The Tax Implications Of Selling A House In A Trust: What You Need To Know

Many people place their homes in a trust to simplify estate planning, minimize tax obligations, or provide for family members with special needs. A trust is a legal arrangement where a third party manages financial assets, such as a home, for the benefit of a designated party. If you sell a home in a trust, the type of trust helps determine whether you’ll pay tax on the sale and how much. Learning more about how trusts work can help you understand the tax implications of selling a home in a trust.

Key Takeaways:

• Trusts are a legal tool often used as part of estate planning.
• The person funding the trust is called the settlor or grantor, the trustee manages the trust, and the beneficiary receives benefits from the trust.
• The tax implications of selling a home in a trust vary significantly based on the type of trust in which the property is held.

What Is A Trust?

A trust is a legal arrangement in which a third party holds or manages property or financial assets for the benefit of a designated party. Trusts often are used for estate planning because they can eliminate the need to go through probate and protect assets from debts or taxes.

There are three parties to any trust:

Revocable Trusts

A revocable trust can be revised and changed in any way the settlor likes. Once the settlor dies, the trust becomes fixed and cannot be changed. Revocable trusts are helpful if someone has significant assets they want to pass to their heirs or use to care for a surviving family member with special needs. The settlor can serve as the trustee on a revocable trust, which makes it a living trust.

Irrevocable Trusts

The settlor cannot change or cancel an irrevocable trust once it’s established. The only way to modify an irrevocable trust is for the beneficiary to consent to the change. One primary advantage of irrevocable trusts is the assets they hold are excluded from the settlor’s estate for tax purposes.

One type of irrevocable trust is a testamentary trust, which is created by the settlor’s last will and testament when they die.

Taxes You May Have To Pay When Selling A House In A Trust

There are several types of taxes you may have to pay when selling a house in a trust.

Capital Gains Tax

Capital gains taxes are paid on profits from the sale of assets, including homes. There is an exemption on taxes for a certain amount of profit if you meet the qualifications. This could come into play if a living grantor sells a home held in a revocable trust.

Here’s how capital-gains taxes work: If you bought a home for $500,000 and sold that later for $700,000, you would owe capital gains tax on your $200,000 profit. The tax rate you can expect to pay will vary based on how long you held the property as well as your income.

However, there’s an exemption for those who have used a property as their primary residence and owned it for two out of the last five years. Although you have to own and live in the home as your primary residence, those can be separate two-year periods. The amount of the exclusion can be up to $250,000 filing as an individual or $500,000 if married filing jointly.

Estate Tax

Estate taxes are paid out of the accounts of the deceased. If the heirs decide to sell the family home, the profits are paid to the estate, which would also be responsible for the taxes.

The threshold rates for the tax brackets on capital gains taxes are different for estates and trusts than they are for individuals.

The capital gains tax is still paid, but it’s out of the proceeds of the trust so that beneficiaries don’t have to deal with it.

Inheritance Tax

Some states charge what’s called an inheritance tax. Instead of or in addition to taxes being paid by the estate, the individual or group inheriting the property pays a tax on the value. Tax rates and exemptions vary quite a bit from state to state.

What’s Your Goal?

Home Purchase

Home Refinance

Tap Into Equity

How a Step Up In Basis Affects Your Tax Bill             

It’s important to note that the tax you pay on selling a home can be reduced with a step up in basis. This means that if your parents bought a property for $150,000 and it was worth $300,000 when you inherited it, the capital gains taxes you paid when you sold the property would be based on the $300,000 value at the time of inheriting rather than the $150,000 value when they bought the property.

However, when you inherit a house as part of a trust, it depends on whether the trust was revocable or irrevocable at the time of the person’s passing. If it was revocable, there is a step up in basis because the grantor retained control and could’ve pulled the home out of the trust at any time.

If the property was transferred to an irrevocable trust prior to death, there’s no step up in basis because it is not considered part of the estate for tax purposes. This is true even though the grantor is responsible for the taxes on the property until it’s passed to the beneficiary under the terms of the trust, even if that only happens after the grantor’s death.

Tax Implications Of Selling A House In A Trust

Many factors are involved in determining your tax liability when selling a home in a trust, depending on the laws in your state, the value of the home, the type of trust, and the terms of the trust.

Here are a few common tax scenarios you may face when selling a home in a trust, though it’s always best to consult an attorney for advice on your specific situation.

If the home is in a revocable trust when sold, tax liability is pretty straightforward. Property of a revocable trust is generally treated as owned by the grantor. That means that when selling a home in a revocable trust, the grantor selling the home is taxed on their capital gains on the sale. The theory is that because the trust was revocable, the grantor never relinquished the asset and would owe the tax liability.

On the other hand, what if the trust is already being paid out based on either the grantor’s death or the appropriate amount of time passing under the terms of the trust? Who is taxed on the sale of the home? The answer to this can depend upon how the trust is set up.

If the documentation underlying the trust permits the trustee to reinvest the profits from the sale of any assets back into the principal and they choose to do so, the tax on that capital gain is charged to the trust itself.

On the other hand, if the trustee regularly passes all gains to the beneficiary, the beneficiary gets taxed on those gains.

Selling A House In A Revocable Trust Vs. An Irrevocable Trust

There are similarities and differences when selling a house in a revocable vs. irrevocable trust. Let’s take them in turn.

If a house is in a revocable trust, you don’t need anyone’s permission to sell the property because you can freely move assets in and out of the trust until you die. Because you can just take the property out of the trust to sell it, there are no special considerations, so you pay taxes as if the trust did not exist.

If you’re selling a house in an irrevocable trust, there are a couple of separate issues to think about: The first is whether there is a step up in basis. The second involves your actual permission to sell.

As to the fair market value question, it helps to know that all revocable trusts become irrevocable on the death of the last grantor. However, because the property was under the grantor’s control until their death, it’s considered part of the estate. A step up in basis would allow the capital gains tax owed by beneficiaries to be based on the difference between the sale price and the home’s value at the time of inheritance.

It works differently if the trust was set up as irrevocable from the start. If that was the case, the property is treated as a gift the second it’s put in the trust. Once in the trust, because it’s no longer under the grantor’s control for estate purposes, you don’t get a step up in basis on inheriting property.

Capital gains taxes would be based on the sale price minus the property’s value when the grantor bought it. Who pays the capital gains taxes depends on whether the profits from the sale are reinvested in the trust or passed through to the beneficiaries as part of regular payments. If they are reinvested, taxes are paid by the trust. Otherwise, it falls to the grantees.

While we’ve gone over several general points here, what happens can vary greatly depending on how your trust is set up. We recommend consulting an attorney. If you choose not to sell but rather have one person take over the home, here’s more information on how to refinance an inherited property to buy out heirs.

Selling a House in a Specialized Trust

There are trusts designed for specific situations, so selling a home held by one of these specialized trusts may have unusual tax implications.

Qualified Personal Residence Trust

Qualified Personal Residence Trusts allow homeowners to transfer a home into a trust and continue to live in it for a specific number of years. Even though you can stay in the home, QPRTs count as irrevocable trusts, partly because you limit how long you can remain living in the home.

When you create the trust and transfer your home into it, the value of your remaining occupancy term is calculated using the value of the home, the occupancy term, your age, and prevailing interest rates. The home’s value is reduced by the value of your occupancy, and your gift tax exclusion is reduced by the property’s resulting value. When your occupancy ends, the home passes to the beneficiary with no further taxes owed.

The beneficiary of the trust could then sell the home, but they would be liable for any taxes owed on the sale. The cost basis of the home is determined using the home’s value at the time of the trust’s creation, so they won’t benefit from a step-up in cost basis.

Charitable Trusts and Real Estate Donations

Charitable trusts allow you to take tax deductions for charitable giving while retaining flexibility over how the assets you’re donating are used.

For example, you could create a charitable trust and donate money to it. You can immediately take a charitable giving deduction but not decide what organizations to give the money to until later.

You also could donate real estate to a charitable trust, taking a deduction for the value of the property you donate. The trust could then sell the property without incurring taxes and use the proceeds for charitable purposes.

Medicaid Irrevocable Trusts

Medicaid is a government program that provides health insurance to people with limited income and financial resources. Because Medicaid looks at people’s income and assets to determine whether they qualify, some people create irrevocable trusts to try to qualify. Because assets in an irrevocable trust are technically owned by the trust and not the grantor, the assets may not be considered when determining the grantor’s Medicaid eligibility.

However, Medicaid has rules to prevent people from placing all of their assets into an irrevocable trust to qualify more easily. For one, if you’re the grantor and beneficiary of the trust, the trust’s assets will be considered when determining eligibility.

Medicaid also looks back on all the assets you’ve given away or gifted in the five years before you applied for Medicaid. Any gifts made during that period can lead to periods of ineligibility for Medicaid based on the size of the gift and the cost of care.

For example, if you gifted $25,000 to a trust and need help paying for medical assistance that costs $2,500 per month, your eligibility for Medicaid would be delayed by 10 months ($25,000 / $2,500 per month).

It’s worth noting that primary residences are excluded, up to a set value, when determining asset-based eligibility for Medicaid.

If you place your home in a trust designed to help you qualify for Medicaid, you must do so at least five years before you apply for Medicaid. Because you must use an irrevocable trust for this purpose, selling the home in the trust would not impact your personal tax situation. Instead, the trust itself or the beneficiary would owe taxes.

FAQ

Here are answers to common questions about the tax implications of selling a home in a trust.

The Bottom Line

You may owe taxes any time you sell a home, regardless of whether it’s in a trust. The type of trust, the timing of the sale, and applicable laws all determine who pays the taxes. In addition to tax considerations, you will need to be sure that the trust documentation clearly shows you have the right to sell the property in your current circumstances. We recommend consulting an estate planning attorney about your situation.

More From Quicken Loans:

• Trust Fund: What Is It, And How Does It Work?
• Real Estate Taxes Vs. Property Taxes: A Complete Guide
• What Is A Property Tax Exemption? Finding And Claiming Property Tax Benefits
• Tax Benefits Of Real Estate Investing: What To Know
• What Is The Property Tax Deduction And How Do You Claim It?   

T.J. Porter contributed to the reporting of this article.