The choice of filing method is up to the trustee, but if you’re already reporting the rental income on Schedule E of the grantor’s 1040 using Optional Method 1, then no Form 1041 is required.
When you transfer assets into an irrevocable grantor trust, the grantor remains responsible for all income taxes on the trust’s income, even though the assets are no longer part of the grantor’s estate. The grantor is treated as the owner of the trust for income tax purposes if certain powers are retained.
Gift Tax Consequences: – was there a gift tax return completed yet?
The initial transfer of assets into the irrevocable trust may trigger gift tax consequences.
Gift Tax Reporting:
If the combined value of the transferred properties exceeds the annual exclusion amount ($19,000 for 2025), you must file Form 709 (United States Gift and Generation-Skipping Transfer Tax Return) to report the taxable gift. The transfer will reduce your lifetime exclusion of $15,000,000 for 2026.
Additional Considerations:
Review any existing mortgages on the properties. If liabilities assumed by the trust plus any liabilities to which the property is subject exceed your adjusted basis in the transferred property, you must recognize gain. The trust’s basis in the property is then increased by the recognized gain.
Powers That Trigger Grantor Trust Status:
The trust is treated as a grantor trust if the grantor retains a reversionary interest of more than 5%, has power to control distributions to beneficiaries without consent of an adverse party, or maintains certain other powers over the trust.
Filing Options:
The trust can file Form 1041 with an attached statement reporting the grantor’s information and all income, deductions, and credits. Alternatively, if the entire trust is a grantor trust, the trustee can use optional reporting methods where income is reported directly to the grantor using the grantor’s Social Security Number, or the trust issues Forms 1099 to the grantor annually.
Key Documents for Transferring Properties into a Grantor Irrevocable Trust:
To transfer a principal residence and rental property into a grantor irrevocable trust, you need the following documents:
Property Transfer Documents:
For the real property transfers (both the principal residence and rental property), you must prepare and record deeds to transfer legal title from your name to the trust. The deed must be recorded or delivered to complete the gift. The deed should name the trust as the new owner (typically titled as “, Trustee of”).
Trust Document:
You’ll need the executed trust agreement itself, which establishes the trust terms and names the trustee.
For the principal residence, be aware that transferring it to an irrevocable trust may affect your ability to claim the home sale exclusion (up to $250,000 for individuals or $500,000 for married couples filing jointly) if you later sell the property, since you must meet ownership and use tests.
You should also obtain a new Employer Identification Number (EIN) for the trust and decide which tax reporting method the trust will use for reporting the rental income.