The Tax Consequences of Revocable Trust Accounts

by Ciaran John ; Updated July 27, 2017

When you establish a revocable living trust, you create a legal entity that can own property and operate accounts. However, the Internal Revenue Service regards you and your revocable trust as a single entity for tax purposes. Consequently, people often refer to revocable trusts as being tax neutral. However, in some circumstances, creating a revocable trust can have tax consequences beyond just your federal income tax liability.

Tax Identification Number

In order to file taxes, you must have a tax identification number or Social Security number. Your revocable living trust operates under your Social Security number. Consequently, you must pay ordinary income tax on income from assets held either in your personal name or in the name of the trust. Therefore, revocable living trusts do not offer you the same potential tax benefits as irrevocable living trusts, which operate and file taxes under a separate TIN.

Cost Basis

Many types of assets appreciate in value over time, and when you sell such an asset, you have to pay capital gains tax. The amount of tax that you pay depends on the premium that you originally paid when you bought the asset. You pay no taxes on your return of premium, and the IRS calls this your cost basis. When you transfer ownership of an asset to your trust, your original cost basis remains in effect. With other kinds of trusts, your cost basis resets when you transfer your assets to the trust. This means revocable trusts do not provide you with the same potential capital gains tax savings as other kinds of trusts.

Death

When you die, the trustee of your revocable living trust disburses your assets to your heirs. The cost basis of your assets resets when your heirs take possession of those assets. This means your heirs can sell your transferred assets very quickly without incurring a capital gains tax liability. State laws on joint revocable trusts vary, but in some states your joint revocable trust becomes an irrevocable trust when one of the trustees dies. Depending on the income generated by the trust, the creation of a separate TIN for the trust at this point, may help to lower the tax burden of the surviving spouse.

Homestead

Many states have homestead exemption laws, meaning that you do not have to pay property tax on the entire value of your home. Additionally, some states, such as Florida, have laws that restrict annual increases in your property tax, and the property tax only resets when your home changes hands. In many states, transferring ownership of your home to your revocable living trust has no impact on your homestead exemption. However, in other states, you and your trust are regarded as separate entities. Therefore, your homestead exemption may reset to a higher tax rate when you transfer ownership of your home to your trust.