real estate depreciation within a trust

[TrustUser]

What is the name of your state?california

 

[TrustUser]

if a piece of real estate is held in a non-revocable trust, how is depreciation handled ? i think i would prefer not to claim it at all. but i dont know if that is an option ? it is an expense item, but not a cash flow item, so i am not sure how it affects distribution, and how it affects principal ?

if i dont claim it at all, then i could simply distribute the income, while the principal stays the same, and the basis of the asset stays the same.

i have never liked the concept of depreciation of real estate, and i wish they would get rid of it. it is a phony scheme used by the bigwigs. fixed assets depreciate over time. as a very general rule, real estate does not depreciate over time. quite the opposite - it usually appreciates.

 

[Taxing Matters]

as a very general rule, real estate does not depreciate over time. quite the opposite - it usually appreciates.

While real estate as a whole has, in the last century or so, tended to appreciate, the buildings and other improvements to land certainly do depreciate over time. A business or investor depreciates assets that waste over time, like cars, machinery, etc. And just like a car or machinery, buildings and other improvements to land do indeed waste away over time. Buildings deteriorate as the years pass, and eventually need major renovation or replacement, just like cars and machinery.

Thus when talking about depreciating real property, it is actually depreciating just the building and other improvements that is involved. You can never depreciate the land itself. When viewed in light of depreciation for other kinds of business/investment assets, the depreciation of buildings/improvements is nothing novel or special. It is not a “phony scheme used by the bigwigs.” It instead reflects the long understood notion that these kinds of assets waste away over time and that a write down of the value of those assets over time is appropriate. They don't suddenly lose all their value at the time you finally dispose of them, after all.

A trust keeps separate books for tax purposes and for trust administration purposes, and the two sets of books will differ in some ways.

For federal and California income tax purposes a trust that is not a grantor trust handles depreciation like any other taxpayer. It deducts the depreciation expense on its return, thus reducing its income for that year (and reducing the basis in the asset depreciated). That is a benefit to the trust, so I don’t know why you would not want the trust to take that deduction. Moreover, when the trust sells that asset, the basis it must use is the basis that the trust claimed or that it could have claimed even if it didn't take the depreciation deductions. Thus, you're going to have the reduced basis on the asset whether you take the depreciation deductions or not, so the trust may as well take that depreciation deduction and get the tax benefit.

The tax law does not specify what is principal and income for purposes of deciding who gets what distributions from the trust (i.e. what goes to the income beneficiaries and what goes the beneficiaries that are to receive trust principal). That instead is spelled out in state trust laws and the governing trust instrument. Most states use one version or another of the Uniform Principal and Income Act (UPIA), the more recent versions being known as the Revised Uniform Principal and Income Act (RUPIA). California's version of the Act is the California Uniform Principal and Income Act, Probate Code §§ 16320-16375. Under this Act, the general rule is that depreciation is charge that reduces the income of the trust and that increases the principal of the trust. This only makes sense because the income beneficiaries are getting income off the the trust principal while those assets are being wasted away over to produce that income. Without this charge, the income beneficiaries would get a free ride, getting the benefit of the income thrown off by the asset but doing nothing to help keep up that asset, which then would be a detriment to the beneficiaries who are to receive the principal. Note, though that the terms of the trust instrument can override the UPIA and provide a different rule. Whether that should be done depends on the details of the trust assets and the goals of the person creating the trust. That's something to discuss with a trust attorney. A short primer on this might help explain the trust accounting for this.

But the bottom line is that for trust administration purposes, not taking depreciation is not an option unless the trust itself were to provide for that (and that would be unusual) and for tax purposes you may decide not to take the depreciation deduction but you end up paying a lot more in tax by doing it and there is no upside to not claiming it.

 

[TrustUser]

thank you for your response. one thing i did not want to have to do is have the beneficaries themselves be forced to claim depreciation on their returns. from your response, i dont think i will need to do that.

so if the trust makes 10,000 in income and has 1,000 in depreciation (no other expenses to make it simple), then i would distribute 9,000. is this correct ?

i disagree with your synopsis about depreciation on real estate. like i said, fixed assets do depreciate. they last for a certain amount of time. but even with maintenance, they eventually end up being worthless.

this is not true with real estate. maintenance costs to keep the building fixed up are expensed. and in so doing, the property keeps its value. properties can lose value over time because of things that happen in their location, but not generally because of the true concept of depreciation.

how many fully depreciated buildings have lost their value, such that the property is worth only what the land is worth ? i would say about 0% of them is a very accurate guestimate.

 

[HRZ]

Your opinion or mine do not count...the federal tax code says you must depreciate the buildings and structures ...and if you fail to do so the tax code treaties you as havving done so anyway when it comes time to sell the real estate and the tax impact boomeranges ...and as trustee the smart thing is to follow the rules .

 

[FlyingRon]

Eh, TrustUser's example makes no sense. Depreciation isn't an expense, it's an exclusion of income for tax purposes. If you have $10,000 in income and an allowable $1000 in depreciation, you pay tax on $9000. Assuming only federal tax and assuming there is no other deductions, that would be $1867 in tax. So you'd pay out $10000-1867 = 8133

 

[Taxing Matters]

Eh, TrustUser's example makes no sense. Depreciation isn't an expense, it's an exclusion of income for tax purposes. If you have $10,000 in income and an allowable $1000 in depreciation, you pay tax on $9000. Assuming only federal tax and assuming there is no other deductions, that would be $1867 in tax. So you'd pay out $10000-1867 = 8133

No. The trust accounting for trust administration purposes differs from tax accounting. What goes to the income beneficiaries of the trust is in most states dependent on the rules of that state’s version of UPIA and what the governing trust instrument says. TrustUser will need to see a trust attorney or trust accountant to review the terms of the trust and apply the UPIA accounting rules to determine exactly what is to get distributed to the income beneficiaries. It's important for the trustee to get this right, and there is no simple answer to give on how that is computed, at least not without seeing the details of the trust involved.

i disagree with your synopsis about depreciation on real estate. like i said, fixed assets do depreciate. they last for a certain amount of time. but even with maintenance, they eventually end up being worthless.

Buildings do indeed depreciate in value over time and either need to be kept up or replaced. I can point you to any number of buildings right in my immediate area that are today not worth nearly what they were when they were new. Indeed, several have been torn down and replaced because they were not worth renovating or maintaining. Sure, the real estate value as a whole might be more because the land value increase offset the building value decrease, but the nevertheless, those buildings are not worth today nearly what they would if they were new.

Certainly it is possible to keep a building going for many years by spending money for the upkeep. You can do that with cars too. There are, after all, some old Model T's out there from a century ago still in fine condition. But that fact does not change that the general principle still applies: things like buildings, machinery, etc, do wear out and lose value unless they are maintained in like new condition, and that costs money to do. There is nothing special about a building as a opposed to machinery and equipment, a bridge, or whatever else we humans construct.

 

[justalayman]

No. The trust accounting for trust administration purposes differs from tax accounting. What goes to the income beneficiaries of the trust is in most states dependent on the rules of that state’s version of UPIA and what the governing trust instrument says. TrustUser will need to see a trust attorney or trust accountant to review the terms of the trust and apply the UPIA accounting rules to determine exactly what is to get distributed to the income beneficiaries. It's important for the trustee to get this right, and there is no simple answer to give on how that is computed, at least not without seeing the details of the trust involved.



Buildings do indeed depreciate in value over time and either need to be kept up or replaced. I can point you to any number of buildings right in my immediate area that are today not worth nearly what they were when they were new. Indeed, several have been torn down and replaced because they were not worth renovating or maintaining. Sure, the real estate value as a whole might be more because the land value increase offset the building value decrease, but the nevertheless, those buildings are not worth today nearly what they would if they were new.

Certainly it is possible to keep a building going for many years by spending money for the upkeep. You can do that with cars too. There are, after all, some old Model T's out there from a century ago still in fine condition. But that fact does not change that the general principle still applies: things like buildings, machinery, etc, do wear out and lose value unless they are maintained in like new condition, and that costs money to do. There is nothing special about a building as a opposed to machinery and equipment, a bridge, or whatever else we humans construct.

A building’s age (not condition but actual age) is nearly irrelevent when establishing value while age weighs heavily in establishing value of a motor vehicle.

It’s the perception of the buyer that causes this. People don’t put much value in the actual age of a building but with a vehicle, buyers do put a value on age. A 2005 widgetmobile will be worth less than an absolutely identical 2010 widgetmobile (barring unique buyers or issues in those model years such as either being a first or last model year and considering that those model years are the same model era) regardless of the condition being identical

Pricing for real estate has a very limited association with original cost while pricing for motor vehicles weighs heavily on original cost.

Additionally, the cost of age when considered weighs much less on a building than a vehicle due to the simple fact the expected functional life of a house is rarely considered where as the expected life of a vehicle is much better known

Simply put; buildings gain charm as they age while vehicles get dusty and rusty, even if it’s only in the buyers mind

In addition, building values are determined much less by age and condition than market valuation. Often times age has absolutely no relevance to price as other facts cause the value to increase or decrease with total disregard to age. That is not applicable to cars since a car is wherever a person chooses to park it.

Your example of buildings in your neighborhood are due to the condition of the buildings and not the actual age. While they often run hand in hand, one should not be confused with the other.

Suggesting a building depreciates simply due to age is just not correct. There are so many factors involved it belies such a simplistic approach.

 

[FlyingRon]

I remember listening to a seminar by a guy who was talking about rental property taxation. The classic is that you buy a duplex. You move into one side and you rent out the other. The IRS believes the side you live in will stand forever, but the other side will fall down in 27.5 years.

 

[TrustUser]

hi tm,

i am not gonna argue any more about the depreciation of buildings. i will just agree to disagree. the details of the trust are simple. the net income is to be distributed to the beneficiaries. if it weren't for depreciation, i would have no questions. there will be times when there is no real estate in the trust. but for now, there is.

 

[TrustUser]

depreciation is a "non-cash flow" expense. other than that, i could simply take the net income, and distribute it. which is why i was hoping i could simply eliminate it completely, and not be forced to claim it, etc.

 

[LdiJ]

depreciation is a "non-cash flow" expense. other than that, i could simply take the net income, and distribute it. which is why i was hoping i could simply eliminate it completely, and not be forced to claim it, etc.

And what would you do if the real estate then needed repairs...after you had distributed all of the income? Depreciation gives you a cushion to get repairs made if needed.

 

[Taxing Matters]

Your example of buildings in your neighborhood are due to the condition of the buildings and not the actual age. While they often run hand in hand, one should not be confused with the other.

Suggesting a building depreciates simply due to age is just not correct. There are so many factors involved it belies such a simplistic approach.

I did not say that they lose value “simply due to age.” As I pointed out, too, some cars can be in nearly perfect condition now 100 years later and they may indeed be worth many times what was orginally paid for it. But in both cases, you don't keep a building, car, or most anything else we humans construct in great shape without paying a cost to maintain it in that shape. Without that cost, they will waste away. The difference is that people are more willing to invest the cost to keep up many buildings in at least reasonably good shape than they will for cars. But that willingness does not change the fact that these assets will, over time, waste without that cost to maintain them. And that is the reason for the allowance for depreciation. It is an acknowledgement of the fact they deteriorate unless you put in the cost to maintain them. Buildings are no different than cars in that regard except they tend to waste much more slowly, which is why depreciation rules depreciate cars much more rapidly than buildings.

 

[TrustUser]

And what would you do if the real estate then needed repairs...after you had distributed all of the income? Depreciation gives you a cushion to get repairs made if needed.

Alerts

that has got to be one of the craziest reasons i have heard for supporting funny money.

have you ever heard of cash reserves ?

 

[justalayman]

You said this;

Buildings do indeed depreciate in value over time and e

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That statement says time is the reason they depreciate. That is just not correct. Then you try to hide that statement by saying they degrade over time but what causes the depreciation is the degradation, not the time.



If you query appraisers I suspect you will find age itself is not relevant in determining value. When age is mentioned it is always accompanied with things referring to using age to speculate on condition or possibility of building materials used or other matters that age suggests may be a problem or even benefit but I haven’t found one that places a value simply due to age.

That is not the situstion with items such as motor vehicles. In general they will depreciate due to age alone.