Trust bought house - limited rental?

[jklcpa]

Mom's estate left a portion in trust for one son, and his sister is trustee.  Son may never see any money from this trust, and son's adult child is named to receive the trust's assets at his passing, not his estate.

For purposes of a "rental" house that trust purchased this year and that son now lives in, do the related party rules apply to this since trust beneficiary's sister is the fiduciary?  Are there similar related party rental loss limitations for irrev. trusts like 280A for individuals? 

Rent is a set monthly amount, and I have to ask how it was determined and if fair value, but what if it's not?  Let's not get into the fact that if this is below fair value rent, then she breached her fiduciary duty to protect assets of the trust, or that she shouldn't be the one collecting the rents since they are related.

Now back to my quandry - The initial up front payments of insurance and taxes caused negative cash flow by 12/31.  Do I mark this as all personal use because beneficiary is related to the fiduciary, or personal if it turns out to be below fair value, or report this in some other way?    

Yeah, head is spinning with end of March confusion that has totally set in with this one. 

 

 

 

[Lee B]

Incredibly poor planning. I have a somewhat similar situation where the family member living in the house pays zero rent.

Fortunately in my client's case, the trust has other significant income producing assets Still a bad situation.

I I tried vigorously to get my client to go back the the attorney who created this mess, but ?

I inherited this return from a CPA Firm who ignored the situation.

To compound the issues, this trust is related to my second largest write up/payroll client whose annual fees run well into 5 digits.

You can tell, I just love attorneys who do all this magical estate planning, who took a one semester tax class in law school.

Just enough knowledge to create a big ugly mess. 

 

[jklcpa]

I hear you on the web of connection to other clients. This is a relative of a relative of an owner's wife to one of my business write ups too.

This trust's only other asset is a checking account, so no other income at all.   Trying not to ignore this, but I'm not sure yet how to report it.

Every time I try to research, all the hits I get are coming up with rentals that are in living trusts or (originally) rentals of the decedent that passed through into a trust.  I don't expect others to research for me, but I'm not finding what I need. Maybe I'm using the wrong key words and searching for the wrong thing, or have found my answer with 267.  Frustrating!

[Lee B]

In my state we have an EA who has been an instructor for Trust and Estate CPE Classes for many years.

So I brought up this situation during class,  where it appears that the fiduciary duties have not been met.

I didn't receive any answers that were helpful. So what happens when the trustee has clearly not fulfilled their duties ?

I didn't get a useful answer 5 years ago and like you I still don't know ?

 

[BulldogTom]

2 hours ago, jklcpa said:

do the related party rules apply to this since trust beneficiary's sister is the fiduciary?  Are there similar related party rental loss limitations for irrev. trusts like 280A for individuals? 

but what if it's not?  Let's not get into the fact that if this is below fair value rent, then she breached her fiduciary duty to protect assets of the trust, or that she shouldn't be the one collecting the rents since they are related.

Now back to my quandry - The initial up front payments of insurance and taxes caused negative cash flow by 12/31.  Do I mark this as all personal use because beneficiary is related to the fiduciary, or personal if it turns out to be below fair value, or report this in some other way?    

 

Three thoughts:

1.  §267 ( b ) clearly states that a fiduciary of a trust and a beneficiary of that trust are related parties.  If the Property is rented (and the funds actually paid) at Fair Market Value, then there is no issue with deducting losses.  If the rent charged is not FMV, then the expenses, other than that which would be generally deductible on Schedule A, would not be allowed.   This is the same general rules for a rental between a parent/child or a child/parent situation.  

2.  I think you are being a little quick to judge on the fiduciary duties.   Real Estate is a generally sound investment.  Since title is presumably not passed to the son, the corpus of the trust is still intact, except for normal losses of first year rental that will presumably be recovered in future years.   Just because it threw a loss in year one due to an extraordinary item does not make it a breach of fiduciary duty IMHO.

3.  I am guessing that the trust document gives wide latitude to the trustee to provide for health, welfare and general maintenance of the son as current beneficiary.   I would also guess that it specifically allows for invading the corpus to do so.   And it probably says on the death of the son, the remainder corpus goes to the grandchild.   

To sum it all up, you need to only determine that the rents paid by the beneficiary are at FMV.  If not, I believe you have a related party loss that cannot be recognized for tax purposes.   Then if gets interesting, to see if you have a distribution or not.  But I don't think you would, unless the trustee was also paying for items that were personal in nature and not related to the preservation and maintenance of the home (electricity, water, etc)

Hope this helps.  Trust but verify.

Tom
Modesto, CA

[jklcpa]

@BulldogTom, thank you, I really appreciate the input, and I do think 267 is the key. You are correct that the trust gives trustee wide latitude where the trustee has ultimate discretion and is left to make the decision on whether income is distributed or adds to corpus.  She will not distribution income;  it all stays in the trust so the trust pays the tax. This is the loosest trust wording ever, with only a couple of sentences in one paragraph within the will.  

 

[BulldogTom]

Any Time.   It is very rare that you even ask for help, and I am floored that I could give you some help you can use.

 

Tom
Modesto, CA

[mfTaxAttorney]

jklcpa and BulldogTom,

There is a Section 280A problem in this case.  This is because: Prop Reg 1.280A-1(e)(5)(ii) provides that use by a beneficiary of the Trust is treated as use by the Trust.   Prop Reg 1.280A-1(e)(2)&(3) provides that although there is an exception to Section 280A when a taxpayer rents out the residence as a principal residence to another (related) person for FMV rent, when the residence is rented out to persons having an interest in the residence, the exception applies only if the residence is rented out pursuant to a "shared equity financing agreement."  Such an agreement requires an agreement between two or more persons who have an interest in the residence.  (The reason for this requirement is that the Regs assumed that a person who is renting it out is not renting it out to himself.  The case of a trust is an anomaly, where the beneficiary does not really own the residence but is deemed to own it.)

A workaround solution to the problem is to have a partnership own the residence.  The partners would be: (1) the Trust which owns 99.9% and (2) a Trust with a different beneficiary (even a relative) which owns 0.1%.  The two trusts would make a  "shared equity financing agreement." 

Note that the proposed regulations were issued in 1983.  Technically, they are not binding, and are merely an indication of the IRS position on this matter.  We could argue that the proposed regulations are poorly drafted, and there is no policy reason to require a "shared equity financing agreement" in our case.  On the other hand, Section 280A(d)(3)(B)(i) does provide that the above exception "shall apply to a rental to a person who has an interest in the dwelling unit only if such rental is pursuant to a shared equity financing agreement."  The Code does not define "an interest"; it is the proposed regs which do.

As I have a client in this situation, I am interested to hear your reactions.