Tax Ramifications of Selling a House That Was in a Revocable Living Trust

One of the most common questions I hear from clients is: what are the tax ramifications of selling a house that was in a revocable living trust?

The good news is simple: selling a house from a revocable living trust is not much different tax-wise than if you sold it as an individual.

This surprises some people who assume that placing property in a trust creates additional tax complications. The reality is that revocable living trusts are designed to be tax-neutral during your lifetime.

Understanding Revocable Living Trusts and Taxes

A revocable living trust is what the IRS calls a “grantor trust” while you are alive. This means:

• You report all trust income on your personal tax return
• The trust does not usually file a separate tax return while you are alive
• All tax benefits and obligations flow directly to you
• The IRS treats the trust as transparent for tax purposes

This tax treatment is one of the key advantages of revocable living trusts. You get probate avoidance and estate planning benefits without creating additional tax complexity.

Learn more about why you should put your home in a living trust.

Selling Your Personal Residence from a Trust

If you are selling your primary residence that is held in your revocable living trust, you still qualify for the same tax exclusions available to any homeowner.

Primary Residence Capital Gains Exclusion:

• Single filers can exclude up to $250,000 in capital gains
• Married couples filing jointly can exclude up to $500,000
• You must have lived in the home for at least 2 of the last 5 years
• The property being in a trust does not affect these exclusions

This means a California homeowner who purchased their house 20 years ago for $400,000 and sells it today for $1,200,000 can potentially exclude $500,000 gain from taxes if they meet the occupancy requirements and are married filing jointly.

How Capital Gains Are Calculated

Capital gains tax applies to the profit you make when selling property. The calculation is straightforward:

Sale Price – Cost Basis = Capital Gain

Your cost basis typically includes:

• Original purchase price
• Costs of purchasing (escrow fees, title insurance, etc.)
• Capital improvements made over the years
• Selling costs (realtor commissions, closing costs, etc.)

Whether your property is in a trust or held individually, this calculation works exactly the same way.

What Happens After You Pass Away

The tax treatment changes significantly when you pass away and your successor trustee takes over management of the trust.

Stepped-Up Basis at Death:

One of the most valuable tax benefits in estate planning is the stepped-up basis. When you pass away, the cost basis of your real estate (and most other capital assets) is “stepped up” to the fair market value on the date of your death.

Example:

• You bought a house in 1980 for $100,000
• You transferred it to your trust in 2010
• You pass away in 2025 when the house is worth $1,500,000
• Your children inherit the house through your trust with a new basis of $1,500,000
• If they sell immediately for $1,500,000, they owe zero capital gains tax

This stepped-up basis rule applies equally whether property passes through a trust or through probate. However, avoiding probate with a trust means your heirs can access and sell the property much faster.

Understanding California probate costs makes the trust advantage even clearer.

California Community Property Rules

California is a community property state, which creates additional tax benefits for married couples.

Community Property Stepped-Up Basis:

If you are married and own real estate as community property (which most California couples do), both halves of the property receive a stepped-up basis when the first spouse dies, not just the deceased spouse’s half.

Example:

• Married couple owns home worth $1,000,000 at first spouse’s death
• Original purchase price was $200,000
• If held as community property: entire $1,000,000 basis is stepped up
• If held as joint tenants: only $600,000 basis ($200,000 + $500,000)

This is why it is critical that married couples title their trust-held real estate correctly. Your estate planning attorney should ensure your trust specifies that California real estate is community property.

Learn more about protecting your family home with proper titling and trust funding.

Investment Property and Rental Real Estate

If you are selling investment property or rental real estate held in your revocable living trust, the same principle applies: tax treatment is identical to individual ownership.

However, rental property does not qualify for the $250,000/$500,000 primary residence exclusion.

For investment property:

• Capital gains tax rates apply to your profit
• Long-term capital gains rates (property held over 1 year) are generally 15% or 20% federal, plus California state tax
• Depreciation recapture may apply if you have been taking depreciation deductions
• 1031 exchanges remain available for deferring gains

Your trust does not prevent you from using a 1031 exchange to defer capital gains by rolling the proceeds into another investment property.

Transfer to Trust: Not a Taxable Event

An important clarification: transferring your house into your revocable living trust is not a taxable event.

Many people worry that funding their trust will trigger taxes. This is not the case.

• No gift tax when you transfer property to your own revocable trust
• No income tax consequences
• No property tax reassessment in California
• Your existing home mortgage is not affected

California specifically protects transfers to revocable living trusts from property tax reassessment. According to the California State Board of Equalization, these transfers are excluded from reassessment.

When the Trust Becomes Irrevocable

After you pass away, your revocable living trust typically becomes irrevocable. At this point, the trust may need to file its own tax returns.

Tax Filing Requirements After Death:

If the trust holds property and generates income (such as rental income or investment income) after your death, your successor trustee must:

• Obtain a tax ID number (EIN) for the trust
• File Form 1041 (trust income tax return) if income exceeds $600
• Issue K-1 forms to beneficiaries showing their share of trust income
• Pay estimated taxes if required

However, if your successor trustee simply sells the property and distributes the proceeds to beneficiaries relatively quickly, trust tax filing requirements may be minimal.

Many families complete trust administration and distribute assets within a few months, especially when using a trust to avoid the probate process.

Selling Trust Property: The Process

When your successor trustee needs to sell real estate after your death, the process is remarkably straightforward compared to probate sales.

Steps for Selling Trust Property:

1. Obtain certified death certificate
2. Provide death certificate to the County
3. Show successor trustee’s authority under the trust
4. List and sell property like any normal real estate transaction
5. No court approval needed
6. No probate referee appraisal required
7. Proceeds distributed according to trust terms

This simplicity is one of the major advantages of trust ownership. Probate real estate sales require court petitions, judicial oversight, and often take 12-18 months or longer.

Common Tax Mistakes to Avoid

Mistake 1: Assuming Trust Sales Are Always Tax-Free

While living trusts provide many benefits, they do not eliminate capital gains taxes on property sales. If you sell appreciated property during your lifetime, you still owe capital gains tax on the profit (unless you qualify for the primary residence exclusion).

Mistake 2: Not Documenting Improvements

Your cost basis includes capital improvements made over the years. Keep records of:

• Room additions
• New roof installations
• Kitchen and bathroom remodels
• Landscaping and hardscaping
• HVAC system replacements

These improvements increase your basis and reduce your taxable gain.

Mistake 3: Confusing Revocable and Irrevocable Trusts

Irrevocable trusts have completely different tax rules. If you transfer property to an irrevocable trust, it is a completed gift for tax purposes and future appreciation occurs outside your estate. This article addresses only revocable living trusts.

Mistake 4: Not Consulting a Tax Professional

While the general rules are straightforward, your specific situation may have complexities. Always consult with a qualified tax professional before completing any significant real estate transaction.

Understanding what a complete estate plan includes helps you coordinate tax and estate planning strategies.

State vs Federal Tax Considerations

California residents face both federal and state taxes on capital gains.

Federal Capital Gains Rates:

• 0%, 15%, or 20% depending on your income level
• Additional 3.8% Net Investment Income Tax for high earners

California Capital Gains:

• California taxes capital gains as ordinary income
• Rates range from 1% to 13.3% depending on total income
• No special capital gains rate at the state level

This means high-income California residents can face combined federal and state capital gains rates approaching 33% on investment property sales.

However, the primary residence exclusion ($250,000 or $500,000) eliminates both federal and California taxes on excluded gains.

Planning Strategies to Minimize Taxes on Rental Properties

Strategy 1: Use the Primary Residence Exclusion

If you have lived in the property for 2 of the last 5 years, make sure you qualify for this valuable exclusion before selling.

Strategy 2: Time Your Sale Strategically

If you have a low-income year, that may be an ideal time to realize capital gains and pay tax at lower rates.

Strategy 3: Consider a 1031 Exchange

For investment property, a properly structured 1031 exchange allows you to defer capital gains indefinitely by reinvesting in replacement property.

Strategy 4: Hold Until Death for Stepped-Up Basis

If you can afford to hold appreciated property until death, your heirs receive the stepped-up basis and can sell with minimal or no capital gains tax. 

Strategy 5: Gift Strategies for Blended Families

Estate planning for blended families may involve gifting strategies that balance tax efficiency with family fairness.

The Role of Your Estate Planning Attorney

While your estate planning attorney creates your trust and ensures property is correctly titled, tax issues often require coordination with your CPA or tax advisor.

Your estate planning attorney helps with:

• Proper trust drafting and property titling
• Understanding how trust structure affects taxes
• Coordinating with tax professionals
• Ensuring community property characterization
• Planning for stepped-up basis benefits

Your tax professional helps with:

• Actual tax return preparation
• Calculating capital gains
• Identifying deductions and exclusions
• 1031 exchange structuring
• Trust income tax returns after death

Finding the right estate planning lawyer who understands these tax implications is essential.

Why DIY Trust Administration Can Be Risky

Some families attempt to handle trust administration themselves after a loved one passes. While this is legally possible, tax issues are one area where professional guidance proves valuable.

DIY estate planning risks extend to trust administration as well.

Common DIY Mistakes:

• Missing valuable stepped-up basis elections
• Incorrect allocation of basis among multiple properties
• Failing to file required trust income tax returns
• Missing deadlines for estate tax returns
• Improper distribution before tax clearances

The Bottom Line on Trust Property Sales

The key takeaway is simple: selling a house from your revocable living trust during your lifetime has essentially the same tax treatment as selling it in your individual name.

You get all the same deductions, exclusions, and tax benefits. The trust wrapper does not create additional taxes or penalties.

The real tax advantage of trusts comes after death, when:

• Heirs receive a stepped-up basis
• Property can be sold quickly without probate delays
• Trust administration is private and efficient
• Capital gains taxes may be eliminated entirely

This combination of probate avoidance and favorable tax treatment is why revocable living trusts are the foundation of most California estate plans.

Key Takeaways

• Selling trust property during your lifetime has the same tax treatment as individual ownership
• Primary residence exclusions ($250,000/$500,000) still apply to trust-held homes
• Capital gains are calculated the same way regardless of trust ownership
• Stepped-up basis at death is one of the most valuable tax benefits in estate planning
• Transferring property into a trust is not a taxable event and does not trigger property tax reassessment
• After death, successor trustees can sell property quickly without probate court approval
• Proper documentation and professional guidance ensure you maximize tax benefits
• Revocable living trusts are tax-neutral during life but provide significant benefits at death
• Coordinate with both estate planning attorneys and tax professionals for optimal results

Frequently Asked Questions

Do I pay capital gains tax when selling a house from my trust?

Yes, if you are selling during your lifetime and the gain exceeds available exclusions. However, the tax treatment is identical to selling property you own individually. You qualify for the same primary residence exclusion ($250,000 single, $500,000 married) if you meet the occupancy requirements.

Does putting my house in a trust affect my property taxes?

No. In California, transferring your primary residence to your own revocable living trust is specifically excluded from property tax reassessment under Proposition 13. Your property taxes remain unchanged.

What is stepped-up basis and how does it work with trusts?

Stepped-up basis means inherited property’s cost basis is adjusted to fair market value on the date of death. This eliminates capital gains tax on appreciation that occurred during the deceased owner’s lifetime. Trust-held property receives stepped-up basis just like individually-owned property.

Can I do a 1031 exchange with trust-held property?

Yes. You can use a 1031 exchange to defer capital gains when selling investment property held in your revocable living trust. The trust ownership does not prevent this tax-deferral strategy.

Do I need a separate tax return for my revocable living trust?

No, not while you are alive. Your revocable living trust is a “grantor trust” and all income and expenses are reported on your personal Form 1040. After your death, the trust may need to file Form 1041 if it generates income or remains open for an extended period.

What happens to my mortgage when I transfer property to my trust?

Nothing. Your mortgage remains unchanged and transferring property to your revocable living trust does not trigger the due-on-sale clause. Federal law specifically protects transfers to revocable living trusts from loan acceleration.

How do heirs report the sale of inherited trust property?

If heirs inherit property through a trust and sell shortly after death, they report any gain on their personal tax return. The stepped-up basis means there is usually little or no taxable gain. They receive a K-1 from the trust if it remains open and generates income.

Does California have an inheritance tax or estate tax?

No. California has no inheritance tax or estate tax. However, federal estate tax may apply to estates exceeding $15 million in 2024 (or $30 million for married couples). Most California families are far below these thresholds.

Final Thoughts

The tax ramifications of selling a house that was in a revocable living trust are remarkably straightforward: during your lifetime, there is no difference compared to individual ownership.

This is one of the beauties of revocable living trusts. You get probate avoidance, privacy, control, and efficient asset transfer without creating tax complications or losing valuable tax benefits like the primary residence exclusion.

The real tax magic happens after your death, when your heirs receive stepped-up basis and can potentially sell inherited property with little or no capital gains tax. Combined with avoiding probate costs that can exceed $46,000 in California, the living trust provides tremendous value to your family.

Whether you are selling property from your trust now or planning for how your heirs will handle inherited real estate, understanding these tax rules helps you make informed decisions and maximize the benefits of your estate plan.

Schedule your free 30-minute Strategy Session today or call (949) 377-2996 with Michael Pevney, your trusted Orange County estate planning attorney.