When the creator of a trust dies, the assets must be distributed correctly or they could be frozen, taxed or their distribution could be challenged. Liquidating trust assets requires following several steps that go beyond simply distributing them to beneficiaries. Reviewing the steps for liquidating assets held within a trust will help you avoid any unnecessary problems once the trust is terminated.
Contact the Beneficiaries
Let the beneficiaries know the trust creator has passed and that the trust is being terminated and its assets distributed. Do this immediately, even before you know how much each person is going to receive. Let the beneficiaries know the process you'll be following. This will include having the trust audited, dealing with the courts, paying liabilities and taxes and handling any other paperwork issues.
This can open a can of worms if antagonistic beneficiaries demand to be part of the process to prevent being cheated. They might hire lawyers and ask the courts for injunctions or other rulings that restrict your ability to operate and delay your work.
You can distribute part of the assets early if you're certain that the trust has more assets than liabilities, retaining some to cover any anticipated debts and taxes. You can also send each beneficiary a copy of the trust agreement and any special instructions the creator left. An attorney knowledgeable in this area should advise you if this is a good idea.
Conduct an Audit
The first step in liquidating the assets of a trust is to review the trust document to learn the directions that were specified for liquidating the assets. How assets can be distributed will depend on what type of trust it is, such as a revocable, irrevocable, special needs, living or testamentary trust, according to the Keystone Law Group. The trust will continue after the death of the creator in some cases, paying and distributing portions of assets for a specified period of time.
Next, have the trust audited to determine exactly what the assets and the liabilities are. You'll learn whether the trust owes the trust manager money for services rendered, if any property taxes on real estate are owed or if the trust has any other obligations. You might also have obligations that will occur once you begin distributing the assets, such as additional management fees and taxes.
In addition to looking at your financial obligations, check to see what other paperwork you’ll need to take care of, such as title searches or transfers. Work with a trust auditor and/or attorney who specializes in trusts, wills and estates, even if you're the trustee. This will ensure that you identify all your responsibilities.
Deal With Any Problems
You might also uncover and have to deal with fraud or mismanagement of the trust after conducting an audit. If you distribute the assets of the trust to beneficiaries and then try to deal with these problems, those beneficiaries could face legal hassles related to the mismanagement or fraud even if they had nothing to do with these problems.
Go to Court to Liquidate an Asset
Part of the process of liquidating an asset or the assets of a trust might include getting approval for the distribution from the court. This process also sets up terminating the trust once its assets are distributed. Use an attorney to determine if you need to work with the courts and if so, how to do this.
Settle Your Obligations
Begin to take steps to meet your obligations after you’ve audited your trust. This can include making payments to nonbeneficiaries, such as paying management fees and taxes.
You might have to file IRS Form 1041 if the trust is required to pay taxes. A tax expert will be able to tell you if the trust owes taxes and how to pay them.
If the decedent leaves a house, you might give the house to a sole beneficiary who wants to live in it, or you might have to sell it and distribute the cash to multiple beneficiaries. You can notify the beneficiaries of the price(s) for which you are going to sell assets to be on the safe side. This can prevent lawsuits that claim you sold the assets below their value.
Distribute the Assets
Distribute the assets of the trust after you've contacted the beneficiaries, paid the trust’s obligations, filed its court, tax and other paperwork and dealt with the issues of selling any necessary assets such as real estate. Your lawyer or tax adviser will help you create the paperwork explaining the distribution and prepare the documents the beneficiaries must sign.
Beneficiaries might have to receive IRS Schedule K-1, which they will use to determine the amount of taxable income they might have received from the trust, although inheritances generally aren't taxable at the federal level. Submit your final paperwork to the courts, the IRS or any other body that requires proof of the distribution after the assets are distributed. You can terminate the trust following the correct legal procedures for doing so after you've met all your obligations.
- Beneficiaries may ask you to distribute the contents of the trust as soon as the law allows. Do not do so until you're certain that the trust retains enough income to pay any taxes or debts; otherwise, you could find yourself liable for any taxes the trust can't pay.
- Part of your duty as trustee is to treat all beneficiaries fairly and impartially. Even if you are a beneficiary, you can't favor your financial interests over those of the other beneficiaries.
Steve Milano has written more than 1,000 pieces of personal finance and frugal living articles for dozens of websites, including Motley Fool, Zacks, Bankrate, Quickbooks, SmartyCents, Knew Money, Don't Waste Your Money and Credit Card Ideas, as well as his own websites.