onehand wrote:That said, it is a friend of mine who asked me to advise her on this situation. Essentially they just want to know how they can take the primary residence exclusion. It's true that estate taxation is not my expertise, but I'm an excellent tax preparer and I know how to look things up, but appreciate some direction about where to look.
Okay, if you really want to tackle this, the first test is whether the trust is treated as a grantor trust. Secs. 671-679 along with a reading of the trust instrument will tell you the answer.
If it’s treated as a grantor trust, then the next question is whether a section 1031 exchange occurred. You said that the trust “sold a house and bought another house.” A sale followed by a purchase isn’t an exchange. There are rules in section 1031 and Treas. Reg. §1.1031(k)-1 that must be followed.
The next question is how the principal residence exclusion applies when section 1031 also applies. Rev. Proc. 2005-14. 2005-7 I.R.B. 528 deals with this situation and has several examples.
If the trust is a regular trust and not a grantor trust, then the principal residence exclusion doesn’t apply because a trust can’t have a principal residence. But section 1031 might apply to the two-thirds of the relinquished property that was rental property.