Revocable living trusts: same rules as individual ownership
A revocable living trust is a grantor trust — the grantor (typically you, the property owner) is treated as the owner for income tax purposes. All rental income, depreciation deductions, and, on sale, depreciation recapture flow directly to your individual return. The trust is invisible to the IRS for income tax.
The significant tax benefit at death: property held in a revocable trust is generally included in the grantor's taxable estate, giving heirs a step-up in basis to fair market value. That step-up eliminates accumulated depreciation and deferred recapture — the trust structure does not change this outcome versus direct ownership.
Irrevocable non-grantor trusts: compressed brackets
When rental property is sold inside an irrevocable non-grantor trust, the trust itself recognizes the gain and depreciation recapture. Trusts reach their top ordinary income rate at a relatively low level of income — far below the individual threshold — so unrecaptured Section 1250 gain can quickly hit the 25% cap, and the 3.8% Net Investment Income Tax also applies to net investment income above the trust's NIIT threshold, which is similarly low.
If the trust distributes the sale proceeds to beneficiaries in the same year as the sale, some or all of the income (including its character — ordinary, capital, recapture) may be distributed to beneficiaries under Section 643 and taxed at their individual rates instead. Timing distributions can therefore matter significantly for after-tax results.
Planning considerations
Placing rental property in an irrevocable trust can complicate the tax picture at sale. The trust does not benefit from the Section 121 home-sale exclusion, and the step-up at death depends on whether the property is included in the taxable estate (which varies by trust type). Trusts that hold rental property long-term should account for the depreciation schedule and potential recapture in planning — the trust's tax rate on recapture income may differ substantially from the grantor's individual rate.
For grantor trusts, the practical takeaway is that the tax consequences of a sale are identical to individual ownership. The trust structure creates asset-protection and probate-avoidance benefits without changing the recapture analysis.
Frequently asked questions
Does a revocable trust change the depreciation recapture tax treatment?
No. A revocable living trust is a grantor trust — all income and gain, including recapture, is reported on the grantor's individual return as if the trust did not exist.
Are trusts subject to the 25% recapture cap on unrecaptured Section 1250 gain?
Yes. Trusts have the same 25% maximum rate on unrecaptured Section 1250 gain, but the trust's income can hit that cap faster because trust brackets are compressed.
Can distributing sale proceeds to beneficiaries reduce the recapture tax?
Potentially, if the trust distributes in the year of sale, the character of the income — including unrecaptured 1250 gain — passes to beneficiaries under the distributable net income rules, and they pay tax at their own rates, which may be lower than the trust's rates.
Sources
- IRS Topic No. 409 — Capital Gains and Losses
- IRS Publication 544 — Sales and Other Dispositions of Assets
- IRS Publication 946 — How to Depreciate Property
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.