Are Trust Assets Subject to Capital Gains Taxes?

capital gains tax

Trust Assets

As your estate plan grows to meet your needs and goals, you may find yourself including a trust as part of your overall plan. Trusts are a popular addition to the average estate plan because a trust can help accomplish such a wide range of estate planning goals. A trust can own taxable assets, including real property, that may be subject to capital gains taxes. To help you better understand how trust assets may be taxed, the Coral Gables attorneys at Stivers Law discuss capital gains taxes and trust assets.

Revocable vs. Irrevocable Trusts

Trusts all fall into one of two categories – testamentary or living trusts. A testamentary trust is activated by a provision in the Settlor’s Will at the time of death whereas a living trust activates once all formalities of creation are in place and the trust is funded. Living trusts can be further divided into revocable and irrevocable living trusts. Because a testamentary trust is activated by a provision in the Settlor’s Will, and a Will can always be revoked up to the time of the Testator’s death, a testamentary trust is also revocable up to that point.

Understanding Capital Gains Taxes

Capital gains taxes are paid when you realize a gain on the sale of an asset. For example, if you purchased real property for $100,000 and sold it ten years later for $200,000, you would realize a gain of $100,000. 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.

Distribution 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 be 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.

Given the complex nature of irrevocable trusts and taxes, it is always best to consult with an experienced trust attorney before deciding what type of trust to create and what assets to use to fund the trust.

Contact Coral Gables Trust Attorneys

For more information, please join us for an upcoming FREE webinar. If you have additional questions or concerns about capital gains taxes and trust assets, contact the experienced Coral Gables trust attorneys at Stivers Law by calling (305) 456-3255 to schedule an appointment.

Author Bio

Justin Stivers is the founder and managing attorney of Stivers Law, an estate planning firm specializing in wills, probate, trust administration, and financial risk management services. Justin’s approach goes beyond just creating legal documents. From aligning investments with estate plans to ensuring comprehensive insurance coverage, he safeguards a client’s legacy from unforeseen circumstances. His commitment extends beyond individual transactions, fostering lifelong partnerships to provide ongoing support and guidance.

With an impressive track record, Justin is licensed by the Florida and the Tennessee State Bars. His professional portfolio boasts Series 65 registration as a Registered Investment Advisor, the Wealth Management Specialist™ designation, and a 2-15 License for Health, Life, and Annuities. His dedication to excellence has earned him positions like Board Member of the Estate Planning Council of Greater Miami, Business Eagle Member of the Florida Justice Association, and active membership in esteemed organizations like the American Academy of Estate Planning Attorneys.

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