Step Up in Basis Question

[JohnH]

Friday afternoon question, since my mind is elsewhere.

Husband and wife own residential rental property with $50K cost basis but appraised at $200K in 2002.  She dies later in 2002 and her half goes into an irrevocable trust. So the cost basis for her trust is $100K.  Adult son and daughter of the couple are the beneficiaries of the trust.    In 2012, the property is transferred to an LLC, owned 50% each by husband and the wife's trust. The LLC files as a partnership, with income/loss being reported by the husband and the trust via their K-1's.

 In 2014, husband dies. Property appraises at $400K.  His will calls for his interest in the property to pass to the same son and daughter as above. Property eventually sells for $400K and the LLC will dissolve.

As I see it, the cost basis for the son & daughter is $200K ($100K each) for their share of the husband's interest in the LLC.   The son & daughter will report zero gain on each of their their proportional shares of the husband's 50% of the LLC ($200K selling price minus $200K stepped up basis), and the mother's trust will report $100K of long term capital gain ($200K selling price minus $100K in cost basis). Is that correct?

Second question - any thoughts on whether the trust can show the $100K of long term capital gain on the K-1's issued to the son & daughter beneficiaries?  (Tax will be much lower if the beneficiaries can report the gain rather than the trust).  So far I've read lots of confusing stuff on this. Any thoughts or speculations would be helpful.

[SaraEA]

Look at the trust document.  Usually capital gains are attributed to the trust corpus, so the trust gets to pay the tax.  (If the trust document doesn't address this issue, look at state law.)  If the trust is going to dissolve, the gains can pass through to the beneficiaries.  If not, it may be able to switch to a "complex trust" and distribute the capital gains.  Again, the trust document will govern.

You have the cap gains calculated correctly.

[JohnH]

Thank you Sara. That's very helpful and a big relief.

[michaelmars]

why is the trust dissolving.  was that the intent?   And if so wouldn't the kids basis be 150?   $100 dad and $50 from trust?

[Roberts]

I believe in most cases you get to make the choice. When you do the Schedule B of the 1041, you first determine the Distributable Net Income and then lines 9 and 10 will inform the IRS who is getting taxed. An attorney I work with will also flip this year to year. For example a set of clients get only the income from the trust and it's not a massive amount of money but the equity securities can generate substantial capital gains. It would be overly burdensome to flow the tax to the beneficiary so we have the trust pay the cap gains taxes and some years it pays the income tax also (rarely).

I believe you are right on the Cap gain figure John.

[michaelmars]

if the trust is ending then I believe the final year its always considered a simple trust and all income will flow to the bene's.

[JohnH]

Thanks for all the additional replies.  The trust is ending because the beneficiaries want to simplify their lives.  Costs are not worth maintaining the trust, in their opinion. All beneficiaries are in agreement to end the trust.