How capital gains tax on the sale of a property held in a trust works. This reader wants to know if they can claim a capital loss on the sale.

Q: I enjoyed your column in the Washington Post. I am trustee of my father’s trust. Upon his death, his 50 percent interest in the home he shared with my step-mother was transferred to the trust. We had the house appraised at the time of his death. We are now selling the house and the trust’s share of proceeds will be less than 50 percent of the basis of the house at the time of my father’s death. 

Can the trust claim a capital loss since the trust did not use the house as a residence? The terms of the trust allowed my step-mother to continue living in the house, but she had to pay all upkeep expenses, real estate taxes, and mortgage payments.

How Capital Gains Tax on the Sale of a Property Held in a Trust Works

A: Let’s start by talking generally about profits and losses on the sale of a primary residence. If you sell your primary residence and lived in that home for two out of the last five years, you get to exclude from any federal income taxes up to $250,000 of profit if you are single, and up to $500,000 if you are married. However, if you lose money on the sale, you can’t take that loss and that loss generally doesn’t have any impact on your federal income taxes.

Now, when you own a property as an investment, then you pay taxes on the profits when you sell the property and you might be able to benefit from the losses on your federal income tax return. However, nothing is simple when it comes to federal income taxes on investment properties, particularly when it comes to more complicated estate matters. 

Your question involves a trust and we presume that the trust you are talking about was not a personal trust that many people have when they own a property during their lifetime. This particular trust became the owner of the property at the time of the homeowner’s death. Presumably, the trust was set up this way to shield it from some federal income taxes, to protect against creditors or some other financial benefits different types of trusts can give trust owners and their descendants. 

Investment Property vs. Primary Residence

Now, your dad only owned half of the home The other half is owned by your step-mother. We’re not sure we see this property falling into the category of an investment property, although a smart tax or estate attorney might be able to make the case. Here’s our thinking: You’re likely not leasing the property to your step-mother as she’s an owner of the property and she’s paying all of the expenses of the property. So the trust has received no income from the property and has incurred no expenses during the ownership of the property. 

That’s not typically how investment property works. In a more typical arrangement, the trust would own the entire property, your step-mother would have had to rent the property from the trust, and there would need to be documentation backing up the arrangement, at the least.

While you should talk to your accountant or tax advisor, it seems to us from the limited information that you’ve provided that you might not benefit from a loss on the sale of the property. 

Depending on the type of trust and other assets held in the trust, you might ask your tax advisor if there is a provision in the tax code that could potentially aid you in the sale – if you have other gains from the sale of other trust assets.

More on Topics Related to Investment Properties and Capital Gains Tax

Avoiding Capital Gains Tax When Selling Investment Property

Making the Most Out of the Sale of an Underwater Investment Property

Is a Rental Property a Good Investment?

Predicting the Future Tax Liability of Inherited Investment Property  

What Are the Implications of Transferring an Investment Property to an LLC?

What Happens When A Lender Places a Lien on an Investment Property?