The Listen to Lawrence Letter: Irrevocable Trusts and Capital Gains

CLIENT QUESTION:

If there is a profit from the sale of a vacation property owned by an irrevocable trust, can the capital gain be reported under the grantor’s Social Security number, or does it have to be reported under the trust’s TIN?

MY RESPONSE:

The question does not say what type of irrevocable trust this is, but assuming it is an irrevocable Medicaid trust, it is likely a grantor trust.

A grantor trust is a trust where, for income tax purposes, the person who created the trust is still treated as the owner and reports the trust’s income on his or her personal income tax return.

All of the irrevocable Medicaid trusts that I prepare are grantor trusts as long as all of the grantors are still living. Therefore, the capital gain from the sale of the vacation property would generally be taxable to the grantor and reported on the grantor’s individual income tax return.

There is an important caveat. Since this is the grantor’s personal income tax liability, the trust cannot pay the tax for the grantor. The grantor must pay the tax from assets outside the trust.

Even if the trust has its own TIN, that does not necessarily mean the trust pays the tax.

If it is a non-grantor trust, the answer is different, and the gain may instead be taxable to the trust.

So, the important question is not simply whether the trust is irrevocable. It is whether it is a grantor trust for income tax purposes.

I hope this helps!

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