MyVeryOwnSelf wrote:

- quote -

The basis of A, B and C, acquired by the trust through
inheritance, is the FVM at date of death; the basis of D and
E, purchased by the trust, is their purchase cost.

Linda Dorfmont E.A., CFP, CSA

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- quote -

At the death of the first spouse the bypass trust gets a
step-up in basis of all its assets at DOD and the
acquisition date is automatically "long term" for those
assets. So, when sold, they are long term and the basis of
anything bought new is its purchase price and new assets
when sold are either long term or short term. Ignore the
death of the second spouse as to assets in the bypass trust
in a non-community property state.

The assets in the spousal trust do NOT get a DOD step up
until the second death. Trades, until then, are either long
term or short term from original acquisition date. Upon
second death spousal assets get step-up to DOD value and
when sold are long term

The sale of any assets in either trust bought after its DOD
is either short term or long term.

In a community property state the spousal trust assets ALSO
get a step-up to DOD valule of first spouse, and ONLY the
spousal trust gets another step up at DOD of second spouse.

MF

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- quote -

The "bypass trust" becomes a SEPARATE tax entity upon the
death of the first spouse, and the cost basis of assets in
the trust at that point are the date of death values. If
those assets are sold, and the funds invested in new assets,
the cost basis of the new assets is their purchase price.
Death of the second spouse will have NO effect on the cost
basis of assets in this "bypass trust", as it is not part of
the estate of the second spouse.


- quote -


Resulting in the following taxable gains/losses:
Asset A: +$10,000
Asset B: -$10,000
Asset C: +$20,000
Capital gains taxes are paid by the trust, not the second spouse.

- quote -

Same as their purchase price ($70,000 and $10,000), since
what goes on in this trust has nothing to do with what the
second spouse does. It became a separate tax entity upon the
death of the first spouse.

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MyVeryOwnSelf <self[at]emailNot.nul> wrote:

- quote -

It's called a "bypass trust" because it contains the
property of the spouse who died first, and it bypasses (is
kept out of) the estate of the surviving spouse.

Since the property in the trust all belonged to the deceased
spouse, it all gets an adjusted basis on the date of death.

Without the bypass trust the couple would incur what I call
the marital penalty in the estate tax. It works like this:

Say a couple together have assets worth $2,000,000. Let's
assume the exempt amount is $1,000,000, which it will go
back to in 2010.

When one spouse dies his half incurs no tax. Normally he
will leave it to his spouse. So when she dies she's got a
total estate of $2,000,000, and a tax of about $380,000.

The bypass trust keeps the first million out of the second
estate. The surviving spouse can manage it, take all the
income, and can even withdraw principal if she needs to.
But she is not considered the owner of the property in the
trust. So that when she dies only her $1,000,000 is counted
in her estate, and she doesn't pay any estate tax either.

- quote -

If assets are acquired after the death of the spouse, they
certainly won't use the date of death value to determine
basis. Only property actually owned by the spouse while he
was alive gets a changed basis. Property acquired by the
trust after death takes the purchase price as the basis.

Stu

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- quote -

The "bypass trust" basis still puzzles me. The confusing
part is when bypass trust assets get sold with the proceeds
invested in new assets after the first spouse's death but
before the second. I can't help thinking that the basis of
the new assets would be their purchase price (adjusted as
needed). Is it really necessary to somehow trace back the
basis of the new assets to the first spouse's date of death?
This would be kind of like an IRA where trades along the way
have no tax consequence.

Maybe a simplified artificial example would help. (A
realistic example would have lots more trades, staggered in
time.)

At death of first spouse, trust has
Asset A: $10,000
Asset B: $20,000
Asset C: $30,000

Ten years later, values have changed; trust sells:
Asset A: $20,000
Asset B: $10,000
Asset C: $50,000

and buys
Asset D: $70,000
Asset E: $10,000

After death of second spouse four years later, trust sells:
Asset D: $80,000
Asset E: $20,000

With no adjustments, what's the basis of Asset D and Asset E?

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- quote -

The property in the bypass trust is what belonged to the
spouse who died first. That's the property that gets a
stepped up basis to the value on the date of death.

The property in the spousal trust belongs to the spouse who
is still alive. It doesn't get a stepped up basis because
there is no date of death. Of course when the second spouse
dies, it gets a stepped up basis to the value on the date of
death of the second spouse.

- quote -

Have both spouses died? If so then the property that came
from each spouse gets a basis based on that spouse's date of
death. If one is still alive, the securities in the spousal
trust will have the purchase price as the basis, unless
there was some adjustment to basis for some reason.

- quote -

Step up of acquisition date? What do you mean? That the
acquisition date would be considered the date of death?

No, it's a gift not a purchase. And a special rule applies.

- quote -

It only applies to the trust holding property belonging to
someone who died. If one spouse is still alive, it won't
apply to the property in the spousal trust.

Stu

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- quote -

That's this case. TP was grantor; TP and spouse were
trustees originally.

- quote -

You mean "spousal trust" here, right?

Also, if securities were traded in the spousal trust years
ago, with none of the original holdings remaining, would the
basis now be the purchase price of each security? No
adjustments are apparent. Assets were muni bond funds. Each
reinvested distribution presumably would be counted as
another purchase. (This means tracking down the history; oh
well...)

- quote -

For the bypass trust, does step-up of basis include step-up
of acquisition date? If so, it'd all be short-term in this
case.

OTOH, instructions for Schedule D say "If you disposed of
property that you acquired by inheritance, report the
disposition as long-term gain or loss, regardless of how
long you held the property." Does this not apply to either
trust?

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- quote -

Generally a couple has a single trust. When one of them
dies it gets divided into two. The spousal trust contains
all the property belonging to the surviving spouse, while
the bypass trust contains the property of the deceased
spouse.

The spousal trust, therefore, remains revocable (e.g. all
income taxed to the surviving spouse) while the bypass trust
becomes irrevocable (a separate tax-paying entity).

Pennsylvania is apparently not a community property state.
So generally the property in the bypass trust will have its
basis increased to the value at the date of death, while
property in the spousal trust will have as its basis the
original purchase price (with whatever adjustments are
appropriate under the circumstances).

- quote -

The basis of property in the bypass trust stays the same -
date of death value for the first spouse who died. The
basis of property in the bypass trust will take on as its
basis the value at the date of death of the second spouse.

- quote -

It's a per-item issue. Short term gains and losses are
netted separately while long term gains and losses are also
separate.

Stu

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- quote -

TP set up two trusts, A (spousal) and B (bypass).

Trusts' assets were invested in muni bond mutual funds.
Distributions were reinvested the for many years. Aside from
reinvested distributions, there were no asset sales or
purchases for several years.

State is Pennsylvania.

In 2006 spouse died, funds were sold, and proceeds were
divided among children of TP&spouse.

How should basis of funds be calculated for income-tax
purposes?

How should capital gain/loss be split between long-term and
short-term?

Any tax gotchas?

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- quote -

I was quoted (by a tax professional) 26CFR1.662 as follows:

"...There is first included in the gross income of each
beneficiary under section 662(a)(1) the amount of income for
the taxable year of the estate or trust required to be
distributed currently to him..."

In the final year of an estate (i.e. in the year the 'final
estate income tax return is filed for), income is 'required'
to be distributed currently to the beneficiaries, and thus,
in that final tax year only, the opinion was that the
beneficiaries had to claim and pay taxes on any estate
income, including estate capital gain.

Similarly, with regard to state taxation, Massachusetts
includes the following instructions:

"Effective for taxable years beginning on or after January
1, 2005, estate and trust income includable in the federal
gross income of a beneficiary by reason of Internal Revenue
Code ("Code") § 652 (the section of the Code that determines
the amount and character of the gross income includable by a
simple trust beneficiary) or § 662 (the section of the Code
that determines the amount and character of the gross income
includable by a complex trust beneficiary) is no longer
taxable at the estate or trust level; rather, it is to be
taken into account in calculating the beneficiary's
Massachusetts taxable income under G.L. c. 62, § 2.

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- quote -

I'll have you know I take Metamucil each and every day,
thank you very much!

Stu

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- quote -

No offence intended, but generally a person gets conflicting
answers because he/she doesn't know how to ask the right
question. It's really quite easy to determine with a bit of
research who's right and who's wrong on a specific topic.
Why don't you post your question here (or on the Misc Tax
board here you get immediate replies). I also suggest any
trustee read Henry Abts' books on creating a Living Trust,
and Settling a Living Trust. However, even Henry leaves
you hanging on a few points, and is not totally accurate or
even lucid regarding a deliberate GST that avoids any GST
tax. Considering the size of his books (which in itself is
quite impressive, but boringly repetitive) and the
considerable advantages to GSTs a couple of pages on the
subject would be expected.

ed

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- quote -

Are you suggesting that the professionals are irregular?
I suppose it would be better to not amplify that line of
thought.<g
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MyVeryOwnSelf <self[at]emailNot.nul> wrote:

- quote -

The reason that there seem to be divergent opinions is that
the result is very fact specific. So I doubt more
information will help you much unless you know exactly what
facts are important and which aren't.

Stu

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- quote -

Could you post what you learn (if practical)?

I for one am in a similar position and have heard divergent
opinions from both professionals and regular folks.

Thanks.

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"ed" <edcosoft[at]sbcglobal.net> wrote:

- quote -

Absolutely correct. Thanks for mentioning that - it's an
issue I hadn't thought of.

Stu

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"tobe" <ybotkaSPM[at]cinci.rr.com> wrote:

- quote -

My understanding is that it is the estate's option either to
pay tax at the estate level or to distribute to
beneficiaries and have them pay their own taxes. If there
are multiple beneficiaries and the property qualifies for
long term capital gain, it may be that the individuals are
more likely to be taxed at a lower rate than the estate.

- quote -

I used to do federal estate tax returns years ago. But they
have become so long and complex that I won't touch them
anymore.

Stu

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- quote -

Possible but unlikely. Most trusts are set up to be
revocable, meaning that they are transparent for most income
tax purposes. Even some irrevocable trusts are specifically
set up as "defective," meaning intentionally created so that
the person who sets up the trust is taxed on all the trusts
income, or the property would be considered in his estate
when he dies. (The grantor trust rules are slightly
different with respect to income taxes as opposed to estate
taxes.)

- quote -

If the trust was a typical estate planning trust, you're
probably in the clear and can use the date of death
valuation. Take it to a tax attorney to review to determine
if that's the case.

Stu

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Thanks for your replies. I will use a professional.

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"joetaxpayer" wrote

- quote -

From my estate/inheritance experience, using a tax
professional, the estate usually passes on (no pun intended)
any capital gains to the heirs via Schedule K1 of the estate
income tax return, and the heirs subsequently pay any
capital gains tax. In fact, this seems to be required in
the final tax year of the estate (which, from the OP's
description, will probably be this year).

Since some States have estate income tax forms which are
even worse than the Federal ones (e.g. Massachusetts), I
also recommend that the OP consult a tax professional in the
state of the deceased who has experienced with estate
returns. I consider myself very experienced in (my own) tax
returns (including, some years ago, an S-corporation
return), and the Federal and State estate income tax returns
were mostly incomprehensible to me.

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