Income Tax Treatment of Residence Held in Bypass Trust

Key Points

1) Authority for obtaining grantor trust treatment and thus section 121 exclusion for residence held in bypass trust

2) Strategy: sale of residence from bypass trust to surviving spouse shortly after first spouse's death, in order to shelter post-death appreciation from capital gains tax

3) Drafting: inclusion in bypass trust of provision regarding use of residence by surviving spouse

A CPA inquires about the income tax treatment of a personal residence held in a bypass (credit shelter) trust.

The surviving spouse continues to live in the home after the death of her husband. When the trust sells the home several years later, does the sale qualify for the capital gain exclusion under Code section 121? A subscriber suggests that if the surviving spouse is the sole trustee of the trust, it may be a grantor trust as to her, making the exclusion available. Others question that conclusion.

One post cites PLR 9034004 as authority for partial grantor trust treatment (and thus the availability of the section 121 exclusion on the sale) if the surviving spouse has permitted "5 or 5" withdrawal powers to lapse during the existence of the trust.

Another strategy for avoiding capital gain is mentioned in this thread and discussed more thoroughly in an April, 1999 ABA-PTL thread. Shortly after the death of the first spouse, the bypass trust sells the residence to the surviving spouse for fair market value. That sale triggers no capital gain because of the step up in basis under Code section 1014. As the owner and occupant of the home, the surviving spouse can use section 121 on a subsequent sale of the home.

A separate question raised by the initial post concerns the use of the home. Should the surviving spouse pay rent to the trust? Responses assert that the payment of rent should not be required if the spouse is income beneficiary of the trust. One post suggests including in the bypass trust specific provisions allowing the survivor to use the residence rent-free.

The Details
List(s): ABA-TAX (11 messages)
Date started: November 18, 1999
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