Home Sale Exclusion and Irrevocable Trusts

Some taxpayers use revocable trusts as an alternative to having their property transferred by will. While there is no income or estate tax advantage to a revocable trust, there is a benefit in having the property pass to beneficiaries on the death of the owner without having to go through the probate process.

However, there is a potential pitfall where a married couple transfers their residence to a revocable trust that becomes irrevocable after the first spouse dies – the $250,000 home sale exclusion may be completely lost or available only to a limited extent even though the surviving spouse has the continued right to occupy the residence. An IRS Letter Ruling (PLR 200104005) indicates the exclusion is available only to the extent the survivor is considered to own trust property. In this ruling, a couple, living in a community property state, established a revocable trust while both were living. Upon the death of the spouse, the trust was split into two trusts, the irrevocable bypass trust and the survivor's revocable trust. The home was assigned to the irrevocable bypass trust, and therefore, the surviving spouse is not considered to own the property and any subsequent sale would not qualify for the home sale exclusion.