How Do I Report Capital Gain on Sale of House in Realty Trust?
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Question:
My mother, a Massachusetts resident, passed away in October 2022. She had an irrevocable trust, established June 2011. The only asset in the trust was her home, which was held in it’s own realty trust, with the irrevocable trust as it’s sole beneficiary. When the house was sold, a 1099-S was issued to the realty trust, which has it’s own tax identification number. My question is whether I should (a) issue a K-1 to the irrevocable rust, and then files tax returns for capital the gains under it’s separate tax identification number or (b) or issue the K-1s to my brother and myself who are equal heirs, and we files Capital Gains on our tax returns.
Response:
Assuming all the proceeds were distributed to you and your brother, I’d skip the irrevocable trust and issue the K-1’s to the two of you. If the irrevocable trust is holding the proceeds, then the K-1 has to be issued to it.
To explain, the double-trust arrangement was often used in Massachusetts in the past as way to avoid the necessity of recording an entire trust at the registry of deeds. So, while your mother’s irrevocable trust was really the owner of her house, it held title through the nominee realty trust. This arrangement is no longer necessary since now the trustees of the irrevocable trust could simply record a trustee’s certificate at the registry of deeds rather than the entire trust. In that case, the irrevocable trust would obtain a tax identification number and file a 1041 tax return, issuing K-1s to you and your brother.
It might have been possible to have obtained a tax identification number for the irrevocable trust alone even with the existence of the revocable trust. But the closing attorney may have required that you obtain the number for the realty trust because it held title to the property.
Given that the realty trust is really acting as agent for the irrevocable trust, if you simply distributed the sale proceeds to your brother and yourself I don’t see any reason to go through the extra steps of obtaining a tax identification number and filing a 1041 return for the irrevocable trust. The tax results will be the same with any capital gains passing through to your brother and you as the ultimate beneficiaries.
You should only need to obtain a tax identification number for the irrevocable trust if you are continuing to hold the funds. Any bank or investment firm will require it in any case in order to set up an account in the name of the trust.
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