied factors involved and the complexity of the tax laws.
Capital Gains Taxes and Trust Assets
Whether or not capital gains taxes are due after the sale of a trust asset will depend on several factors, starting with the type of trust involved. If the trust is a revocable trust, the trust is not usually a separate tax entity during the lifetime of the Settlor. As such, the Settlor retains incidents of ownership over the property held by the trust. If a trust asset is sold, and a gain is realized, triggering a capital gains tax obligation, that gain must be reported on the Settlor’s personal tax return.
Conversely, an irrevocable trust is typically a separate tax entity because when you transfer ownership of property into it, you give up control and any opportunity to take the assets back. For this reason, gains or losses are not reported on the Settlor’s personal tax return. Unfortunately, however, that is not the end of the capital gains tax analysis. You must still consider what type of irrevocable trust is involved.
A simple irrevocable trust is required to disburse all income made by the trust every tax year. Those disbursements are then taxable to the beneficiaries as income. Some irrevocable trusts, however, are more complex and are permitted by law to retain income. This type of irrevocable trust may only distribute some of the income to the trust beneficiaries. Capital gains, however, are not considered to be income to irrevocable trusts. Instead, capital gains are viewed as contributions to the principal. Consequently, if the trust sells an asset and realizes a gain, that gain would not be distributed, meaning the trust would have to pay taxes on the gain as profit to the trust.
What Happens If Assets Are Distributed to a Beneficiary?
If an irrevocable trust distributes, or transfers, an asset to a beneficiary, instead of selling the assets and distributing the gain, then the beneficiary becomes responsible for any taxes due. Although the initial distribution may not be taxable, capital gains taxes may become due if the beneficiary sells the asset down the road. In that case, the amount of capital gains tax due will usually be calculated using the value of the assets at the time it was distributed to the beneficiary as the basis, not the value of the asset at the time it was originally purchased.
Contact Grand Forks Trust Lawyers
Please join us for an upcoming FREE seminar. If you have additional questions or concerns about capital gains taxes and your trust, contact the Grand Forks trust lawyers at German Law by calling 701-738-0060 to schedule an appointment.