Reporting depreciation when trusts own business entities.

• Author: Foster, Aaron P.

It is becoming increasingly common for trusts to be owners of either operating businesses or rental real estate activities that are structured as partnerships or S corporations. In this context, tax practitioners need to be aware of two special rules that apply to a nongrantor trust or estate that owns the passthrough entity. First, estates and trusts are ineligible to claim Sec. 179 deductions, so the business itself needs to make special basis adjustments to avoid wasting the deduction or a portion of it. Second, depreciation and depletion should be "separately stated items" on the partnership or S corporation Schedule K-1, Partners [or Shareholder's] Share of Income, Deductions, Credits, etc., if a trust or estate is an owner.

Sec. 179 Deduction

Often, when a business claims a current deduction under Sec. 179 for depreciable assets placed in service, it passes the deduction through to the partners or shareholders (on line 12 of the partnership Schedule K-l or line 11 of the S corporation Schedule K-1). However, Sec. 179(d)(4) denies this deduction for estates and trusts (other than grantor trusts). Nevertheless, a business with an estate or trust as a partner or shareholder typically still will choose to take the Sec. 179 deduction to benefit its other owners.

Normally, a business reduces the depreciable basis of the assets by the full amount of the Sec. 179 deduction taken. However, because the deduction allocated to the estate or trust otherwise would provide no tax benefit, Regs. Sec. 1.179-1(f)(3) provides that the business does not reduce the basis of the asset by the portion of the Sec. 179 deduction allocated to the trust or estate.

Example 1: A partnership with a nongrantor trust as a 25% partner acquires an asset for $1,000 that qualifies as Sec. 179 property and places it into service. The partnership elects to apply Sec. 179, and thus $250 of its Sec. 179 deduction is allocable to the trust.

In this situation, the partnership would reduce the basis in the asset by only $750, rather than $1,000, leaving it a $250 basis in the asset. Thus, if the partnership immediately disposed of the asset for $100, it would have a $150 loss allocable to all partners instead of a $100 gain allocable to all partners.

The increased basis at the time of disposal benefits all shareholders and is not allocated solely to the trust. In the end, the partnership gets a total deduction of $1,000 (the $750 deduction and $250 of basis), but the timing is...