Creating a Florida Irrevocable Homestead Trust for Ad Valorem, Income, and Transfer Tax Purposes
Parents often want to assist their children by helping them purchase or own a home. There are several ways to help children acquire a home, including transferring an existing home to a child, parents purchasing and retaining ownership of the home for the child to reside in, or transferring cash to the child and allowing him or her to purchase and own a home. The problem with parents purchasing and/or retaining a home in the parents’ name and allowing the child to reside in the home is that the home will not qualify as a homestead for ad valorem tax and asset protection purposes[1] or for benefits under §§121 and 163(h) of the Internal Revenue Code of 1986, as amended (I.R.C.),[2] if the parents reside in another home and claim that home as their primary residence. Similarly, there is a problem when parents transfer cash to the child to purchase and own the home because the transfer of the cash will constitute a taxable gift by the parents under I.R.C. §2501; increase the value (together with applicable appreciation) subject to estate taxes on the death of the child under I.R.C. §2001[3]; and, if the child is married or later marries, the home could potentially be subject to equitable distribution as a marital asset if the child gets a divorce.[4]
To avoid the problems set forth above, parents can transfer the home or cash to acquire the home to an irrevocable trust with particular provisions discussed in this article. The transfer of the home or cash by the parents is still a taxable gift under I.R.C. §2501; however, if properly structured, the home can be treated as owned by the child: 1) for ad valorem tax purposes to receive the property value exemption, the 3% cap on ad valorem tax value appreciation, and the portability of up to $500,000 of under-assessment; and 2) for federal income tax purposes, to receive the benefits under I.R.C. §§121 and 163(h), while being excluded from the child’s estate for estate tax purposes and not being treated as owned by the child as a marital asset if the child gets a divorce. This article discusses creating such an irrevocable trust and the treatment of such trusts for federal income tax, estate tax, ad valorem tax, and the treatment of such trusts for marital dissolution purposes. In addition, it provides some sample provisions that should be included in such trusts.
Federal Income Tax Issues
An irrevocable trust is one that cannot be revoked or modified by its settlor/creator.[5] When parents transfer property to an irrevocable trust, they are treated as the grantor of the trust for federal income tax purposes.[6] If parents retain other powers set forth in I.R.C. §§673, 674, 675, 676, or 677 (the grantor trust powers), then the trust will be disregarded for federal income tax purposes, and the parents will be treated as owning the property owned by the trust pursuant to I.R.C. §671.[7] However, if parents do not retain the grantor trust powers,[8] then, pursuant to I.R.C. §678(a), the child can be treated as the owner of the property owned by the trust if 1) the child has a power exercisable solely by the child to vest the corpus or income therefrom in the child; or 2) the child has partially released or otherwise modified such power, and after the release or modification retains such control as would, within the principles of I.R.C. §§671 to 677, inclusive, subject a grantor of a trust to treatment as the owner thereof. A trust in which a beneficiary (the child) is treated as the owner for federal income tax purposes is referred to as a beneficiary deemed owned trust or BDOT.
To be considered a BDOT, the trust 1) must provide the beneficiary the sole right to withdraw income and/or corpus of the trust in his or her sole discretion; 2) must not have any of the grantor trust powers making it a grantor trust; and 3) if there are discretionary distributions also authorized from the trust, must have an independent trustee or an adverse party who must approve distributions.
The concept of a BDOT is based on Mallinckrodt v. Nunan, 146 F.2d 1 (8th Cir. 1945), in which the beneficiary only had the right to withdraw income and not corpus. In Mallinckrodt, a father created a trust for his son, the son’s wife, and their children. The son’s wife was to get the right to withdraw the first $10,000 of income per year, and the son had the right to withdraw all income in excess of $10,000 per year. The son did not make any withdrawals from the trust, and the trustee reported all of the income from the trust as being taxable to the son. The IRS challenged such allocation of trust income determining that such income should be taxable to the son. The court determined that the income the son could have withdrawn, but did not, should be taxable to the son because it is the equivalent of ownership of the income for purposes of taxation. The court stated that there is no difference whether the possessor of such power is a grantor who retained such power or a beneficiary who acquired such power, and the son had “realizable” economic gain in each of those years making the income taxable to him.
To cause the child to be treated as the owner of the BDOT, the trust needs to provide that the child, acting alone, has the right to withdraw either all or a portion of the corpus or income of the trust. Note that the child needs to have the exclusive right to withdraw the income from the trust and not just be the sole income beneficiary, because that would not be a BDOT under I.R.C. §678(a)(1).[9] A typical right of a beneficiary to withdraw a portion of the corpus of the trust is a power to withdraw the greater of $5,000 or 5% of the aggregate value of the trust. These amounts are based upon I.R.C. §§2041(b)(2) and 2514(e) because a lapse of this withdraw right does not cause the child to include such lapsed property in the child’s estate for estate tax purposes or cause the child to be treated as making a taxable gift with respect to such lapsed property.[10] However, the problem with only using this withdrawal power is that only a portion of the home owned by the trust is treated as being owned by the child.[11] Moreover, giving the child a right to withdraw the entire corpus subject to an annual lapsing of such power limited to the greater of $5,000 or 5% of the aggregate value of the trust creates a hanging power of appointment as to the withdrawal right that has not yet lapsed, causing such hanging value to be included in the child’s estate for estate tax purposes pursuant to I.R.C. §2041(a)(2).
A better BDOT alternative for a trust holding a personal residence as discussed in this article is to provide the child the unfettered annual noncumulative right to withdraw 100% of the income of the trust and define income to include capital gains.[12] To avoid potential transfer taxes imposed on the lapse of the annual noncumulative right to withdraw 100% of the income of the trust, the lapse power should be restricted to the greater of $5,000 or 5% of the aggregate value of the trust. The trust that only owns a home is likely to only have income and capital gains that exceed this restriction on the lapse power in the year of the sale of the home. For example, if the trust purchased a home for $1 million in which the child resided for at least two years and subsequently sold the home for $2 million, the child would have capital gain equal to $750,000 ($250,000 of the gain is excluded pursuant to I.R.C. §121, assuming the child is not married and $500,000 of the gain is excluded if the child is married and the spouse also satisfies the two-year residency rule). Such sale would trigger a tax to the child who is not married equal to $178,500.[13] Now, the child could withdraw the capital gain of $750,000. Assume that the child elects not to withdraw the $750,000 from the trust and the trust makes a distribution in partial satisfaction of the withdrawal right to the child of $178,500 to pay the income taxes related to the sale of the home. In year one, the withdrawal power would be reduced by the income tax distribution of $178,500, and an additional $91,500 based on the restriction on the lapse power (5% of $1,821,500, which is the $2 million sale proceeds less the income tax distribution of $178,500). After this lapse, the hanging withdrawal power would be $480,000. Assuming that there is no other trust income and the trust’s assets remain at $1,821,500, it will take six years for the hanging withdrawal power to be reduced to zero with the annual lapse reduction of $91,500.
Allowing a BDOT to specially allocate income that includes capital gain was approved in Campbell v. Commissioner, T.C. Memo 1979-495, 39 T.C.M. 676 (1979). In Campbell, the trust was created by the taxpayer who designated his daughter as the trustee. The trust provided that the net income from the trust must be distributed by the trustee to the beneficiaries [the taxpayer and his wife], jointly or the survivor of them, not less than once each year — provided, however, the trustee shall distribute only that part of the net income that is derived from capital gains as is requested each year by the beneficiaries. If no such request is made, then all such capital gains shall be retained as a part of the trust fund and be reinvested as principal. The taxpayer did not request, and the trust did not distribute, the capital gains income, although the taxpayer clearly could have requested it. Citing Mallinckrodt, the Tax Court in Campbell held that:
Section 678(a)(1) clearly provides that a person with the power, exercisable solely by himself, to vest the corpus or the income in himself will be treated as the owner of that portion of the trust over which his power exists. Here, [the taxpayer and his wife] had the power exercisable solely by themselves to receive the King Trusts’ capital gains income. Accordingly, pursuant to section 678(a)(1), [the taxpayer and his wife] are deemed to be the owners of the capital gains income from the King Trusts.
Based on the foregoing, Edwin Morrow, a tax attorney who writes about BDOTs, states that “with the plain language of §678(a)(1), regulations under Treas. Reg. §1.671-2 and longstanding case precedent, it’s clear that beneficiaries with withdrawal rights over trust taxable income, regardless of whether there is any power whatsoever over corpus beyond that, MUST report any such income (and expenses, credits allocable thereto) on their Form 1040. There is no authority to argue otherwise.”[14]
As stated previously, to create a BDOT, the grantor cannot retain any grantor trust powers. It is easy to avoid including provisions typically used to cause a trust to be taxed as a grantor trust, such as the right to revoke the trust,[15] to reacquire trust corpus by substituting other property of equivalent value,[16] to borrow corpus or income from the trust without adequate interest or collateral,[17] or to add a beneficiary to the trust.[18] However, it should also be noted that such powers causing a trust to be taxed as a grantor trust can reside either in the grantor, the grantor’s spouse,[19] or a non-adverse party,[20] which may not be as obvious. One power that can cause a trust to be taxed as a grantor trust includes the power to control the beneficial enjoyment of trust corpus or income and may be invoked by giving the spouse or a non-adverse party such power.[21] For example, if the grantor’s spouse has a power to withhold distributions of trust corpus or income, then the trust will be taxed as a grantor trust even if a beneficiary has the right to withdraw trust corpus or income.[22] If the trust provides for discretionary distributions as the trustee determines and the grantor, the grantor’s spouse, or a non-adverse party is the trustee, then the trust will be taxed as a grantor trust and not a BDOT. To avoid this grantor trust treatment and still allow for a trustee to have the right to make discretionary distributions, the trust needs either to appoint an independent trustee[23] or the beneficiary with the withdrawal right needs to serve as a co-trustee and needs to consent as an adverse party to any powers that could cause the trust to be taxed as a grantor trust. Further, the grantor should not retain the power to remove and replace a trustee with himself or herself or a related or subordinate party because that would cause such powers to be deemed as controlled by the grantor.[24]
A home owned by a BDOT has been treated as owned by a beneficiary for I.R.C. §121.[25] In addition, Treas. Reg. §1.121-1(c)(3)(i) provides the following:
(i) Trusts. If a residence is owned by a trust, for the period that a taxpayer is treated under sections 671 through 679 (relating to the treatment of grantors and others as substantial owners) as the owner of the trust or the portion of the trust that includes the residence, the taxpayer will be treated as owning the residence for purposes of satisfying the two-year ownership requirement of section 121, and the sale or exchange by the trust will be treated as if made by the taxpayer.
Thus, an effectively created BDOT should be able to receive the deduction benefits under I.R.C. §§121 and 163(h) for income tax purposes.
Federal Transfer Tax Issues
The amount includable in the estate of a beneficiary of a BDOT with withdrawal rights is the value of the remaining hanging power of appointment at the date of death of the beneficiary pursuant to I.R.C. §2041(a)(2). By using the trust discussed herein and providing the beneficiary with the power to withdraw the income, including capital gains, the entire trust should be considered a BDOT as described above; and, because the power is limited to income and capital gains, this amount does not include any corpus of the trust and only includes such portion of the income that has not yet been reduced by the lapse power (which as stated above, in a trust similar to the example above with its main asset being a principal residence would generally be the capital gains associated with the sale of the residence). So, in the prior example of a BDOT that sold a house for $2 million and made an income tax distribution of $178,500 to the beneficiary in partial satisfaction of the withdrawal right, the beneficiary would include $480,000 in his or her estate if he or she died in the year of the sale (the remaining hanging power reduced by the distribution and the lapse under I.R.C. §2041(a)(1) if the child dies after the initial) and not the full $2 million.[26] This amount would be reduced each year by the lapse power of the greater of $5,000 or 5% of the aggregate value of the trust. If the child died prior to the sale of the house, then there would be no estate tax inclusion.
Ad Valorem Tax Issues
Homestead is a home used and occupied by a Florida natural person with an actual intent to permanently live in the home, which is limited in size to no greater than one-half acre of contiguous land located within a municipality or no greater than 160 acres of contiguous land located outside of a municipality.[27] Courts have relaxed the requirement of ownership by a natural person.[28] These cases address ownership of a homestead via a revocable trust. In Alexander, the court stated:
An individual must have an ownership interest in a residence that gives him or her the right to use and occupy it as his or her place of abode in order to qualify for Florida’s Homestead exemption. The individual claiming the exemption need not hold fee simple title to the property. Instead, it is sufficient if the individual’s legal or equitable interests give the individual the legal right to use and possess the property.
The court in Sussman noted that the argument that an owner cannot be denied homestead protection simply because title is held via trust, rather than individually, is correct on the law.
As to the permissibility of owning a homestead in an irrevocable trust, Florida Attorney General Opinion 72-12 held that an irrevocable trust can own homestead so long as the beneficiary (who is residing in and using the homestead as his or her permanent home) is provided a present possessory right to the homestead and the trust is passive. Consistent with that opinion, courts and the Florida Department of Revenue have determined that homestead can be owned by an irrevocable qualified personal residence trust provided that the grantor retains the exclusive right to reside in the home.[29] Accordingly, although there is no guidance directly on point, a valid assumption can be made that homestead can be owned by an irrevocable BDOT provided that the BDOT contains a provision providing that the beneficiary has the exclusive and continuous present right to full use, occupancy and possession of the homestead real estate owned by the BDOT for the life of the beneficiary and the beneficiary uses the home as his or her personal residence. The BDOT should waive any fiduciary duty of the trustee to sell the homestead or diversify trust assets.
Marital Asset Issues
Assets owned by a trust that a divorced spouse is not actively managing have been determined to be nonmarital property that is not subject to equitable distribution under F.S. §§61.075(6)(a)(1)(b) and 61.075(6)(b)(1).[30] In Nelson v. Nelson, 206 So. 3d 818 (Fla. 2d DCA 2016), the husband transferred an out-of-state home to an irrevocable trust in which his wife was the trustee and his wife and adult daughter were the beneficiaries — such home was held to be a nonmarital asset. However, if marital assets (e.g., a spouse’s salary) are used to pay down a portion of a mortgage on or are used to pay for expenses related to a nonmarital home owned by the BDOT, the nonmarital home can become a marital asset subject to equitable distribution under F.S. §§61.075(6)(a)(1)(b) and 61.075(6)(a)(1)(c). If a BDOT was created to own a home to be used by the child and his or her spouse, it is strongly recommended that the child and spouse execute a prenuptial agreement to ensure that the home and assets owned by the BDOT are nonmarital assets.[31]
Suggested Trust Provisions
A BDOT should have the following provisions:
• Withdrawal Power Over Income —
This Trust hereby grants to Child, and this Trust is a grantor trust pursuant to Code §678(a)(1) because Child has, the unfettered right and power to withdraw from the Trust one hundred percent (100%) of the income of the Trust in each calendar year. Such right and power shall be non-cumulative so that any amount in which Child is entitled to withdraw, but does not withdraw in any calendar year shall lapse on the last day of such calendar year and may not be withdrawn in any succeeding calendar year. For purposes of the foregoing sentence, “income” shall mean all income determined for income tax purposes (and not determined for trust accounting purposes) as set forth in Treas. Reg. §1.672-2(b) and shall specifically include (A) any dividends, interest, fees and other amounts characterized as income under Code §643(b), (B) any net capital gains realized with respect to assets held for twelve months or less, and (C) any net capital gains realized with respect to assets held longer than twelve months. The power to withdraw income under this Section shall prevail over the Trustee’s power to withhold distributions pursuant to Section __ hereof [trustee’s right to make discretionary distributions]. In accordance with Mallinckrodt v. Commissioner, 146 F.2d 1 (8th Cir. 1945), Campbell v. Commissioner, T.C. Memo 1979-495, and PLR 201633021, the allocation of such specific income was determined by courts and the Internal Revenue Service to allocate capital gain to the designated beneficiary that is treated as the grantor pursuant to Code §678(a)(1). Pursuant to Treas. Reg. §1.121-1(c)(3), if a residence is owned by a trust, for the period that a taxpayer is treated under Code §§671 through 679 (relating to the treatment of grantors and others as substantial owners) as the owner of the trust or the portion of the trust that includes the residence, the taxpayer will be treated as owning the residence for purposes of satisfying the two-year ownership requirement of Code §121, and the sale or exchange by the trust will be treated as if made by the taxpayer. Accordingly, Child shall be treated as owning the Home for income tax purposes provided such Home is owned by the Trust and the sale or exchange of the Home shall be treated as if made by Child.
• Limitation on Lapse Power —
Withdrawals by Child may be made at any time within sixty (60) days prior to the end of the year (the “Lapse Period”) in which the Trustee informs Child of the income of the Trust. The right of withdrawal is not cumulative, and if a person entitled to make a withdrawal does not exercise such right during the Lapse Period, said right shall lapse; provided, however that if Child’s withdrawal power lapses in any calendar year and the amount subject to such power exceeds the greater of (a) five percent (5%) of the trust assets, (b) Five Thousand Dollars ($5,000.00) or (c) the largest amount as may be permitted to lapse, under Sections 2514(e) or 2041(b)(2) of the Code, without Child being considered to have made a gift or to have released a general power of appointment (collectively, the “Annual Lapsing Cap”), then such excess amount shall not lapse, but shall hang and continue to be subject to this withdrawal power by Child in any subsequent year subject to the Annual Lapsing Cap. Upon the death of Child, all remaining right to make withdrawals by Child from the Trust shall lapse and terminate. If Child fails to exercise said withdrawal power or exercises it with respect to only a portion of the trust assets subject to said withdrawal power, then any portion of the trust assets not withdrawn shall be added to the trust corpus and administered as herein provided.
• Corrective Amendment to Address Code §678(b) —
This Trust does not contain, nor is it intended to contain, any power or right granted to Child’s parents that would cause this Trust to be a grantor trust pursuant to Code §§671 to 677 with either of the parents being considered the grantor. As a beneficiary of this Trust, Child is an adverse party pursuant to Code §672(a) and is not a related or subordinate party under Code §672(c). Accordingly, the powers under Code §§674, 675 and 677 that would otherwise cause a trust to be treated as a grantor trust thereunder do not apply to this Trust because any such powers would require the consent of Child as a co-trustee of the Trust and Child is an adverse party.[32] Notwithstanding the foregoing, to the extent that there is any right or power in this Trust that could be construed to create an argument that this Trust can be treated as a “grantor trust” for federal income tax purposes pursuant to Code §678(b) and Code §§671 to 677, the parties agree to make such modifications to the terms of this Trust retroactive to the date this Trust was created so as to cause this Trust NOT TO BE TREATED as a “grantor trust” pursuant to Code §678(b).
• Ad Valorem Tax Provision —
Despite any other provision of this Trust, Child shall have the exclusive and continuous present right to full use, occupancy and possession and to reside on any real property owned by the Trust during Child’s lifetime, including without limitation, the Home. It is understood that Child will be entitled to claim any available homestead tax exemption for any real property owned by the Trust; and, for purposes of that exemption, Child’s interest in such property will be deemed an interest in real property and not an interest in personal property. This provision does not restrict the Trustee from selling, leasing, or encumbering that property without my joinder in any deed or other instrument. It is the intent of the Grantor that any real property owned by the Trust on which Child resides and is using as his personal residence will be eligible to qualify for the homestead exemption under Section 196.031, Florida Statutes.
• Discretionary Reimbursement of Income Taxes —
The Trustee may, but shall not be required to, reimburse and pay to Child or Child’s personal representative any income or principal of this Trust on account of or in discharge of Child’s income tax liability (whether Federal, state or otherwise), if any, in respect of property held in any trust created hereunder and taxable to Child including, but without limitation, tax on realized capital gains. Any distributions made pursuant hereto shall reduce Child’s withdrawal right for such calendar year and/or any hanging withdrawal right as set forth herein.
Conclusion
Creating a BDOT for the child can secure income tax and ad valorem tax benefits as if the child owned the home in his or her own name, but avoid estate tax inclusion as to the corpus and potentially avoid the home being treated as a marital asset if the child marries or is married and subsequently gets divorced.
[1] A permanent resident of Florida that owns his or her principal residence in Florida qualifies for 1) a $50,000 exemption (and an additional $50,000 exemption if the owner is age 65 or older) from the value of the property for ad valorem tax purposes; 2) a 3% cap on the annual increase in the ad valorem tax value of the home; 3) portability of an under-assessment (the amount by which the just value exceeds the assessed value) of up to $500,000 upon the sale of the home and acquisition of a new home in Florida within two years of the sale; and 4) an exemption from claims of creditors other than for payment of taxes and assessments thereon, obligations contracted for the purchase, improvement or repair thereof, or obligations contracted for other labor performed thereon. See Fla. Const. art. VII, §6, and Fla. Stat. §§196.031 and 196.075 for the property value exemption; Fla. Const. art. VII, §4(d), and Fla. Stat. §193.155 for the 3% cap on annual increase in property value; Fla. Const. art. VII, §4(d)(8), and Fla. Stat. §193.155 for portability; and Fla. Const. art. X, §4, for creditor exemption. For a thorough discussion of the ad valorem tax benefits, see Charles Ian Nash, Chapter 6 – Homestead: Non-Creditor Issues, Asset Protection in Florida (Fla. Bar). For a thorough discussion of the exemption from creditors, see Barry A. Nelson, Chapter 5 — Homestead: Creditor Issues, Asset Protection in Florida (Fla. Bar).
[2] I.R.C. §121 allows the owner of a home to exclude $250,000 of gain from the sale of the home, or $500,000 of gain if the owner files a joint return with his or her spouse, provided the owner has used the home as his or her principal residence for at least two years during the five-year period prior to the sale. I.R.C. §§163(h)(2)(D) and 163(h)(3) allows the owner to deduct interest on the first $750,000 of mortgage indebtedness used to acquire or improve the home. The reduction on the mortgage indebtedness from $1 million to $750,000 applies for indebtedness incurred after December 15, 2017, until January 1, 2026.
[3] In the year 2020, each person (each parent and each child) has a unified credit for estate, gift, and generation-skipping taxes (transfer taxes) equal to $11,580,000, which is indexed for inflation and could increase each year. However, such amount is reduced by 50% on January 1, 2026 (or sooner if this law is changed). Accordingly, it may make sense to avoid transfer tax inclusion for the child.
[4] Fla. Stat. §61.075(6)(a)(1)(a) for assets acquired during the marriage, Fla. Stat. §61.075(6)(a)(1)(b) for enhancement and appreciation in value of nonmarital assets from the efforts of either party during the marriage or from the contribution to or expenditure thereon of marital funds or other forms of marital assets, or both, and Fla. Stat. §61.075(6)(a)(1)(c) for the pay-down of principal of a note and mortgage secured by nonmarital real property and a portion of any passive appreciation in the property, if the note and mortgage secured by the property are paid down from marital funds during the marriage.
[5] Fla. Stat. §736.0103(17) defines a revocable trust as a trust that can be revoked by the settlor without the consent of the trustee or a person holding an adverse interest.
[6] Treas. Reg. §§1.671-2(e)(1), 1.671-2(e)(2).
[7] See Treas. Reg. §§1.671-1(a), 1.671-2(a).
[8] I.R.C. §678(b) provides that I.R.C. §678(a) (causing the child to be the owner of the trust’s property) shall not apply with respect to a power over income (and the IRS interprets this also to apply to a beneficiary’s power over corpus) if the grantor of the trust (the parents) is otherwise treated as the owner under I.R.C. §§671 to 677.
[9] See PLR 200018021 and PLR 202022002 (treating a trust in which a beneficiary has the right to withdraw all of the proceeds from the sale of LLC membership interest but not withdraw the LLC membership interest itself as a BDOT under I.R.C. §678(a) that allows the first trust to sell a portion of the LLC membership interest to a second trust that is a grantor trust for income tax purposes with the beneficiary being the grantor and not recognize such sale as being taxable in accordance with Rev. Rul. 85-13).
[10] A lapse of a greater amount is treated as a taxable gift.
[11] See Treas. Reg. §1.671-3(a)(3) and PLR 200104005 (if a person is treated as owning an undivided fractional share of trust corpus or an interest represented by a dollar amount, then a pro-rata share of each such item of capital gain shall be allocated to that person).
[12] Treas. Reg. §1.671-3(c) provides that if the child is treated as an owner solely because of his or her interest in or power over ordinary income alone, he or she will take into account in computing his tax liability those items that would be included in computing the tax liability of a current income beneficiary, including expenses allocable to corpus that enter into the computation of distributable net income. See also Rev. Rul. 81-6 (trust created by parent with an independent trustee that provided a minor child with the right to withdraw all trust income treated as a BDOT per I.R.C. §678(a) even though the minor child could not exercise such right to withdraw without the appointment of a guardian because I.R.C. §678 is based on the existence of such power rather than the capacity to exercise such power) and PLR 201633021.
[13] The gain of $1 million is reduced by $250,000 under I.R.C. §121 and would be subject to the capital gains tax rate for assets held for more than one year of 20% pursuant to I.R.C. §§1(h) and 1222(4) and the net investment income tax of 3.8% pursuant to I.R.C. §1411.
[14] Edwin P. Morrow, IRC §678(a)(1) and the “Beneficiary Deemed Owner Trust” (BDOT), LISI Estate Planning Newsletter #2587 (Sept. 5, 2017), available at https://ssrn.com/abstract=3165592; see also PLR 201633012.
[15] I.R.C. §676.
[16] I.R.C. §675(4)(C).
[17] I.R.C. §675(2).
[18] I.R.C. §674(b)(5). See also PLR 9010065 in which an independent trustee’s power to add charitable beneficiaries caused the trust to be taxed as a grantor trust pursuant to I.R.C. §674(a).
[19] I.R.C. §672(e)(1).
[20] I.R.C. §672(b). A nonadverse party means any person who is not an adverse party. Pursuant to I.R.C. §672(a), an adverse party means any person having a substantial beneficial interest in the trust that would be adversely affected by the exercise or nonexercise of the power which he or she possesses respecting the trust. A person having a general power of appointment over the trust property (i.e., a right to withdraw corpus or income) shall be deemed to have a beneficial interest in the trust.
[21] I.R.C. §674(a).
[22] I.R.C. §§674(a) and 678(b). See PLR 200730011.
[23] I.R.C. §674(c)(2) and Treas. Reg. §1.674(c)-1 (emphasis added). An independent trustee is a trustee who is not the grantor, the grantor’s spouse, or more than half of whom are related or subordinate parties who are subservient to the wishes of the grantor. I.R.C. §672(c) defines a “related or subservient party” as any non-adverse party who is the grantor’s spouse that is living with the grantor or any of the grantor’s parents, issue, brother, sister, employee of the grantor, a corporation, or any employee of a corporation in which the grantor has significant voting control or an employee of a corporation in which the grantor is an executive.
[24] See Rev. Rul. 95-58 holding that such powers cause the trust corpus to be includable in the grantor’s estate pursuant to I.R.C. §2036(a)(2).
[25] See Rev. Rul. 66-159, Rev. Rul. 85-45, and PLR 1999-12026, in which the IRS looked through the trust to the beneficial owner under I.R.C. §678(a) for qualification under I.R.C. §121 and its predecessor, I.R.C. §1341. As Morrow notes in IRC §678(a)(1) and the “Beneficiary Deemed Owner Trust” (BDOT): [a]lthough in those cases the beneficiary had a right to withdrawal the entire trust principal, not just the capital gains from the sale of the home, the statute should equally apply if all the capital gains are subject to a withdraw right, as discussed above. This is perfectly consistent with Treas. Reg. §1.671-3(a)(2) and I.R.C. §678(a).
[26] I.R.C. §§2041(a)(1) and 2041(b)(1), and Treas. Reg. §20.2041-3(d)(3). See also Estate of Dietz v. Commission, T.C. Memo 1996-471, and PLR 201038004.
[27] Fla. Const. art. X, §4, and Pasternack v. Klein, 2019 WL 330593 (M.D. Fla. 2019).
[28] As to homestead being owned by a revocable trust, see Callava v. Feinberg, 864 So. 2d 429 (Fla. 3d DCA 2004); Engelke v. Estate of Engelke, 921 So. 2d 693 (Fla. 4th DCA 2006); In re Alexander, 346 B.R. 546 (Bankr. M.D. Fla. 2006); In re Edwards, 356 B.R. 807 (Bankr. M.D. Fla. 2006); In re Cocke, 371 B. R 554 (Bankr. M.D. Fla. 2007); In re Im, 495 B.R. 46 (Bankr. M.R. Fla. 2013); and In re Sussman, 2019 WL 2402997 (Bankr. M.D. Fla. 2019).
[29] Stone v. Stone, 157 So. 3d 295 (Fla. 4th DCA 2014); Robbins v. Welbaum, 664 So. 2d 1 (Fla. 3d DCA 1995), TAA 04B4-011, and TAA 96-03.
[30] Oxley v. Oxley, 695 So. 2d 364 (Fla. 4th DCA 1997) (inter vivos trust owned by husband considered a nonmarital asset not subject to equitable distribution); and Barner v. Barner, 716 So. 2d 795 (Fla. 4th DCA 1998) (an inheritance of timberland by the wife is a nonmarital asset even though the income from the timberland was used to support the family).
[31] See Fla. Stat. §61.075(6)(b)(4).
[32] The child is designated as a co-trustee if the grantor or grantor’s spouse is also designated as a co-trustee.
Thomas O. Wells, J.D., LL.M. in taxation and CPA, practices tax, transactional, estate, and wealth preservation law in Coral Gables with the firm of Wells & Wells, P.A. He has an LL.M. in taxation from the Graduate Tax Program at the University of Florida Levin College of Law, is board certified by The Florida Bar in tax law, was named 1999 CPA of the Year in Business and Industry by the Florida Institute of Certified Public Accountants, and is a fellow in the American College of Trust and Estate Counsel. He is also the author of “Chapter 4 — Asset Protection Provided with Florida Business Entities” published by The Florida Bar in Asset Protection in Florida.
This column is submitted on behalf of the Tax Section, Dennis Michael O’Leary, chair, and Taso Milonas, Charlotte A. Erdmann, and Jeanette E. Moffa, editors.
