Distributions From an Estate or Trust
Have you received an inheritance? People often ask, "Is it taxable?" but rarely ask, "Is my inheritance a tax deduction?" When considering estates that mainly consist of real estate, such as the decedent’s home, there is often no taxable income passed onto the beneficiary, but rather a tax deduction. Unfortunately, this is a deduction that can easily be missed on your tax return, especially if received in the past three years.
Where do Excess Deductions Come From?
Excess deductions arise when the income earned in an estate or non-grantor trust is less than the deductible expenses incurred by the estate or trust. This is often seen when an estate’s main asset is the decedent’s home. This can mean that there is little taxable income but the estate has legal, accounting, and administrative fees to close the estate, resulting in expenses in excess of income.
Why Missed?
Excess deductions are only passed to beneficiaries in the year an estate or non-grantor trust is terminated, therefore a one-time expense. Beneficiaries who receive the K-1 reporting the deduction may not realize it is a taxable event and never mention the inheritance or form K-1 to their accountant. (Alternatively, they may do their own taxes and don’t know where to enter the information on the tax return.)
For those working with accountants, and who actually bring the inheritance to their accountant’s attention, the deduction likely was still not taken. The Tax Cuts and Jobs Act (TCJA), which went into effect for tax years beginning in 2018, was one of the largest and quickest tax code changes ever made. For that reason, there were many holes and unintended consequences that also came with the new code. Before the TCJA, excess deductions from an estate or non-grantor trust were considered miscellaneous itemized deductions and were deducted on the beneficiaries Schedule A.
However, the TCJA took away miscellaneous itemized deductions from Schedule A, so at first glance it appeared that excess deductions from an estate or non-grantor trust were lost. It wasn’t until October 19, 2020, that we received final regulations from the IRS that certain excess deductions can be taken on the beneficiary’s individual income tax return.
Before then, there was nowhere to take the deduction under the TJCA.
We Can Help
If you're looking for assistance with your finances, we're here to help. All of our advisors are also CPAs, and we will ensure your financial planning is tax-efficient.
For the DIY group out there, we’ll be following up with a second article on how to properly report the excess deductions on your form 1040 or 1040X if amending your return.