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Trust [Allocation??] question


Edsel

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The best way to ask a question is to form an example.  Addressing the example will tell me all I need to know.

A trust receives $12,000 in cash, $5,000 of which is LTCG.  The trust distributes $8000 to the beneficiaries, leaving $4000 in the trust.  Which of the following would be correct (if any)?

  1. Trust reports $5,000 as LTCG income, and $8000 as a pass through deduction to the beneficiaries.  The K-1s show $5000 in LTCG for the beneficiares.
  2. Trust reports $5,000 as LTCG income but only 2/3 of the proceeds were distributed.  $3667 is reported as a beneficiary deduction, but the beneficiaries have only $3667 on their K-1s as LTCG (some 2/3 of the gain).  The remaining $1333 is taxable to the trust as current LTCG income.
  3. Trust reports $5,000 as LTCG income and $1000 is reported as a beneficiary deduction.  The trust kept $4000 of the money, so the K-1s for the beneficiaries report only $1000 LTCG and the trust is taxed on $4000 as current LTCG income.

The entirety of this line of questioning depends on the ordering of beneficiary income - FIFO, LIFO, or (moving) average...

Thanks in advance for your consideration and comments.

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It would depend upon how the trust is written up.

The IRS really only cares that the income is reported and someone is paying the proper amount of tax. A trust can distribute capital gains or keep them, depends upon the trust. A trust can spit out principal assets if the trustees are so inclined and it's allowed by the trust.

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Thank you Roberts for your response.  I'm certain the trust instrument does not cover this, but I will ask to see nevertheless.  Whatever total distribution is allocated will be a combination of income and return of capital (lowering of basis).

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Assuming the other 7,000 is income other than capital gains, typically, you just report 7,000 income, 5,000 capital gains and 8,000 in distributions and ATX will do the rest. The result will be 7,000 of income on the K1, less any expenses to offset the income, and the capital gains stay in the trust. But as Roberts already said, it depends.

And since 8,000 is more than 7,000, this is a complex trust, which usually only gets a $100 exemption.

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