I know that when a living trust owns a home, then upon the death of the grantor the beneficiaries of the trust receive the stepped up basis, just as if the trust had not owned the home. My questions:

(1) Where is that specified in an IRS publication? and

(2) How is the subsequent sale of the home reported? The settlement agent is going to issue a 1099 to the trust (or can the trustee specify that the 1099's be issued to the beneficiaries who should receive the proceeds?). If there are is no capital gains tax due because the basis and sales price are equal (i.e., quick sale following death), does the sale need to be reported to the IRS? If so, how is that done mechanically, by the trust and/or the beneficiaries?

Many thanks.

Yes, we all assume that property owned in a living trust receives a step up in basis upon the grantor's death. However, that doesn't apply to all living trusts. Basically, it must be a living trust in which the grantor has retained certain powers so that the property held in the trust is still treated as being owned by the grantor.

The most common power retained by a grantor is the right to amend or terminate the trust and take the property back. This power is typically found in a revocable living trust; i.e., the type of living trust that most people have as part of their estate plan to avoid probate. Another power that is often retained by a grantor is the right to appoint the property in the trust to his or her estate or a creditor, etc. Both of these powers are really the equivalent of continued ownership of the property in the trust. That's why the tax laws require that the grantor report the trust income on his or her own personal income tax return. It's also the reason why property in a revocable living trust is included in the grantor's estate for federal estate tax purposes.

Because the property is treated as owned by the grantor at the time of his or her death, it also qualifies for the step up in basis upon the grantor's death.

The authority for this is found in I.R.C. Section 1014 and Treas. Reg. 1.1014-1 through 1.1014-8). See Treas. Reg. 1.1014-2(a)(2)&(3), which I am reproducing below.



If the trust sells the home in question, then the trust is required to report the sale on its income tax return (Form 1041) for the year in which the sale was made, subject to the filing requirements for a trust. The settlement agent should. issue the Form 1099 to the trust, not the beneficiaries. Whether any income gets passed out to the beneficiaries depends upon the distributions made during the tax year and the distributable income of the trust.

I highly recommend that the trustee report the sale on the Form 1041 even though a Form 1041 may not be required, just so that a formal accounting record is in evidence for the IRS and the beneficiaries. Otherwise, questions may be raised later on when memories have faded.

Thanks for the post. If you have further questions, please let us know.