How Would You Fund This Bypass [B] Trust?

[SFBOB]

Taxpayers were married 30 yeras and lived in a community property state.

A revocable trust provides for a bypass trust upon the death of the first spouse, wife died November 2009.Community property consisits of the pesonal residence FMV $1,000,000, residential rental property FMV $2,000.000, Stocks and mutual funds FMV $2,000,000.

I have learned that passive loss on rentals [ as a result of stepped up basis] will not pass through to the survivng spouse if the rentals are used to fund the trust.The passive loss remains in the trust until the rentals are sold or the assets are distributed to the beneficiaries upon the death of the surviving spouse.

The trust document provides for distribution of all income at least annually, [ capital gains at the discretion]of the surviving spouse. It would seem that the main disadvantage of funding the trust with stocks and mutual funds would be tying up principal that may be needed by the surviving spouse.

Surviving spouse is 60 years old and lives on the income from the rentals and investments. If this were your client, how would you fund the trust? Thanks for your time. Bob

[jasdlm]

Is the residential rental property 1 unit (i.e. is it all or nothing into the bypass trust if you choose real estate)?

[SFBOB]

Thanks jasdim I am on three forums and only 2 replys. The rentals are 2 single family residential rentals. Each FMV $1,000,000. My thought is would the Stock and Mutual funds create a problem if used to fund the trust?Problem with using the rentals is the suspended passive losses are not available to reduce the srviving spouse's current income. Your continued thoughts will be appreciated. Bob

[SaraEA]

There are a lot of issues here. First, this being a community property state, I believe half the value of the community property passes from the wife to the husband. Her estate is therefore $2.5m, which is below the taxable estate threshold unless she exceeded $1m lifetime gifts in the past. The real issue is how to minimize the surviving spouse's estate so the eventual tax bite won't be too big. You say he needs income and perhaps principal to live on now and likely more as he ages and may require expensive assistance and care. Thus the readily consumable assets should be kept out of the B trust. The more of them he consumes, the smaller his estate will be. Of course, at the moment there is no estate tax, but I can't believe Congress will allow wealth to transfer freely so I'm sure they'll pass something.

What concerns me is the wording of the B trust that the surviving spouse gets all the income annually and capital gains at his discretion. Capital gains are income, no? Note that the Code allows for getting some of the income, but the wording has to be expressed as a certain percentage or fraction to be eligible for the marital deduction. Since the wife has no taxable estate, why would they even want a marital deduction? Let all her assets be included in her estate, she pays no tax, and then his estate doesn't have to include assets already "taxed" to her. Not sure on the logic of this, but it's a thought.

Are you sure the wife's half of the suspended losses carry forward to the trust? I thought they were lost forever upon death. If the husband doesn't plan on selling the properties, I wouldn't worry about the suspended losses. His heirs may get stepped-up basis after the losses are factored in (and after whatever happens with the new laws on stepping up, which are such a nightmare no one believes they will stand).

State law governs property interests, so these add another wrinkle. I'm glad I'm not you!

[ed_accountant]

If this were my client, I would advise them to hire an estate/probate attorney to devise an estate plan. I am always careful not to provide legal advice due to the liability.

The liability of giving bad advice will surely exceed any fee obtained..

[SFBOB]

Client and his attorney have decided to fund the trust with the rental property. Main reason is to make the principal amount from the stocks available to the surviving spouse if needed. I have confirmed with NATP for a $25.00 question that the passive looses remain in the trust and are released when the property is sold or pass to the beneficiaries. Thanks to all for the feed back.Bob

[SFBOB]

The client after deciding to fund the bypass trust with rental property, asked me to make a projection of how the children would fare on his death after 20 years.

[1] I have reconfirmed that the suspended losses on the residential rental property remain in the trust and do not pass to the survivor annually for his benefit on the 1040.[2] I worked an example of suspended losses carried forward for 20 years an prepared example return on the 2008 ATX software. Result is when the property is sold the gain reported in the 4797 results in a K-1 entry on line 11D, Net Operating Loss Carryover. The benefit to the beneficiariy will require an amended return with an NOL carryback at the time of death of the father.

[iNTERESTING STUFF THIS TRUST TAXATION]. Most of us do not get envolved unless we have a good rerlationship with a trust attorney. There is good money in this work if you can get it!!!. Thanks to all for your feed back Bob