Capital Gains Tax on a House Sold From a Trust

Your largest income tax exclusion might be from selling your house.

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Suppose you created a trust and placed your house in the trust. If you control the trust and the property in the trust, and you retain power such as the ability to amend, revoke or terminate the trust, the Internal Revenue Service will likely regard the trust as a grantor trust and tax you on the trust's income, deductions and credits as though you received them directly. However, when you sell the house, the tax treatment is consistent, and you qualify for capital gains exclusions as though you owned the house, provided you meet the requirements for the exclusion.

Grantor Trust

If the trust that owned the house is treated as a grantor trust according to IRS Regulations 671 to 679, and you are the owner of the trust or the owner of the portion of the trust that owned the house, the IRS essentially disregards the trust for federal income tax purposes. Just as you are taxed on the income and deductions of the trust, you also qualify for any corresponding credits and exclusions, such as the exclusion of capital gains from the sale of the house.

Computing Gain

If you are the owner of the trust for federal income tax purposes, your gain on the sale of the house is the difference between the selling price minus the selling expenses and your basis in the house. Your basis in the house is the basis of the house in the trust plus the cost of any improvements that increase the value of the house. Improvements include additions, heating and air conditioning systems, landscaping, storm doors and windows, flooring, carpeting and more.

Capital Gains Exclusion

As of 2013, you might be able to exclude up to $250,000 of capital gain from your federal income taxes if you meet three conditions. The first is an ownership test. During the five years prior to the sale of the house, you must have a two-year period in which you owned the house. The second is a use test. You must have lived in the house as your primary residence during the same two-year period. The third condition requires that, during the two years prior to the sale of the house, you didn't exclude the gain from the sale of another house.

Partial Exclusion

If you don't meet one of the three requirements, you might qualify for a partial exemption if you sold the house because you changed jobs, because of your health or because of an unforeseen circumstance such as unemployment or divorce. Calculate the number of days in which you did not meet the conditions during the last four calendar years, divide that by the number of days you owned the house during the same four years and multiply that by the total gain to determine the amount that qualifies for exclusion.