Question: Suzanne and Mike Sparks, a married couple, transferred their assets, including rental properties, to a single qualified revocable trust of which they were both considered grantors. As such, the income, expenses and credits were reported on their Form 1040, U.S. Individual Income Tax Return, (MFJ). When Mike died on April 1, 2023, the trust became irrevocable as to the assets of the deceased spouse. For 2023 reporting purposes, the revocable trust would report 100% of its income and deductions for the period from Jan. 1, 2023, to April 1, 2023, and then only Suzanne’s trust income and deductions through the end of the year. Now, Form 1041, U.S. Income Tax Return for Estates and Trusts, must be filed to report the irrevocable trust’s income for Mike’s trust assets for the balance of the year. Since a Form 1041 would also be required for Mike’s estate, would they be required to file two Forms 1041 – one for the newly formed irrevocable trust and one for Mike’s estate?

Answer: No, as long as they make the §645 election to have Mike’s portion of the qualified revocable trust treated as part of the related estate, they can combine the income tax reporting of the qualified revocable trust and estate into one Form 1041.

Mike’s executor elected to treat Mike’s portion of the trust’s assets as part of Mike’s estate for income tax purposes. Once the election has been made by filing Form 8855, Election To Treat a Qualified Revocable Trust as Part of an Estate, the box in item G of the heading on Form 1041 (page 1) should be checked. The executor must also attach a statement to Form 1041 providing the name and TIN of each electing trust, and the name and address of the trustee for each electing trust.

Because of this election, the income, deductions and credits associated with Mike’s portion of the trust from April 2, 2023, through March 31, 2024 (the year-end of the estate), will be included on the estate’s Form 1041 for the same period, and no separate trust tax return will be filed for Mike’s portion of the trust. Though Mike’s portion of the assets are in an irrevocable trust, only one Form 1041 (for the estate) is required to report the activity on Mike’s assets as a result of making the §645 election.

To learn more on trusts, check out our three-part on-demand webinar on forming, operating and terminating a trust.

Question: Bill and Ted have each been tenant-stockholders in their local housing cooperative, The Excellent House, for many years. Part of the monthly maintenance fees they pay are applied towards the co-op’s annual real estate taxes. Bill and Ted recently heard that these taxes are not subject to the state and local tax (SALT) limitation, which is currently $10,000. Therefore, the taxes could be potentially deducted using Schedule A (Form 1040), Itemized Deductions, in addition to other state and local taxes, despite the $10,000 limit. Is this true?

Answer: No. Deductions for the co-op’s real estate taxes are covered under §216(a)(1), which indicates taxes are still subject to the SALT limitations.

The Joint Committee on Taxation said, “[i]t is intended that the limitation apply to the deduction for amounts paid or accrued to a cooperative housing corporation by a tenant-stockholder under section 216(a)(1) (relating to real estate taxes) in the same manner as the limitation applies to real estate taxes under section 164.” Joint Committee on Taxation Staff, General Explanation of Public Law 115-97, JCS-1-18 p. 68 (December 2018).

Question:

Tristan owns land with standing timber that he sells as part of his business. He has held the timberland for several years and decided to cut the timber this year. Tristan’s basis in the standing timber is computed as $15 per cord. As of Jan. 1 in the year he is cutting the timber, the fair market value (FMV) is $35 per cord. A logging company will be cutting and hauling the timber at $75 per cord. He will be selling the timber for $200 per cord. Tristan wishes to make the election to treat the cutting as a sale or exchange under §631(a). Under this method, how much of the gain will be taxed as ordinary income and how much will be taxed as capital income on a per cord basis?

Answer:

Tristan will have an overall gain of $110 per cord. Of that gain, $20 per cord will be taxed as capital gain, while $90 will be taxed as ordinary income.

The capital gain portion is calculated as follows: $35 FMV - $15 basis = $20 capital gain.

The ordinary income portion is calculated as follows: $200 sales price - $75 cost to have logger cut and haul timber - $35 FMV = $90 ordinary income.

Question: Linda has a traditional IRA account with Fidelity Investments. What are the methods of transferring her account to another brokerage firm without incurring taxes and penalties?

Answer: Linda has two choices for rolling over her account from one firm to another. The first choice is to have the assets distributed to her, and then, within 60 days, recontribute all of the funds to a different account. Fidelity Investments will send Linda a check for the funds in her account. As long as the check is made out to the receiving trustee for the benefit of the taxpayer, it is not treated as a distribution to the taxpayer. Linda has 60 days to recontribute the assets to an eligible plan willing to take the contribution. If she misses the 60-day recontribution period, she would be taxed on the distribution and could be subject to an early distribution penalty. In some cases, the IRS may agree to a penalty waiver if the deadline is missed for good cause. Linda may roll over amounts out of her IRA only once within a 12-month period from the date of receipt of the distribution.

The second choice is a “direct rollover” from her IRA to the trustee of the receiving plan (sometimes called a “trustee-to-trustee transfer”). In this method, Linda never receives the plan assets and the trustees of each plan simply transfer the funds.

Question: John, age 52, has a traditional IRA worth $100,000. His basis in the IRA is $0 (that is, all contributions were tax deductible). Also, in 2022 he incurred a large capital loss in other non-IRA accounts from a poor investment, which resulted in a $100,000 capital loss carryover to 2023. John’s neighbor, Jay, suggested he convert his IRA to a Roth IRA before the end of this year so John can offset the entire $100,000 in income that would normally be recognized in the conversion with the capital losses carried forward from 2022. Is Jay correct?

Answer: No. The Roth IRA conversion represents ordinary income [§408(d)(1), IRS Pub 590-B] while capital losses are only deductible against gains from capital assets [§1211(b)]. If there are no capital gains to offset the capital loss carryforward, the taxpayer is allowed a deduction of $3,000 ($1,500 if married filing separately) against other income [§1211(b)(1) and (2)], but the remainder of the capital losses will be carried forward to 2024 and beyond. The Roth conversion will be fully includable as income. Assuming no other capital gains, $3,000 will be allowed as a capital loss deduction and $97,000 of the capital loss will be carried forward to 2024.