04 Dec What happens to tax credits now that our home is in a trust?

Q. My wife and I are in our mid-80s. We live on a modest pension and social security and do not spend our entire income. Our home is mortgage-free and we have what we thought would be a nest egg sufficient to see us comfortably to the end of our lives. We have one daughter. We put some marital assets including bank savings, equities, and our home in an irrevocable living trust with our daughter as trustee and beneficiary in March, 2020. The trust has an EIN. Our IRA accounts, personal checking accounts, and a small money market account are not part of the trust assets. We hope that in creating the trust, we won’t lose tax credits and my veteran’s credit on the home. What do we need to know?
— Seniors

A. The income taxation of trusts is an incredibly complicated topic.

For starters there are two types of trusts for income taxation purposes. There are simple trusts and complex trusts, said Bernie Kiely, a certified financial planner and certified public accountant with Kiely Capital Management in Morristown.

He said there are also the concepts of income and principal. Principal is also known as corpus.

“A simple trust must distribute all its income currently. Generally, it cannot accumulate income, distribute out of corpus, or pay money for charitable purposes,” Kiely said. “If a trust distributes corpus during a year, as in the year it terminates, the trust becomes a complex trust for that year.”

Whether a trust is simple or complex determines the amount of the personal exemption — $300 for simple trusts and $100 for complex trusts — that applies in calculating the tax owed, he said.

A complex trust is any trust that does not meet the requirements for a simple trust. Complex trusts may accumulate income, distribute amounts other than current income and make deductible payments for charitable purposes, he said.

Kiely said if your trust document requires all income to be paid out to you and your spouse, then it is a simple trust.

“The trust will receive a deduction on its tax return form 1041 for the income that was paid out to you. You will report the income you receive on your tax return form 1040,” he said. “You will be responsible to pay federal and state income tax on the trust income.”

Any principle, such as stock gains or losses, plus mutual fund capital gains distributions belong to the trust and are reported by the trust on its tax return, Kiely said. The trust will have to pay the tax on any principal income it receives.

You asked about the tax credit on the house.

If you, through your lawyer, retitled the house in the name of the trust, then it is no longer your house. Your home now belongs to the trust.

“Since it is no longer your house, you no longer have the right to get a tax deduction for the real estate taxes,” Kiely said, adding that it’s probably a moot point because you have no mortgage, which means no mortgage interest.

The standard deduction for senior citizens is $27,400 for tax year 2020, so you are probably taking the standard deduction, he said.

You also asked about your veteran’s credit.

Homeowners who served in the military are entitled to a $250 reduction on their real estate tax, Kiely said.

“Since your home is owned by your trust, which hasn’t served, the $250 reduction in your real estate tax bill is gone,” he said. “However, you are still eligible for your $6,000 veteran’s exemption on your New Jersey income tax return. This exemption is because you served it has nothing to do with home ownership.”

But Kiely said one thing troubles him.

“What disturbs me is by placing your home and investments into the trust you are denying your daughter a step up in the cost basis on your home and investments when you pass,” he said. “This will cost your daughter thousands of dollars in income taxes when you are gone. You should talk to your attorney about this.”

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This story was originally published on Dec. 4, 2020.

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