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Old 02-16-2020, 08:17 PM
Roderick Femm's Avatar
Roderick Femm is offline
Join Date: Jul 2005
Location: On the cusp, also in SF
Posts: 7,682

Tax advice: living trust, form 1041

Situation: I have administered a living trust for 10 years. The only asset after the first year was a house which someone was buying on a private contract. So the trust was earning interest from this mortgage, there was a little fiduciary expense, and the net income was distributed to the beneficiaries, so that the trust didn't pay any tax.

Last year, the buyers of the house were finally able to re-finance, and so the trust's asset of a house was changed into an asset of money. During the year, the trust earned some interest from the original contract, but the trust had a lot of legal expenses* somewhat related to the sale, so for last year the expenses were larger than the income. Therefore, net revenue was a loss, there was no income to disburse, and I presumed that there would be no tax for the trust.

Now, in filling out form 1041, it doesn't seem to be as straightforward as I thought. The form refers to the instructions when there is a loss, and I don't understand the instructions for line 23 (no surprise there). If it makes any difference, this will be the last trust tax return, as all assets have now been distributed and all debts paid.

I will probably go and ask the IRS themselves about this, but I'm hoping to have some idea of what I'm walking into before I go.

*The legal expenses were to fix a wonky title to the house, which was the fault of the original Trustee who transferred the house incorrectly from himself to the trust, and who is now dead so he couldn't fix it himself. This was necessary in any case, whether the house was sold now or at some future time.
Old 02-19-2020, 09:36 AM
Tom Tildrum is offline
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Join Date: Apr 2002
Location: Falls Church, Va.
Posts: 14,084
I do a relatively uncomplicated Form 1041 every year. I get the sense that even the IRS deals with trust taxation issues rarely.

My read of Line 23: Ordinarily, if the trust's overall net income is a loss, it could typically carry at least some of that loss into the next year and apply it to reduce its income then. If the trust is shutting down, though, and will not file a return next year, those losses can be distributed to the beneficiaries, similar to an asset of the trust. The beneficiaries might be able to deduct some or all of that loss from their own tax returns, depending on their personal tax situations. I do not know what forms need to be filled out to record such a transfer.

Please note that I am not a tax lawyer, nor am I your lawyer, and I may be wrong.
Old 02-19-2020, 10:27 AM
Tired and Cranky is offline
Join Date: Dec 2014
Posts: 1,797
This is outside my bailiwick and my personal experience, but I think Tom Tildrum is basically right. I might be wrong though, so talk to an accountant or trust lawyer.

If I understand correctly, the general rule is that the trust has to carry the loss forward and use it to offset future income. If it's the trust's last year, however, it can distribute the loss to the trust beneficiaries on the schedule K-1. They can use the loss to offset income on their personal tax return.

The instructions for Form 1041 (p. 27) say:

On the termination of the estate or trust, any unused NOL [net operating loss] carryover that would be allowable to the estate or trust in a later tax year, but for the termination, is allowed to the beneficiaries succeeding to the property of the estate or trust. See the instructions for Schedule K-1 (Form 1041), box 11, codes D and E, later.
The same document has the Schedule K-1 instructions, which say (p. 40):

You can't show any negative amounts for any class of income shown in boxes 1 through 8 of Schedule K-1. However, for the final year of the estate or trust, certain deductions or losses can be passed through to the beneficiary(ies). See the instructions for box 11 for more information on these deductions and losses.
The instructions to Box 11, Code A (p. 41) explain how to pass the loss through to the beneficiaries on the K-1. It says to allocate the losses to beneficiaries in accordance with Internal Revenue Code Sec. 1.642(h)-4. I can't for the life of me figure out how that allocation works though.

Good luck.


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