Given the numerous and varied goals that can be attained through the use of a trust, a trust is a common addition to the average estate plan. If you are contemplating the addition of a trust to your estate plan, you should understand how trusts operate and be clear on the advantages and disadvantages of including a trust in your plan. To get you started, the Essex Junction attorneys at Unsworth LaPlante, PLLC discuss whether a trust pays capital gains taxes.
Understanding Capital Gains Taxes
Capital gains taxes are incurred upon realizing a profit from the sale of an asset. For instance, if you acquired real property for $500,000 and sold it a decade later for $1 million, you would realize a gain of $500,000. That gain would be subject to capital gains taxes by the U.S. government. The complexities arise in determining when these taxes are due, calculating the taxable gain, and ascertaining the tax amount owed, given the intricacies of the numerous factors and tax laws involved.
Capital Gains Taxes and Trust Assets
Whether capital gains taxes are owed following the sale of a trust asset hinges on several factors, primarily the type of trust in question. In the case of a revocable trust, it typically does not function as a separate tax entity during the Settlor’s lifetime. Consequently, if a trust asset is sold, resulting in a capital gain, the tax obligation must be reported on the Settlor’s personal tax return, as the Settlor maintains ownership control over the trust property.
Conversely, an irrevocable trust is typically treated as a distinct tax entity, as the Settlor relinquishes control and the ability to reclaim the assets transferred into it. Gains or losses from the sale of trust assets in an irrevocable trust are not reported on the Settlor’s personal tax return; however, the analysis doesn’t end here because the type of irrevocable trust also plays a crucial role.
A simple irrevocable trust is required to distribute all income generated annually, and these distributions are taxable to the beneficiaries as income. In contrast, more intricate irrevocable trusts are permitted to retain some income, with capital gains considered contributions to the principal. Consequently, if the trust sells an asset and realizes a gain, the gain is not distributed but is treated as profit to the trust, incurring taxes.
Distribution to a Beneficiary
In scenarios where an irrevocable trust transfers an asset to a beneficiary instead of selling the assets and distributing the gain, the responsibility for any ensuing taxes falls upon the beneficiary. While the initial distribution may not be taxable, any future capital gains taxes arise if the beneficiary decides to sell the asset. In such cases, the taxable amount is typically calculated based on the asset’s value at the time of distribution to the beneficiary, not its original purchase value.
Given the intricate nature of irrevocable trusts and taxation, seeking guidance from an experienced trust attorney is advisable before determining the type of trust to establish and the assets to use for trust funding. Likewise, if you are administering a trust, be sure to consult with a legal and tax professional to determine if capital gains taxes are due from the trust.
Do You Have Questions about Capital Gains Taxes and Trusts?
For more information, please attend one of our upcoming FREE webinars. If you have questions about trusts and capital gains taxes contact an experienced Essex Junction estate planning attorney at Unsworth LaPlante, PLLC by calling 802-879-7133 to schedule your appointment today.
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