A coworker at AmeriSave recently told me about a family she worked with who got a home through a trust. They thought selling it would be easy, just like selling any other piece of real estate. They didn't know that the kind of trust, when the sale happened, and a few IRS rules they had never heard of would decide if their tax bill was zero or more than six figures.
That story isn't out of the ordinary. I see the effects of these choices all the time in my job as a project manager at AmeriSave. Families come in ready to sell, refinance, or buy a home, but then they find out that trust-held property has a whole different set of rules.
It is one thing to sell a house you own outright. It's a whole different story to sell a house that is in a trust. The tax effects depend on whether your trust can be changed or not, whether you meet certain requirements, how capital gains brackets apply to trusts and individuals, and whether the estate tax exemption is even relevant to your situation.
The good news is that once you know how these five things work, you can make choices that could save you tens of thousands of dollars. You wouldn't fix up a house without knowing the rules for building it. The same thing goes here. Before you make a move, you should know the rules.
Take a deep breath. We'll go over all five things together, and by the end, you'll know exactly what to expect and what to ask your estate planning lawyer.
For tax purposes, a revocable living trust is often the easiest type of trust to set up. You're putting a legal wrapper around your home when you make one and move it into it, but you still have full control. You can make changes to the trust, end it, or take the property back at any time.
The IRS doesn't see the trust as a separate entity because you still have control over it. It sees you and the trust as one and the same. This is known as "grantor trust status," and it means that all of your income, deductions, and gains go to your personal Form 1040. You don't have to file a separate tax return for the trust for this transaction.
In practical terms, this means that selling a home that is in a revocable trust is almost the same as selling a home that you own in your own name. You put the sale on your own tax return. If you meet the requirements, you can claim the primary residence exclusion. You pay capital gains taxes at the rates that apply to you. The trust structure is helpful for planning your estate and avoiding probate, but it doesn't change how the IRS taxes the sale.
Sections 671 through 679 of the Internal Revenue Code set the rules for grantor trusts. According to these rules, the person who set up the trust must report all of its income on their own tax return. This is one of the main reasons why families all over the country still like revocable trusts. Many homeowners who use revocable trusts as part of their overall financial plan work with AmeriSave. One of the best things about them is that they are easy to understand for tax purposes.
The way irrevocable trusts work is very different. You lose control of property when you put it in an irrevocable trust. The trust becomes its own legal entity and gets its own tax ID number. It has to file its own income tax return using Form 1041.
The tax consequences here get bad very quickly. The IRS Form 1041-ES for the tax year shows that trust income tax brackets are much smaller than individual tax brackets. The highest federal income tax rate for individuals is 37%, but this rate only applies to people whose taxable income is more than $640,600 for single filers. A trust pays that same 37% rate on about $16,000 in taxable income.
The trust brackets for regular income are as follows: 10% on the first $3,300 or so, 24% on income between $3,300 and $11,150, 35% on income between $11,150 and $15,200, and 37% on anything above that. These brackets are much tighter than what people have to deal with, which means that trusts pay higher effective tax rates on smaller amounts of income.
Capital gains in trusts also face similar compression. If you make long-term capital gains in a trust, you won't have to pay any taxes on the first $3,300. You will have to pay 15% on gains between $3,300 and $11,700, and 20% on all gains over $11,700. For single filers, the 20% rate doesn't start until their taxable income is more than $546,100. For married couples filing jointly, it doesn't start until their taxable income is more than $613,700.
When you add real money to these brackets, the difference is clear. If an irrevocable trust sells property and makes $200,000 in long-term capital gains, it could owe about $38,000 to $40,000 in federal capital gains taxes if it keeps those gains. If someone in the 15% tax bracket reported the same $200,000 gain, they would owe about $30,000, which is $8,000 or more less than if the gains were taxed at the corporate rate.
One thing that catches many families off guard is that every revocable trust automatically becomes irrevocable when the person who created it passes away. The grantor is no longer alive to change or revoke the trust, so by definition, it becomes permanent.
Here's what that looks like in practice. Your mother created a revocable living trust and placed her home into it. While she was alive, the trust was transparent for tax purposes. When she passed away, that trust immediately became irrevocable. If you're now selling that home as a trustee or beneficiary, the irrevocable trust tax rules apply going forward.
The silver lining is that property in revocable trusts that become irrevocable at death typically receives a step-up in basis to fair market value as of the date of death. We'll dig deeper into how step-up in basis works in the next section, but this feature alone can save families enormous amounts in capital gains taxes.
Step-up in basis is arguably the single most valuable tax benefit in real estate, and understanding how it applies to trust property can mean the difference between owing nothing and owing six figures.
Under Section 1014 of the Internal Revenue Code, property inherited from a deceased person receives a new cost basis equal to the property's fair market value on the date of death. This "steps up" the basis from what the original owner paid for the property to its current market value, effectively erasing all the capital gains that accumulated during the deceased person's lifetime.
Here's a real-world example. Say your father purchased a home for $150,000 back in 1990. When he passed away, the property was worth $750,000, meaning $600,000 in appreciation had built up over thirty-five years. Without step-up in basis, selling that property would trigger capital gains taxes on the full $600,000. At a 20% federal rate plus the 3.8% Net Investment Income Tax, that's roughly $142,800 in federal taxes alone.
With step-up in basis, your new cost basis becomes $750,000. If you sell for $750,000, your taxable capital gain is zero. That entire $142,800 tax bill disappears.
Property held in revocable trusts is included in the grantor's taxable estate for federal estate tax purposes, which is exactly what makes step-up possible. Even though the trust holds legal title, the grantor maintained the power to revoke the trust and reclaim the property during their lifetime. Under IRC Section 2038, that retained power means the property is part of the grantor's estate.
This is one of the strongest reasons families use revocable living trusts for estate planning. You avoid the public probate process, simplify administration after death, and still receive the full step-up in basis for appreciated assets. At AmeriSave, we often see families using revocable trusts as part of a broader homeownership strategy, and the tax efficiency is a core advantage.
A practical example from here in Louisville: a family placed their $225,000 home into a revocable trust. When the parents passed away, the home had appreciated to $425,000. The children inherited the home with a stepped-up basis of $425,000. They sold it for $430,000, resulting in a taxable capital gain of just $5,000. Without the step-up, they would have owed taxes on approximately $205,000 in gains.
This is where irrevocable trusts really hurt. When the grantor dies, property that was put into an irrevocable trust while the grantor was still alive usually does not get a step-up in basis. The IRS sees the original transfer as a gift that has already been made. At that point, the property was no longer part of the grantor's estate, so it doesn't qualify for the date-of-death valuation adjustment.
The trust gets the grantor's original cost basis, which is sometimes called a "carryover basis." If your grandmother put her $200,000 home into an irrevocable Medicaid Asset Protection Trust and the home is now worth $450,000, the trust's basis stays at $200,000. The trust will have to pay capital gains taxes on the full $250,000 in value when it sells.
A $250,000 capital gain puts you well into the highest tax brackets at the trust level. After the trust's small exemption, the federal capital gains tax would be about $49,000 to $50,000. Many states also charge their own capital gains taxes on top of that. If the property had stayed in a revocable trust or the grantor's own name, the step-up could have gotten rid of the whole tax bill.
There are only a few cases where property in an irrevocable trust might still be part of the grantor's estate and get a step-up. These cases involve powers or interests that the grantor wants to keep, which requires careful legal structuring. If you have an irrevocable trust and are thinking about selling a property, you need to talk to a lawyer who knows a lot about estate planning.
If you live in one of the nine community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, or Wisconsin), there's an additional benefit worth knowing about. When one spouse passes away, both halves of community property receive a full step-up in basis to fair market value. In the other 41 common law states, only the deceased spouse's share gets stepped up.
Here's why that matters. A married couple in Texas purchased a home for $300,000. When the first spouse passed away, the property was valued at $700,000. Under community property rules, the entire property receives a stepped-up basis of $700,000. The surviving spouse can sell for $700,000 with zero capital gains tax.
In a common law state like Kentucky or Florida, only the deceased spouse's half would receive the step-up. The surviving spouse's half retains the original basis, resulting in a blended basis of roughly $500,000. That's $200,000 in additional taxable gain compared to the community property outcome.
One of the best tax breaks for homeowners is Section 121 of the Internal Revenue Code. If you're single and sell your main home, you can keep up to $250,000 in capital gains from taxes. Couples who are married and file together can leave out up to $500,000.
To be eligible, you must have owned the home for at least two of the five years leading up to the sale and lived there as your main home for at least two of those same five years. The periods of ownership and use don't have to be the same, but both must be met. IRS Publication 523 says that you can't usually claim the exclusion more than once every two years.
The numbers show that this exclusion is very strong. If a married couple bought a house for $300,000 and sold it for $850,000, they would have made $550,000 in capital gains. Section 121 says that the first $500,000 is not included. There is only $50,000 that is taxable. That's $7,500 in federal taxes instead of $82,500 without the exclusion, at a long-term capital gains rate of 15%. That's a $75,000 savings from just one tax rule.
Whether the Section 121 exclusion applies to trust-held property depends entirely on the type of trust and its relationship to the person who lived in the home.
For revocable trusts where the grantor is still alive, there's no issue at all. IRC Section 121(d)(9)(C) specifically states that if property is held by a trust and the taxpayer is treated as the owner under the grantor trust rules, the taxpayer is treated as owning the property for purposes of the exclusion. The trust sale is treated as if made by the taxpayer personally.
Think of it like this: you created a revocable living trust and placed your home in it eight years ago. You've lived in that house the entire time. When the trust sells the home, you meet both the ownership and use tests. You take the full Section 121 exclusion on your personal return. The trust structure doesn't change anything about your tax treatment.
Irrevocable trusts face much more limited circumstances. Trusts themselves can't claim the Section 121 exclusion because trusts don't have residences. They're legal entities, not people who live in homes. The exclusion was designed for individuals and married couples.
There's one narrow exception. If an irrevocable trust is structured as an intentionally defective grantor trust and the grantor is treated as the owner for income tax purposes and meets the use and ownership tests, the exclusion may be available. These are technically complicated structures that require careful legal drafting.
When a grantor dies and the trust becomes irrevocable before the home is sold, things get complicated. The question is if the person who inherits the house can still get the exclusion.
The answer depends on whether the person who died met the requirements for ownership and use, as well as whether the beneficiary does. You can combine time periods in some cases.
For example, your mother lived in her house as her main home for fifteen years. She had a revocable trust that held the house. She died, and the trust gave you the money. You moved in right away and lived there for a year before deciding to sell. You can use your mother's time of ownership and use to meet the tests under IRC Section 121(d)(9)(C). You qualify by combining periods, even though you've only lived there for twelve months.
When combining periods, surviving spouses get more flexible treatment than other beneficiaries. Non-spouse beneficiaries have to follow stricter rules, so it's important to get professional help here.
What if you don't meet the full two-year requirement? Section 121 provides partial exclusions for sales triggered by employment changes, health issues, or other unforeseen circumstances. The partial exclusion amount equals the maximum exclusion multiplied by a fraction: the shorter of your ownership or use period divided by 730 days.
For example, if you owned and lived in your home for 18 months before selling due to a job relocation, you'd receive 75% of the full exclusion (18 divided by 24 months). That's $187,500 for a single filer or $375,000 for a married couple filing jointly.
When trust property is involved and there's any question about exclusion eligibility, I always tell colleagues to recommend that clients consult both their estate planning attorney and their tax advisor before proceeding. Missing the qualification window by even a few days can cost real money. At AmeriSave, we encourage homeowners to build these professional consultations into their timeline early.
When selling trust property, the difference between the capital gains rates for individuals and trusts can be both a chance to plan and a risk.
Long-term capital gains rates for individual taxpayers who file in the tax year are based on their total taxable income. If a single person's taxable income is less than about $49,350, they don't have to pay any taxes on long-term capital gains. The 15% rate applies to income between $49,350 and $546,100, and the 20% rate starts at $546,100. Married couples who file together have higher thresholds: the 0% rate applies to income up to about $98,900, the 15% rate applies to income up to $613,700, and the 20% rate applies to income above that.
Trusts have brackets that are much smaller. According to IRS Revenue Procedure 2025-32, which announced the inflation adjustments, trusts pay 0% on the first $3,300 of long-term capital gains, 15% on gains between $3,300 and $11,700, and 20% on all capital gains over $11,700.
Let's put some real money into this. If a trust sells property and makes a $100,000 long-term capital gain, it would pay 0% on the first $3,300, 15% on the next $8,400, and 20% on the last $88,300. The total amount of federal capital gains tax is about $18,920. For someone in the 15% bracket, that same $100,000 gain on their individual return would mean paying $15,000 in capital gains taxes. The trust pays almost $4,000 more on the same gain.
Many trusts must also pay the 3.8% Net Investment Income Tax under Section 1411 of the Internal Revenue Code. This additional tax applies to undistributed net investment income for trusts and estates.
For trusts, the NIIT threshold is extremely low, roughly matching the top of the lowest trust bracket. Since that threshold is so small, most trusts with any meaningful investment income or capital gains will face the 3.8% surtax. On a $100,000 capital gain retained by a trust, the NIIT adds approximately $3,800 on top of regular capital gains taxes, pushing the combined federal tax bill to around $22,700.
Individual taxpayers don't face the NIIT until their modified adjusted gross income exceeds $200,000 for single filers or $250,000 for married couples filing jointly. This creates yet another advantage for moving capital gains out of the trust and onto individual returns when the trust documents allow it.
One of the most effective ways to reduce the overall family tax bill is to distribute capital gains to beneficiaries rather than keeping them at the trust level. This requires careful planning and the right language in the trust documents, but the savings can be substantial.
The Internal Revenue Code generally allows trusts to take a deduction for income distributed to beneficiaries. The beneficiaries then report that income on their own returns. Because beneficiaries are almost always in lower tax brackets than the trust, this shift produces real savings.
Here's how the math works. If a trust retains a $200,000 capital gain, it may owe approximately $40,000 in federal taxes at compressed trust rates. If instead the trust distributes those gains equally to three adult children who each fall into the 15% capital gains bracket, each child reports about $66,667 in gains and pays roughly $10,000. The total family tax bill drops to $30,000, saving $10,000 compared to trust-level taxation.
For this strategy to work, the trustee, the trust's tax preparer, and the beneficiaries' tax advisors all need to coordinate. Timing is critical because distributions generally must occur during the trust's tax year to receive proper tax treatment. This isn't something you can fix retroactively after December 31.
AmeriSave's team often works with families who are exploring how trust distributions affect their next home purchase or refinance. Understanding the after-tax proceeds from a trust property sale helps families plan their next move with confidence.
Don't overlook state-level capital gains taxes, which stack on top of federal taxes. Some states tax capital gains as ordinary income at their regular rates, while others offer preferential rates. A handful of states have no income tax at all: Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming.
On the other end of the spectrum, California, New York, New Jersey, and several other states impose top marginal rates exceeding 10%. On a $200,000 capital gain, California alone could add more than $20,000 to the tax bill. When you combine federal trust-level taxes, the NIIT, and state taxes, the effective rate on large capital gains can exceed 35% to 40%.
Multi-state trust issues add even more complexity. Depending on where the trust is administered, where the trustee lives, where the beneficiaries reside, and where the property is located, the trust may owe taxes in more than one state. Professional guidance is a must in these situations.
When Congress passed the One Big Beautiful Bill Act, which made the higher estate tax exemption permanent, the federal estate tax landscape changed a lot. The current tax year allows for an exemption of $15 million per person or $30 million for a married couple. This means that the first $15 million of your estate won't have to pay federal estate taxes. The 40% federal estate tax rate only applies to amounts over that amount.
Things have changed a lot since a year ago. The previous exemption of about $13.99 million per person was set to end on December 31, 2025, which would have cut the amount to about $7 million to $8 million. Families with estates worth between $7 million and $14 million were very worried about that expected drop. By making the higher exemption permanent and raising it to $15 million, Congress took away that uncertainty.
The $15 million exemption means that federal estate taxes don't matter for most American families. The Tax Policy Center says that in the past few years, fewer than 2,000 estates in the US owed federal estate tax at the old exemption levels. That number will go down even more now that the exemption is even higher.
Because you could change or cancel the trust while you were alive, property held in revocable trusts is part of your taxable estate. This inclusion is what lets the basis go up. On the other hand, property in properly structured irrevocable trusts is usually not part of your taxable estate. This exclusion is the main reason people use irrevocable trusts to plan their estates, but AmeriSave homeowners should think about the trade-off of losing the step-up benefit.
Even though the federal exemption is now $15 million, twelve states plus the District of Columbia impose their own estate taxes with much lower thresholds. These states include Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, and Washington, as well as Washington D.C.
Massachusetts and Oregon have exemptions of just $1 million. New York's exemption is $7.35 million for the current year, but New York has a "cliff" provision: if your estate exceeds 105% of the exclusion amount, the entire estate becomes taxable with no exclusion at all. Several other states have exemptions in the $3 million to $6 million range.
Six states also impose inheritance taxes on beneficiaries who receive property from an estate: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Maryland is the only state with both an estate tax and an inheritance tax.
When trust property includes real estate located in a state with an estate tax, that property is typically subject to that state's tax when the grantor dies, regardless of where the grantor lived or where the trust is administered. Vacation homes, rental properties, and out-of-state real estate create multi-state issues that require careful planning.
One of the most consequential decisions in trust and estate planning is whether to sell property before or after the grantor's death.
If the grantor sells before passing away, they realize the capital gain during their lifetime. They may be able to use the Section 121 primary residence exclusion if it's their main home. If the property doesn't qualify for the exclusion, they'll owe capital gains taxes at their individual rates.
If the trust or estate sells after the grantor's death, beneficiaries receive the step-up in basis on property that was in a revocable trust. The stepped-up basis eliminates most or all capital gains tax on appreciation that occurred during the grantor's lifetime.
Here's a specific scenario. Your father has a rental property worth $600,000 that he bought for $200,000. If he sells before he passes away, he owes capital gains tax on $400,000. At 20% plus the 3.8% NIIT, that's about $95,200 in federal taxes. If instead the property stays in his revocable trust and the estate sells it after his death for $600,000, the stepped-up basis eliminates the entire gain. No capital gains tax. The savings: $95,200.
The counterargument is that markets can shift, property values might decline, or there may be a need for cash during the grantor's lifetime. Every situation requires individual analysis of tax consequences, liquidity needs, market conditions, and family circumstances. AmeriSave encourages families to work closely with their estate planning attorney and tax advisor to run the numbers for both scenarios.
A Qualified Personal Residence Trust, or QPRT, is a special kind of irrevocable trust that lets you keep living in your home for a certain number of years while taking it out of your estate.
You put your home into the QPRT and keep the right to live there rent-free for a set amount of time when you set it up. When the term is over, the designated beneficiaries get the property. You pay the beneficiaries fair market rent if you want to stay there after the term ends.
The estate tax benefit comes from the fact that the IRS thinks your gift to the QPRT is worth less than the full market value of the home. Because you still have the right to use the property for years, that retained interest lowers the amount of the gift that is taxable. The longer you keep your term, the less valuable the gift is.
Under the grantor trust rules, the grantor is treated as the owner for income tax purposes during the QPRT term. If the QPRT sells the house during the term, the grantor can use the Section 121 exclusion on their own tax return.
After the term is up, the beneficiaries get the house with the grantor's original carryover basis. There is no step-up because the property was successfully taken out of the estate. If the property goes up a lot in value, the people who inherit it will have to pay capital gains taxes when they sell it. QPRTs work best for homes that are worth a lot of money and where the main goal is to get rid of estate tax exposure.
Medicaid Asset Protection Trusts (MAPTs) are irrevocable trusts designed to protect assets for heirs while keeping those assets from being counted for Medicaid eligibility. Medicaid won't count assets in an irrevocable trust if the grantor doesn't retain certain rights, though there's a five-year lookback period. Transfers made within five years of applying for Medicaid can result in penalty periods where you're ineligible for benefits.
From a tax perspective, MAPTs are typically structured as intentionally defective grantor trusts. The grantor pays income taxes on all trust income even though they can't access the trust principal. When a MAPT sells a home, the gain flows to the grantor's personal return, and the grantor can still claim the primary residence exclusion if the home meets the Section 121 requirements.
The biggest disadvantage mirrors other irrevocable trusts: there's no step-up in basis when the grantor passes away. Beneficiaries inherit the property with the grantor's original cost basis, which can create substantial capital gains tax liability on appreciated real estate.
In my Master's of Social Work (MSW) program, we study how elder care intersects with financial planning through a systems-thinking lens. Families dealing with these asset protection decisions are managing legal, financial, tax, and emotional factors simultaneously. It's one of the hardest situations families face, and having the right professional team makes all the difference.
Charitable Remainder Trusts (CRTs) let you sell property that has gone up a lot in value, get income for life or a set number of years, and help a charity while also getting big tax breaks.
You give a CRT real estate that has gone up in value. The CRT doesn't have to pay capital gains taxes on the sale of the property because it is tax-exempt. The trust keeps all the money it makes, invests it, and gives you a set amount each year for life or up to 20 years. At the end, your chosen charity gets whatever is left over.
There are three main tax breaks. First, you can deduct the present value of the remainder interest going to charity from your income taxes right away. The trust also doesn't have to pay capital gains tax on the sale. Third, you turn an asset that doesn't make money into a steady stream of income.
Let's use actual numbers. You own a rental property that is worth $800,000 and has a basis of $150,000. If you sell it yourself, you'll have to pay capital gains tax on $650,000, which is about $130,000 to $155,000, depending on rates and the NIIT. The full $800,000 stays invested if you give it to a CRT and the trust sells. You get $40,000 a year from a 5% annual payout, and you can get a charitable deduction worth $40,000 to $200,000 upfront, depending on IRS actuarial factors and your age.
The downside is that your heirs won't get the property or its remaining value. CRTs work best when you have a lot of valuable assets that have gone up in value, you want income instead of a lump sum, you want to give to charity, and you don't need to pass this asset on to family.
Special Needs Trusts (also called Supplemental Needs Trusts) hold assets for a person with disabilities without disqualifying them from government benefits like Supplemental Security Income or Medicaid. These are almost always irrevocable trusts with a trustee managing distributions that supplement, rather than replace, government benefits.
When real estate in a Special Needs Trust is sold, the tax treatment depends on whether the trust distributes the gains to the beneficiary or retains them. Retaining gains means the trust pays at compressed trust rates. Distributing gains means the beneficiary reports them at their individual rate.
There's a unique complication with Special Needs Trusts: distributions to the beneficiary must be carefully structured to avoid jeopardizing government benefits. Cash payments often reduce SSI dollar for dollar. The trustee must coordinate with the beneficiary's benefits planner before making any distributions that include capital gains income. In most cases, retaining gains at the trust level and paying the higher tax rate is preferable to risking the beneficiary's eligibility for essential government programs.
You shouldn't rush into selling property held in a trust until you understand these five things. Your taxes depend on the kind of trust you have. Depending on the structure, step-up in basis can save or cost you six figures. The primary residence exclusion might or might not apply. Trust bracket compression means that keeping gains at the trust level is almost always more expensive than giving them out. Most families can breathe easier with the estate tax exemption, which is now permanent at $15 million, but they still need to plan.
AmeriSave suggests that you start by hiring three professionals if you are selling trust property. These are your estate planning attorney, who will look over the trust documents and make sure you have the right to sell; a tax advisor (CPA or enrolled agent), who will show you how the sale will affect your taxes in different situations; and a real estate professional, who will handle the sale itself. These experts should be talking to each other, not working on their own.
Our team at AmeriSave helps families at every step of the homeownership process, even those who are selling property held in trust and making plans for their next move. If you want to buy a new home, refinance, or use your equity to get a cash-out refinance or a HELOC, you need to know where you stand after taxes. This is the first step in everything else.
The fees for professional help are small compared to the taxes you might have to pay or the legal problems you could cause by selling in the wrong way. This step is important. Your future self will be grateful.
The amount depends on the type of trust, how much you paid for the property, and whether you meet the requirements for the Section 121 exclusion. If you meet the two-year ownership and use tests, you can leave out up to $250,000 in gains as a single filer or $500,000 as a married couple. If your gains are more than the exclusion, they are taxed at federal long-term capital gains rates, which range from 0% to 20% depending on how much money you make. Irrevocable trusts pay capital gains taxes at lower trust rates, with the 20% rate kicking in for gains over about $11,700. If the grantor died recently and the property got a step-up in basis, there might not be much or any taxable gain if it is sold right away. You need to look at each case separately, taking into account the type of trust, how the property will be used, when it will be sold, and whether step-up applies.
There is a big difference. The IRS sees revocable trusts as transparent for income tax purposes. This means that selling a home in one is taxed the same way as selling a home you own outright. You can report the sale on your individual Form 1040, claim the primary residence exclusion if you meet the requirements, and pay capital gains taxes at your own rate. There is no need for a separate trust return. Irrevocable trusts, on the other hand, are their own taxable entities. When an irrevocable trust sells property, it may have to pay capital gains taxes at lower rates that start at 20% on gains of $11,700. Form 1041 is used by the trust to report the sale. If the trust gives the gains to the beneficiaries in the same tax year, the beneficiaries may be able to pay less tax on those gains instead.
According to IRC Section 1014, a "step-up in basis" is a rule that changes the cost basis of inherited property to its fair market value on the day the owner died. This means that there are no capital gains taxes on any growth that happened while the person was alive. If a parent bought a house for $200,000 and it was worth $600,000 when they died, the stepped-up basis would be $600,000, which would completely wipe out the $400,000 gain. This is very important for trust property because the type of trust determines who can use it. Revocable trust property gets a step-up because it stays in the grantor's taxable estate. Irrevocable trust property usually doesn't because it was taken out of the estate while the grantor was still alive. The difference can mean a lot of money in taxes on a single property, like $100,000 or more.
The federal estate tax exemption is $15 million for each person and $30 million for married couples. The higher exemption was supposed to end, but it didn't. The One Big Beautiful Bill Act made the higher exemption permanent and raised it to $15 million, with adjustments for inflation in the future. This means that families don't have to worry about the drop to $7 million to $8 million that was supposed to happen on January 1, 2026. The 40% federal estate tax rate only applies to estates worth more than the exemption. Most American families don't have to worry about federal estate taxes because the threshold is $15 million. However, twelve states and D.C. have their own estate taxes that kick in at lower thresholds.
Yes, but only in certain situations. The grantor of a revocable trust can take the full Section 121 exclusion on their personal return as long as they pass the two-year ownership and use tests. This is allowed for grantor trusts by IRC Section 121(d)(9)(C). The exclusion is only available for irrevocable trusts if the trust is a grantor trust for income tax purposes and the grantor meets the requirements for ownership and use. When a grantor dies and a revocable trust becomes irrevocable, beneficiaries may qualify by combining their own periods of ownership and use with those of the deceased grantor. Surviving spouses have more options for combining periods. The most important thing to ask is if the person who is claiming the exclusion meets both tests for two of the five years before the sale.
Trust tax brackets are much smaller than individual brackets, so trusts pay the highest marginal rates on very low incomes. For this year's tax returns, people don't reach the top 37% bracket until their taxable income is more than $640,600 for single filers or $768,600 for married couples. When taxable income is about $16,000, trusts and estates pay 37%. The same rule applies to capital gains: single filers pay 0% on long-term gains up to about $49,350 and 20% on gains over $546,100. Trusts don't pay any taxes on the first $3,300 of gains, but they do pay 20% on gains over $11,700. Because of this compression, it is almost always more expensive to keep income or capital gains at the trust level than to give them to beneficiaries who pay taxes at their own rates.
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