Category: Estates & Trusts: Income Tax;
Deductions & Credits; Individuals; Tax Returns, Examinations
& IRS Procedure Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com Taxpayer (TP) is an individual. In 1993 TP transferred his principal residence to a revocable living trust (the Trust). The Trust is a domestic trust, TP is a citizen or resident of the United States, and TP's principal residence is located in the United States. The questions for consideration are as follows: 1. Does transfer of the home to the Trust affect TP's ability to claim the federal home mortgage interest deduction with respect to the mortgage on the residence? 2. Does transfer of the home to the Trust affect TP's ability to claim deferral of gain under Internal Revenue Code (IRC) §1034 on the eventual sale of the residence. 3. Does the Trust have a federal income tax filing requirement? The comments set forth below pertain to federal income tax consequences only. The ramifications of the transaction for state income taxes as well as other state and/or local non-income tax rules have not been considered. In general, IRC §§671 through 677 provide that a taxpayer who transfers property in trust but retains certain prohibited powers will be taxed as the owner of the property of the trust. Among the prohibited powers is the power to revoke the trust. (IRC §676) It is assumed that under the governing instrument of the Trust TP has such a power of revocation. Accordingly, TP is considered the owner of the trust property and is taxed thereon as if the Trust did not exist. Trusts of this type are referred to in the tax literature as grantor trusts. It is well established that the transfer of a taxpayer's property to a grantor trust (assuming that the taxpayer's entire interest in the property is transferred) does not give rise to a change in reporting for the property. In other words, the taxpayer merely continues reporting as though the transfer had not occurred. 1. The transfer to the Trust does not affect TP's mortgage interest deduction. It seems clear from the language of IRC §676 that the mortgage interest deduction should not be affected by the transfer of TP's principal residence to the Trust. Given that the grantor (TP) shall be treated as the owner of the property, the owner (TP) should continue to enjoy the deductions related to the property. To resolve any doubt that may exist, IRC §163(h)(4)(D) directly addresses the issue and provides that interest paid by a trust is qualified residence interest if the trust establishes that the residence is a qualified residence of a beneficiary who has a present interest in the trust. Assuming that the interest on the mortgage in question was qualified residence interest prior to the transfer, it appears that TP qualifies under §163(h)(4)(D) and thus the transfer does not affect TP's mortgage interest deduction at all. 2. Based on current law, the transfer to the Trust does not affect TP's ability to use §1034 on the eventual sale of the residence. Again, the general principal of §676 should alone be sufficient to reach this conclusion, but Revenue Ruling 66-159, 1966-1 C.B. 162 removes any doubt by specifically sanctioning §1034 treatment in a grantor trust situation. Obviously, the sale and rollover must qualify under §1034 in all other respects such that the only issue is whether ownership of the property by the Trust affects the ability to use §1034. 3. Assuming that TP is both the grantor and the trustee or co-trustee of the Trust and assuming that TP's entire interest in the home has been transferred, the Trust does not have a federal income tax reporting requirement under current law. All income and expenses of the trust should be reported on TP's 1040. Regulation §1.671-4(b) addresses the issue by specifically providing that Form 1041 need not be filed and all items of income, deduction, and credit should be reported on the individual's Form 1040. I cannot locate any other special federal income tax filing requirement for the Trust. Also, I spoke with a colleague that represents a major individual client who has a revocable living trust. The colleague confirmed that to his knowledge there are no other required federal income tax filings. |
