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The proceeds from the sale of a house in trust is subject to taxes and its tax treatment will depend on the type of trust the house is in: revocable or irrevocable. A trustee should seek the advice of a trust attorney to better understand the consequences of selling a house in a trust.
Revocable vs. Irrevocable Trust
A revocable trust is a trust where the grantor reserves upon himself the right to modify, amend or cancel the trust. An irrevocable trust, on the other hand, cannot be modified, amended or terminated by the grantor.
Because the grantor can still modify and amend a revocable trust, the revocable trust is also considered, for tax purposes, a grantor’s trust. As a grantor’s trust, any income from said trust is reported using the grantor’s social security number. The income from the sale of a house in a revocable trust will be reported using the grantor’s income tax return. In essence, the property in a revocable trust is considered the grantor’s property.
An irrevocable trust, on the other hand, is considered a separate legal entity, independent from the grantor. For this reason, an irrevocable trust has its own tax identification number (EIN). With its own EIN, any income from the sale of a house in an irrevocable trust will be reported using the irrevocable trust’s own EIN and return.
Tax Benefits Between an Individual and an Irrevocable Trust
An individual person/grantor holding property under a revocable trust can avail of certain tax benefits that are not available to an irrevocable trust.
For example, the capital gains exclusion is a tax benefit available to individuals or married couples, but not to irrevocable trusts. Also known as the primary residence exclusion or home sale exclusion, this tax benefit allows the exclusion of capital gains up to $250,000 for individuals and $500,000 for married couples who meet the ownership test and the use test for the sale of their house. To be eligible for the exclusion, the individual or married couple must show that they owned and used the house as their main home for a period totaling 2 years out of the 5 years prior to the sale. This capital gains exclusion can be applied to houses under a revocable trust for as long as the grantor qualifies.
An irrevocable trust, on the other hand, cannot avail of the capital gains exclusion because it is a separate legal entity independent from its grantors. Thus, any income arising from the sale of a house in the irrevocable trust will be treated as trust income.
Tax Rates for Grantor and Irrevocable Trusts
The tax rates between a grantor trust and an irrevocable trust significantly vary. Below are the tax rates for 2023:
2023 Irrevocable Trust Tax Rates
| Income Range | Tax Rate |
|---|---|
| $0 to $2,900 | 10% of income over $0 |
| $2,901 to $10,550 | $290 + 24% of income over $2,750 |
| $10,550 to $14,450 | $2,126 + 35% of income over $9,850 |
| $14,450 or more | $3,491 + 37% of income over $13,450 |
2023 Federal Income Tax Brackets
| Tax Rate | For Single Filers | For Married Individuals Filing Joint Returns | For Heads of Households |
|---|---|---|---|
| 10% | $0 to $11,000 | $0 to $22,000 | $0 to $15,700 |
| 12% | $11,000 to $44,725 | $22,000 to $89,450 | $15,700 to $59,850 |
| 22% | $44,725 to $95,375 | $89,450 to $190,750 | $59,850 to $95,350 |
| 24% | $95,375 to $182,100 | $190,750 to $364,200 | $95,350 to $182,100 |
| 32% | $182,100 to $231,250 | $364,200 to $462,500 | $182,100 to $231,250 |
| 35% | $231,250 to $578,125 | $462,500 to $693,750 | $231,250 to $578,100 |
| 37% | $578,125 or more | $693,750 or more | $578,100 or more |
Give above, assuming that both the grantor and the irrevocable trust have a net taxable income of $50,000 for the year 2023:
- An individual grantor or grantor trust will pay $6,307.50 in federal income tax, computed as: ($11,000 * 0.10) + (($44,725-$11,000)*0.12) + (($50,000-$44,725)*0.22);
- An irrevocable trust will pay $16,644.50 in federal income tax, computed as: ($2900*0.10) + (($10,550-$2900)*0.24) + (($14,450-$10.550)*0.35) + ($50,000-$14,550)*0.35).
There is a significant difference of $10K in tax liability between an irrevocable and revocable trust, given the same amount of income at $50,000. For this reason, when planning to transfer properties in trusts, these tax rates should be taken into account. Irrevocable trust taxes are always higher than grantor/revocable trust taxes. However, some people still transfer real estate to irrevocable trusts, despite the tax implications, to be Medicaid-eligible (especially when they own more than one home) and to protect the home from Medicaid asset recovery.
Tax Basis When Selling a Home Under a Trust
When selling a home under a trust, another major consideration is the tax basis to be used. Tax basis refers to the value or cost of an asset for purposes of computing the income. The tax basis will depend on a number of factors.
If the house is in a revocable trust and the grantor is the one selling the house, the tax basis to be used will be the grantor’s tax basis, which is the grantor’s acquisition cost plus the cost of improvements. For example, if the grantor purchased the house for $40,000 and made $10,000 worth of improvements, the tax basis is $50,000. If the grantor subsequently sells the house for $80,000, the income is equivalent to the selling price ($80,000) less the tax basis ($50,000), which is $30,000. This income, however, may be excluded under the capital gains exclusion if the grantor qualifies under the ownership and use tests.
If the house is in an irrevocable trust, the irrevocable trust receives a carry-over tax basis, which is the tax basis of the grantor. Given the same facts, the irrevocable trust will have a carry-over tax basis of $50,000 and will receive $30,000 income if the house is sold for $80,000. This income cannot be excluded under the capital gains exclusion because an irrevocable trust does not qualify for this tax benefit.
If the house is in a revocable trust and the grantor then dies, making the trust irrevocable, the trust gets a step-up basis at the time of the grantor’s death, which is the fair market value of the property at the time of the grantor’s death. In the same example above, if the grantor’s basis is $50,000, but at the time of his death, the fair market value of the property is $80,000, the trust receives a step-up basis of $80,000. If the trust, after receiving the house from the grantor after the grantor’s death, immediately sells the house for $80,000, the trust will not have any income because the selling price is $80,000 and the trust’s step-up basis is $80,000, resulting to $0 income.
The proceeds of the sale of a house in trust will be treated different on a tax perspective depending on a number of factors. Issues may be complex and it is important to seek the advice of a trust attorney in case there are any doubts. Should you have any concerns regarding sales of a house under a trust, we at the Law Offices of Albert Goodwin are here for you. We have offices in New York City, Brooklyn, NY and Queens, NY. You can call us at 212-233-1233 or send us an email at [email protected].
About the Author
Albert Goodwin Esq. is a licenced New York attorney with over 17 years of courtroom experience. His extensive knowledge and expertise make him well-qualified to write authoritative articles on a wide range of legal topics. He can be reached at 212-233-1233 or [email protected].
