Estate - Form 1041/K-1

[anteater]

What is the name of your state? PA

The decedent owned a rental property that was bequeathed to a specific beneficiary. The property was appraised at the time of death at $183,000. That value was used for calculation of the Pennsylvania inheritance tax. The total estate was under the federal estate tax minimum. The property was sold by the estate one year later for a net of $171,000.

Does the estate recognize a loss on the disposal of the property?

If so, does that loss get passed through to the specified beneficiary on a K-1?

Thanks.

 

[seniorjudge]

What is the name of your state? PA

The decedent owned a rental property that was bequeathed to a specific beneficiary. The property was appraised at the time of death at $183,000. That value was used for calculation of the Pennsylvania inheritance tax. The total estate was under the federal estate tax minimum. The property was sold by the estate one year later for a net of $171,000.

Does the estate recognize a loss on the disposal of the property?

If so, does that loss get passed through to the specified beneficiary on a K-1?

Thanks.

Did the estate file a return (other than the inheritance tax return) in Pennsylvania?

 

[anteater]

Did the estate file a return (other than the inheritance tax return) in Pennsylvania?

Not completely clear on your question.

PA Income Tax Return? Yes

Federal Estate & GST Tax - 706? No, the gross estate was not large enough.

 

[abezon]

Unless the will specified otherwise, capital gains are taxed at the estate level and are not passed through to the beneficiaries on a K-1. Ordinary income is passed through on K-1s.

The estate has a capital *loss* of around $12k. Losses are claimed by the estate and are netted against capital gains, then deducted against ordinary estate income, up to $3,000 per year. Thus, while the rental house was specifically left to 1 beneficiary, the loss from the sale of the house reduces all beneficiaries' share of the net estate income.

Unused losses are carried forward indefinitely. In the estate's final year, any unused losses are passed through to the beneficiaries on the K-1. At this time, the losses should be apportioned among the beneficiaries in accordance with their share of the capital gains/losses. If the house was not sold during the estate's final year, the executor will need to keep meticulous records of the source of any capital gains/losses and how much of each beneficiary's share got used each year.

The easiest thing to do is to close the estate during the same fiscal year as the sale. The executor should definitely hire a good tax pro for help & should probably consult said tax pro soon, if the estate is on a calendar year. Sometimes the executor can make enough distributions to say with confidence that the estate's income will be under $600 in future. Since an estate does not need to file a return if its income is under $600, the executor could "close" the estate for tax purposes while maintaining a reserve to pay final expenses such as tax prep & attorney fees.

 

[seniorjudge]

...The estate has a capital *loss* of around $12k. Losses are claimed by the estate and are netted against capital gains, then deducted against ordinary estate income, up to $3,000 per year. Thus, while the rental house was specifically left to 1 beneficiary, the loss from the sale of the house reduces all beneficiaries' share of the net estate income....

Explain that, please. Thank you.

 

[anteater]

Unless the will specified otherwise, capital gains are taxed at the estate level and are not passed through to the beneficiaries on a K-1. Ordinary income is passed through on K-1s.

The estate has a capital *loss* of around $12k. Losses are claimed by the estate and are netted against capital gains, then deducted against ordinary estate income, up to $3,000 per year. Thus, while the rental house was specifically left to 1 beneficiary, the loss from the sale of the house reduces all beneficiaries' share of the net estate income.

Unused losses are carried forward indefinitely. In the estate's final year, any unused losses are passed through to the beneficiaries on the K-1. At this time, the losses should be apportioned among the beneficiaries in accordance with their share of the capital gains/losses. If the house was not sold during the estate's final year, the executor will need to keep meticulous records of the source of any capital gains/losses and how much of each beneficiary's share got used each year.

The easiest thing to do is to close the estate during the same fiscal year as the sale. The executor should definitely hire a good tax pro for help & should probably consult said tax pro soon, if the estate is on a calendar year. Sometimes the executor can make enough distributions to say with confidence that the estate's income will be under $600 in future. Since an estate does not need to file a return if its income is under $600, the executor could "close" the estate for tax purposes while maintaining a reserve to pay final expenses such as tax prep & attorney fees.

The sales took place this year and the estate is being closed this year. The "loss" on sale of the property will dwarf any other gains or ordinary income in the estate. (Particularly, since there was another property bequeathed to another beneficiary sold under similar circumstances.)

I am the beneficiary and, since I paid inheritance tax on the higher value, I want the bloody loss!

 

[abezon]

Explain that, please. Thank you.

The key is the difference between trust income & trust principal in estate/trust law. "Income" is passed through to the beneficiaries every year & taxed on their return. (Usually resulting in a lower tax rate overall since estates & trusts hit high tax rates quickly.) Income includes interest, dividends, rents, etc. However, capital gains & losses are allocated to trust principal & are taxed at the estate/trust level. The designation of income & principal is set by state law, so there can be variations, but most states have set up their laws this way.

SO, say there are 2 beneficiaries who share the residue of an estate 50-50, and beneficiary A was specifically given a rental house. Any net estate income is shared equally between A & B. Also assume the estate has "income" of $10,000. If there is a net capital gain, the estate pays the capital gains taxes and passes the interest & dividends through to be taxed on A & B's returns equally ($5,000 each). A net capital loss must be used at the estate level to offset up to $3,000 of the estate's taxable ordinary income, which will reduce the interest & dividend income passed to A & B equally ($3,500 each).

In the estate's final year, capital gains & losses are passed through to the beneficiaries per the will without using any capital losses to offset the estate's ordinary income. If the house is sold in the estate's final year, A's K-1 shows $5,000 interest & dividends & a $12,000 capital loss; B's shows $5,000 int & div.

Things get really complicated when there are multiple sources of capital gains/losses, and the will specifies different treatment for the different sources.

All of these complications can be avoided by either having the estate sell the assets during its final year or by passing title of the assets to the heirs & letting them sell the assets under their own names, removing the estate from the tax calculations.

Clear as mud now?

 

[seniorjudge]

Thank you for your time and explanation.

You cleared up everything!