Selling a home in a revocable trust

Jan. 1, 2004
Several years ago, I established a revocable living trust as part of my estate planning documents. At the urging of my attorney, I transferred title to the personal residence that my wife and I have lived in for many years into the trust.

Selling a home in a revocable trust

Charles Blair, DDS and John McGill, MBA, CPA, JD

Several years ago, I established a revocable living trust as part of my estate planning documents. At the urging of my attorney, I transferred title to the personal residence that my wife and I have lived in for many years into the trust. Now we are planning to sell the home, and the gain will be substantial. Since the property was transferred into the trust, will this cause me to pay tax on the gain?

No. The IRS has previously ruled that since this is a revocable trust, you are still considered to be the owner of the home. Accordingly, as long as you and your wife have used this home as your principal residence for at least two of the five years prior to the sale, you can exclude up to $500,000 of the gain.

Recently I have read several reports about executives from large corporations taking large interest-free loans to finance investments. Since I am incorporated, can I do this through my corporation?

Yes; however, the Internal Revenue Service has established special rules to prevent individuals from avoiding taxes on the economic benefit of these interest-free loans.

Under the IRS rules, you are considered to have received an income equal to the "forgone" interest — the minimum amount the corporation should have charged you —based upon the Applicable Federal Rate (AFR) in effect at the time of the loan. Accordingly, you are required to report the appropriate amount of this "deemed interest" on your federal- and state-income tax returns.

The IRS also considers you as having repaid the interest back to the corporation. Provided that you use the funds for investment purposes, you should be able to deduct the deemed interest paid as an investment interest expense on Schedule A, so there should be no tax cost to you. The corporation will, however, have to pay tax on the phantom interest earned, even though no actual cash changed hands. For information on the applicable federal rate, you should contact the IRS.

Last year I became disabled and have just now begun receiving disability insurance benefits. For over 30 years, I paid the disability insurance premiums through my regular "C" corporation and deducted them. However, in the year of disability, I paid the premiums personally. Will I have to pay tax on the disability insurance proceeds? If so, how much?

No. The IRS has previously issued a Private Letter Ruling indicating that it is the payment of the disability insurance premium in the year of disability that controls the taxation of the related proceeds. Accordingly, even though you paid premiums for many years through your professional corporation and deducted them in the year of disability, the premiums were paid personally and were not deducted. Accordingly, all of the disability insurance proceeds will be tax-free to you.

I am age 45 now and would like to consider an early retirement in 10 years at age 55. My financial adviser has recommended maximizing retirement-plan contributions to build up the maximum amount of wealth prior to my anticipated early retirement age. However, I believe that I should save money personally, rather than through the retirement plan, since I will have to pay taxes upon the withdrawals at age 55. What do you think?

In most cases, you will be best served by continuing to maximally fund your retirement plan. Assuming reasonable staff-funding costs, you will end up with a higher accumulation at your anticipated early retirement age since the funds contributed to the plan will be tax-deductible and will grow tax-deferred until withdrawn by you.

Most doctors are under the impression that they cannot touch their retirement plan or IRA funds until age 59 1/2 without suffering a 10 percent early distribution penalty. Fortunately, there are several exceptions. For example, at age 55, you could terminate the plan, roll over the funds into an IRA, and begin taking distributions of your estimated life expectancy and avoid the penalty.

Despite these methods to access your retirement plan and IRA funds on a penalty-free basis, you will probably be best served by continuing to allow these funds to grow and compound on a tax-deferred basis. Most doctors can maximize their net-worth position upon retirement by drawing down their retirement assets in the following order: Utilize practice sale proceeds first, then consume personal investments and Social Security benefits (beginning at age 62), and defer receipt of retirement plan and IRA distributions until the latest possible date, age 70 1/2.

Dr. Blair is a nationally known consultant and lecturer, and is a member of the American Academy of Dental Practice Administration. Mr. McGill is a tax attorney, CPA, and MBA, and is the editor of the Blair/McGill Advisory, a monthly newsletter helping dentists to maximize profitability, slash taxes, and protect assets. The newsletter ($195 a year) and consulting information are available from Blair/McGill and Company, 2810 Coliseum Centre Drive, Suite 360, Charlotte, NC 28217, or call (704) 424-9780.

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