Trust Return Distribution in Kind

[Mel7777]

Hello!   I have a client who died 10/31/2023 who had a house and two investment accounts in a revocable trust.  There have been several legal issues so the first return has not yet been filed.  When the executor is ready to file...

1. What are some considerations to consider to select the reporting year, whether to elect the first year as a short filing period, 10/31-12/31/2023 or to use a fiscal year, 10/31/2023-10/30/2024?  The house was distributed in 2024.

2.  How do we represent the distribution of the home on the K-1 given that it is a distribution of principal? with the change in FMV as a gain (loss) based on the difference of the FMV on the date of distribution and the date of death.

3.  The house was actually in the original trust to go to three people evenly.  One person did not want it so the other two people paid the third person out in cash 7 months after date of death. Is there any representation necessary on the tax return? Should a K-1 go to the person who received the cash as a distribution of principal and gain/loss if there was any?

Thank you!

[sjrcpa]

Trusts can only have Calendar Years.

But if you make a 645 election to treat the estate and trust as one, then the estate can have a fiscal year. This election is only good for 2 years from date of death.

When distributing property you can make an election to recognize gain at the trust/estate level but I have rarely seen it done.

Show as other distributions and it will carry out income earned on Beneficiary K-1s

[Mel7777]

SJRCPA -

Thank you for responding!

The house that passes from the trust to the beneficiaries would be considered a distribution of principal and not taxed as income, right? only the gain/loss (based on the change in FMV) would have a tax effect?

I may be missing something - I was likening this to an inheritance, outside of a trust, and you're given the FMV on the date of death, that value isn't taxed to you. You pay tax on the gain when it's sold.  I have not before worked with a real property going into a trust and then being distributed. Have been reading IRS docs and trying to figure out how to represent in ProSeries.  I appreciate your thoughts on the taxation of this. 

In ProSeries I see the worksheet, Amounts to Allocate to Schedules K-1, but do not see how to handle the distribution of principal.  I humbly appreciate your guidance.

[sjrcpa]

Show the distribution of property as Other Amounts Distributed. I think you use the carrying cost (dod value plus any additions). The way the income distribution calculation works, the distribution will be deemed to carry out current year net income. The net income amounts will appear on the K-1s.

[BobKamman]

Election of a fiscal year must be made on a timely-filed return.  You're too late for that. 

If the trust directed the house to be distributed in kind, then it may not be a K-1 item.  The three beneficiaries instructed the trustee to sell it?  The trustee has authority to do that, but not to file tax returns?  Has the house been sold yet?  

[sjrcpa]

"Election of a fiscal year must be made on a timely-filed return"

@BobKamman The election is made on the first return filed. It does not have to be timely filed.

[BobKamman]

From the Form 8855 instructions, which apply to this case because they want the trust to be taxed as part of the estate:

When To File
File the election by the due date (including extensions, if any) of the Form 1041 (or Form 1040-NR, if applicable) for the first tax year of the related estate (or the filing trust). This applies even if the combined related estate and electing trust(s) don't have sufficient income to be required to file Form 1041.

* * *

And as I read it, the election applies only to the first two years of the estate, starting from date of death. So, in this case, the end of this month. Might not be helpful if nothing has been sold yet.

[sjrcpa]

@BobKamman You are correct there. But if not making that election, the estate can elect a fiscal year on its first return. A trust would be stuck with calendar year.

So many elections.

[BobKamman]

The problem, of course, is that there are apparently no assets in the estate.  The question involves the trust's assets and income. 

As I frequently have said, 90% of the people with living trusts don't need one (and create tax problems like this one for beneficiaries), while 90% of the people who might benefit from a living trust don't have one.  Two years after death, and the trust still is bogged down in administrative problems?  Ironically, in my state these cases end up in probate court -- just what the decedent was told would be avoided.  

[Mel7777]

Thank you for your insights!

Do you think a 645 election could still be made?  Date of death was 10/31/2023, no filings done 😞  

This situation is this - 

The uncle died leaving his house to his nephew, niece, and stepdaughter equally.  The trust states the house was to be sold and distributed to the trust of the nephew, the trust of the niece, and outright free of trust to the step daughter.  They did not sell they house but used a distributive deed in June 2024.  The distributive deed allocates it 50% to the nephew's trust and 50% to the niece's trust and the niece/nephew paid 1/3 value to the step daughter in cash. 

This would be treated as an inkind distribution, not needed to report on the K-1 and the niece/nephew get the step up in basis - correct?

Additionally, the uncle's trust established a family foundation with the requirement that distributions may be made at the wish and desire of the settlor to a qualified charitable recipient.  He also named a third party to be involved in the decisions of the donations.  The three people (nephew, niece, foundation rep) have not agreed and funds have not been released from the uncle's trust to the foundation.  Since the foundation has not been funded and thus no income, no tax return will be filed but the earnings left in the uncles trust are taxed at trust tax rates.  Am I missing anything?

Thank you very much for any thoughts to consider.

[Mel7777]

The foundation is not considered a reporting entity since it does not have any control of income producing property - correct? So no filing for the foundation until it is funded.

[sjrcpa]

Too late for the 645 election.

As Bob quoted from the instructions:

When To File
File the election by the due date (including extensions, if any) of the Form 1041 (or Form 1040-NR, if applicable) for the first tax year of the related estate (or the filing trust). This applies even if the combined related estate and electing trust(s) don't have sufficient income to be required to file Form 1041.

[BobKamman]

Way too many moving parts there, for me.  I'm still trying to figure out how the charitable contributions are being made at the wish and desire of the settlor, who is dead.  And all the niece and nephew get is part of a house, with strings attached (it's not outright) but they have to fork over cash to buy out the stepdaughter?  That's what happens when you try to manage from the grave.  

Maybe accrual method would help here, but I doubt it. And if the trust had DNI in 2024, and two of the beneficiaries (maybe three) got a distribution in 2024, shouldn't that be income to them on a K-1?  Are they waiting for you to tell them how much, by October 15?  

[sjrcpa]

I'm confused, too.

[Mel7777]

Thank you!

Yes, it's confusing! 

Yes they do have some interest and dividends in 2024 as their distributable net income and want that for the personal returns.  I am trying to verify there is no additional gain on the house to recognize. Waiting for the CMA and hopefully a copy of the receipt and release from the attorneys.

They did take distributions greater than the interest and dividends, so it is appropriate to show the net income on Schedule B, line 10 as the amount required to be distributed?