1041 Trust return, 3 beneficiaries, house sold

[Just-Lisa-Now-]

Dad died 7 years ago and house went into his trust, 2022 house was sold, had quite a bit of gain. 

One of the beneficiaries lived in the house as a personal residence for the 7 years between when Dad died and the house was finally sold.  

Does he get the IRC121 exclusion?  How does that figure into the 1041 return?

[IRonMaN]

The trust was the owner, not him.  Doesn't sound like there is any exclusion coming.

[Just-Lisa-Now-]

that's what I thought as well, but I see that the 1041 does have a HomeSale worksheet in the list of forms so I thought maybe I was missing something...when would a 1041 use the Homesale worksheet?

[IRonMaN]

When?  You got me.

[Just-Lisa-Now-]

Oh and the beneficiary's tax preparer is telling him that he does qualify and I need to give him a corrected K-1....so I thought maybe I was the one missing something.

[BobKamman]

Of course the knee-jerk reactions here are always NO!  But I would keep trying to find a way to get to YES!  As for the question on where you would use the exclusion on a Form 1041, see this:

Treas. Reg. Sec. 1.121-1(c)(3).

(i) Trusts. If a residence is owned by a trust, for the period that a taxpayer is treated under sections 671 through 679 (relating to the treatment of grantors and others as substantial owners) as the owner of the trust or the portion of the trust that includes the residence, the taxpayer will be treated as owning the residence for purposes of satisfying the 2-year ownership requirement of section 121, and the sale or exchange by the trust will be treated as if made by the taxpayer.

But why was this trust not terminated seven years ago?  Is there a provision in it, that required it to continue?  Is it still in existence, with other assets?  I think you have more of a "substance over form" case, where really the other beneficiaries just kept legal title in the trust but equitable title among themselves.  

[Just-Lisa-Now-]

I read that exact section that you highlighted, but I wasnt sure what constituted "others as substantial owners".   I could see it if the house was co-owned by the trust and someone else on the title.

I'll need to talk to the trustee again.  The house was all there was left, I'm not sure why they waited so long to sell it.

So the other beneficiaries wouldn't get the exclusion, how would it only be allocated to one of them?  The mechanics of reporting it on the return seemed to trip me up enough that it didnt seem like it was right..

[IRonMaN]

I was confident that Bob would come in at some point and say that I was wrong and follow up with a wonderful story that if you stare at that frog long enough eventually a prince will appear.🐸🤴

[BobKamman]

They should have deeded the house to the three beneficiaries, before they sold it.  Then it's not a trust problem, it's a beneficiary with a Section 121 issue who may have a problem.  I would want to see the trust document, to find a reason the sale was delayed so long.  Smells like breach of fiduciary duty. 

I don't think the exclusion goes on the 1041, though.  The question is how to show it on the return of the beneficiary who may qualify.  He has a Schedule K-1 that shows a large capital gain, right?  He can leave it off the trust distributions line of the Schedule D, run it up the 8949 flagpole and see if IRS salutes it.  

Has the trust been paying the real estate taxes all this time?  Anyone claim those deductions?  If there was income, looks like a good way to get around the SALT cap until you get caught.  How about insurance, maintenance and repairs?  100% paid by the occupant?  Looks like rent to me, for the 2/3 not owned.  

[Just-Lisa-Now-]

These are brand new clients, they only came to me to report the sale of the house sold by the trust. I didnt prepare anyone's personal returns. I honestly didnt even know one of the siblings had been living in it, she just told me it hadnt been rented out.

Trustee knew they would have gain from the sale, I guess I should have asked more questions, it just seemed fairly straightforward.  Geez I prepared this back in early February (feels like a long time ago! LOL) , I dont remember all the particulars.

[BobKamman]

Probably came to you because the first two preparers declined it. 

[sjrcpa]

 I think Bob is pushing the envelope. @BobKamman Where in Sections 671-679 would the beneficiary living in the house be treated as a substantial owner?

But, what, if anything, does the trust document say about the house?

A client of mine died a few months ago. Her house and other assets are in a trust. The trust says:

Son John gets the house.

Blacksheep/drug addict son Steve gets $1.

Sons John and Mike split everything else.

Maybe we could argue John is treated as a substantial owner. (But he said he's not selling it)

[BobKamman]

@sjrcpa "But, what, if anything, does the trust document say about the house?"

Exactly.  Don't indict me until you have read the charges against the trustee.  If the trust says, "Sell or distribute everything when I die once the bills are paid," but the Wayward Trustee took directions from the three beneficiaries to let Charlie stay in the house as long as he wanted, then what you have is a new revocable trust by the three of them, and they are all equitable owners who didn't believe in following instructions.  On the other hand, if the trust says, "Let Charlie live there as long as he wants, and sell it only when he wants to move --- and if he dies first, it doesn't go to his estate," then Sections 671-679 don't apply. 

In your example, If John and Mike agree to keep the house in the trust, contrary to instructions, because that way John's wife doesn't need to know about it and a divorce is expected eventually, then yes, you should argue that John is a substantial owner, beginning with trustor's date of death.