Can You Trust Your Trust? – Part 1—Credit Shelter Trusts

By Stephen J. Silverberg
New York Elder Law Attorney

Many trusts may be no longer necessary, may conflict with current tax laws or no longer meet the original intent of the person establishing the trust because of changes to federal estate tax laws. There may have been changes in family situations or perhaps a beneficiary has suffered a health event, creating a need for government benefits. Regardless of federal or NY estate tax laws, there are important options available.

Can you trust your trust? It depends. Let’s start with a look at Credit Shelter Trusts. These trusts are typically used to let a married couple reduce estate taxes when the second spouse dies.

In 1990, upon his wife’s death, a credit shelter trust was established for the benefit of the surviving husband. The trust was funded with a rental building and received a step-up in basis to $600,000. Funding the trust avoided the imposition of a federal estate tax upon the wife’s death. Upon the husband’s death, the children become the owner of the building.

It is now 2017, and the surviving husband is still alive. Over the years he received the income generated by the building, and the building is fully depreciated. The building has appreciated in value to $1.1 million.

Originally, the trust was necessary to avoid the imposition of a federal estate tax on the death of the wife. However, in 1990 the federal estate tax exemption was $600,000; and 2017 the federal estate tax credit is $5.49 million. Assuming the husband’s estate is under this number, there will be no federal estate tax.

However, upon the husband’s death, when the children become owners of the building, there is no step-up in basis; they inherit the property at the trust’s tax basis. Due to the past depreciation deductions, if the children sell the building there will be a recapture of the depreciation resulting in substantial income tax liability. Appreciation in the value of the building will produce capital gains.

The best move?

Distribute the property out of the trust directly to the husband or decant the credit shelter trust into a trust which will include the value of the building in the husband’s taxable estate. Upon the death of the husband, the children’s tax basis will be equal to the fair market value on the husband’s date of death. This wipes out any potential income tax attributable to both the appreciation of the property and the depreciation taken over the past 17 years.

If the children sell the building, a capital gain would is determined by the excess of the sales price over the value of the building on the husband’s date of death. Often all potential capital gains taxes are eliminated. And, since the husband estate was under the federal estate tax limit, there is no estate tax.

The same would hold true if the assets of the credit shelter trust are securities that appreciated over the years. The same strategy would eliminate any capital gains to the children upon the sale of the securities after their father’s death.

Every situation is different and a careful review of the existing trust document and each client’s situation is necessary to determine whether using any of these strategies are appropriate.

About the Author
Stephen J. Silverberg is nationally recognized as a leader in the areas of estate planning, estate administration, asset preservation planning, and elder law. He is a past president of the prestigious National Academy of Elder Law Attorneys (NAELA), and a founding member and past president of the New York State chapter of NAELA.