The Internal Revenue Code defines numerous types of trusts, including grantor, simple and complex trusts. Complex trusts holding capital assets, such as stocks and bonds, can have realized or unrealized gains or losses. Under certain circumstances the Internal Revenue Service requires complex trusts to file tax returns and can levy taxes on capital gains. While realized gains or losses can impact tax liability, the IRS does not levy taxes on unrealized gains.
The Internal Revenue Code defines numerous types of trusts. Simple trusts distribute income annually and do not contribute to charities. Grantor trusts are entities in which the grantor or owner of the trust maintains control of assets or directs the distribution of assets or income. Trusts that do not meet the definition of a simple or grantor trust are considered complex trusts by the IRS. Complex trusts often earn an income and can also make contributions to charities.
Realized vs. Unrealized
Assets in trusts can earn gains or incur losses. For a gain or loss to be “realized” an asset must be sold. Value increases and decreases of assets still held constitute “unrealized” gains or losses. Gains and losses are determined by the basis of an asset, which typically equals its purchase price. For example, if a share of stock in a trust is purchased for $50 and sold for $75, the trust would earn a realized gain of $25. However, if the trust continues to hold the share of stock, it earns an unrealized gain of $25 when the stock price reaches $75.
Capital gains, including gains earned by trusts, are typically reported to the IRS as income. Capital gains and losses only apply when a trust sells an asset. If a trust sells an asset after holding it for more than one year, the IRS considers the loss or gain long-term. For example, if a trust holds a share of stock for two years, then sells the share above the basis price, the transaction constitutes a long-term capital gain. If a trust sells an asset after owning it for one year or less, the IRS considers the gain or loss as short-term. The IRS typically imposes higher taxes on short-term gains compared to long-term gains to discourage speculation. The IRS can impose taxes on capital gains earned by complex trusts. If the trust sells assets for a loss, it can qualify for a capital loss deduction. However, the IRS does not offer a tax deduction for unrealized losses.
Complex trusts are typically considered entities by the IRS. In certain cases the grantor, trustee or owner of a complex trust must file a tax return for the trust. As of the 2010 tax year, the IRS requires tax return filings for trusts earning incomes of $600 or more. Trusts with nonresident alien beneficiaries must also file a tax return, regardless of the amount of earned income. Trusts must report all realized gains or losses, but are not required to report unrealized capital gains or losses.
- IRS: Topic 409-Capital Gains and Losses
- Citizen for Tax Justice: The Hidden Entitlements-Indefinite Deferral of Tax on Unrealized Capital Gains
- Bankrate: Taxability of Complex Trust
- IRS: Form 1041-U.S. Income Tax Return for Estates and Trusts
- IRS. "Abusive Trust Tax Evasion Schemes - Questions and Answers: Basic Trust Law." Accessed June 26, 2020.
- Commonwealth Financial Network. "Estate Planning With Intentionally Defective Grantor Trusts." Accessed June 26, 2020.
- IRS. "184.108.40.206 (09-16-2013) Trusts - Intentionally Defective Grantor Trust (IDGT)." Accessed June 26, 2020.
Michael Evans graduated from The University of Memphis, where he studied photography and film production. His writings have appeared in numerous print and online publications, including International Living, USA Today, The Guardian, Fox Business, Yahoo Finance and Bankrate.