Real Estate Professional Tax Loophole - holdings in a trust

7 Replies

Question for the CPA's - Person A is setting up a trust for estate planning purposes.  Person B will be the beneficiary of that trust upon the death of Person A.  The assets of the trust are primarily income producing real estate and are all free and clear.  (Not sure if this matters, but there is also stock/cash in the trust.)  Is there anything that would prevent Person B (who manages, draws income, etc. from the trust assets) from obtaining status as a Real Estate Professional under the tax code?  Does the fact that assets are in trust affect this?  ( Let's assume that the trust gives Person B the power/authority to leverage the current assets and borrower against the currently existing assets thereby allowing Person B to acquire additional real estate.)

Person A set up a revocable living trust which has 5% of the rights but has 100% voting/control.  Person B set up an irrevocable generation skipping trust that has  47 1/2% % which is NON-voting.  (And there is a Person C with an identical 47 1/2 % in another irrevocable generation skipping trust.)  Upon the death of Person A, the remaining 5% with voting control will be transferred to Person B and Person C.  

Upon the death of Person A, Person B will be managing the real estate that is held in each of the Trusts of B and C.  

Clear as mud now, right? :)

You should consult with a CPA/Tax Professional.

The Trustee would need to meet the real estate professional rules to qualify the Trust.

If all the assets of the trust are owned free and clear, then I am guessing the trust will not have a net passive income loss from the rental activity, making Real Estate Professional Status moot.  The trust is a pass-through entity will its net positive income taxed on the beneficaries' tax returns.  

Originally posted by @Dave Toelkes :

If all the assets of the trust are owned free and clear, then I am guessing the trust will not have a net passive income loss from the rental activity, making Real Estate Professional Status moot.  The trust is a pass-through entity will its net positive income taxed on the beneficaries' tax returns.  

 The trust gives trustee authority to borrow.  I’m not well versed in the tax loop hole, but would it not make sense to take advantage of that?  If the Trustee wishes to continue investing in additional real estate would that not be the best avenue?  Or would paying cash be the safe play?

If the trustee buys smartly, even a financed property will have a positive cash flow.  If depreciation offsets the cashflow giving a breakeven or slightly negative tax loss, it still passes through to the beneficiaries to be reported on their personal 1040s. 

i would further hazard to guess that the eventual beneficiaries will want to dissolve the trust upon the death of the grantor.  The trustee will sell all the assets of the trust at stepped up basis, distribute the net proceeds to the beneficiaries and file the final trust tax return and Schedule K-1s.  The situations you are anticipating will most likely never arise.

@Mark Dante

This is a tricky situation that can have many twists. I would hash it out with a good tax accountant, and not online.

Short of this substantial discussion, let me throw in some general principles.

  • The tax liability from the trust flows thru to the beneficiaries, not the trustee. Accordingly, the RE Pro status will be a beneficiary's issue, not a trustee issue.
  • As @Dave Toelkes pointed out - it only matters if the trust creates an overall loss. Let's assume it does.
  • To qualify for the RE Pro status, each beneficiary needs to show "material participation" in the trust's activities. Person A apparently has very light involvement and therefore will not qualify.
  • It is not clear to me whether Person B is already a beneficiary of the trust or will only become one upon the death of A. If he is not yet a beneficiary - nothing to discuss. If he is already a beneficiary, and he receives losses from the trust via K-1 - then he might be able to qualify for RE Pro due to his extensive involvement in his trustee's role.
  • However, if Person B is not a beneficiary himself, but the actual beneficiary is his irrevocable trust (which you seemingly implied) - then the whole thing is out. The irrevocable trust will be receiving K-1 from the "mother trust" and paying its own taxes as a trust. Person B watches this whole thing from the outside.

But really, it all should be discussed at more depth before drawing conclusions. Too many other pieces are missing, and they can easily change the big picture. 

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