Short Answer

Yes. In North Carolina, you can structure a revocable, grantor trust to let you withdraw investment “income” (interest, dividends, and fund distributions) without by itself triggering capital gains. Capital gains tax is typically triggered when assets are sold or when a mutual fund makes a capital-gain distribution. Your trust can also include a trustee “power to adjust” or a total return unitrust payout to provide steady cash flow without forcing sales.

Understanding the Problem

In North Carolina, can you set up a trust so you can take regular income during life—while funding it with appreciated mutual funds—without causing capital gains? You are the settlor who wants your trust revised so you can draw income while preserving the underlying investments for children.

Apply the Law

Under North Carolina’s trust and principal-and-income rules, “income” generally means the trust’s accounting income (interest, dividends, and similar receipts). Capital gains usually belong to principal unless the trust or trustee properly allocates them to income. In a revocable, grantor trust, transferring your appreciated mutual funds to the trust does not itself create capital gains, and you can receive income distributions directly. If you want predictable cash flow regardless of how much traditional income your portfolio produces, North Carolina allows a trustee to adjust between income and principal or convert to a total return unitrust (a 3%–5% annual payout), typically without selling core assets. For administration issues (like converting to a unitrust), the Clerk of Superior Court is the main forum if court approval is sought.

Key Requirements

• Use a revocable grantor trust: Funding the trust with appreciated assets is a non-taxable event; you can receive income during life.
• Define “income” and permit adjustments: State that income means trust accounting income and authorize the trustee’s power to adjust between income and principal to support sustainable cash flow.
• Consider a total return unitrust: Allow or elect a 3%–5% annual unitrust payout so the trustee can distribute a set percentage without focusing on sales.
• Avoid unnecessary sales: Recognize that selling appreciated shares to raise cash triggers capital gains; design distributions to use organic income and cash balances first.
• Respect tax allocation rules: Capital gains are typically principal and taxed accordingly; they generally don’t pass out as “income” unless properly allocated under governing terms and consistent administration.

What the Statutes Say

• N.C. Gen. Stat. § 37A-1-104 (Trustee’s power to adjust) – Lets a trustee shift amounts between income and principal to be fair to income and remainder interests.
• N.C. Gen. Stat. § 37A-1-104.3 (Total return unitrust) – Allows conversion to a 3%–5% payout unitrust and related procedures.
• N.C. Gen. Stat. § 37A-5-505 (Income taxes) – Allocates tax on receipts: tax on capital gains is paid from principal.
• N.C. Gen. Stat. § 105-160.2 (North Carolina tax on estates and trusts) – Explains how North Carolina taxes undistributed fiduciary income.

Analysis

Apply the Rule to the Facts: Because your trust is revocable and grantor-type, transferring your appreciated mutual funds into it will not itself trigger capital gains; you’ll keep reporting the trust’s income on your return. You can receive the portfolio’s interest and dividends as “income” without selling positions. If you want steadier cash flow than the portfolio’s income provides, add trustee power-to-adjust language or a total return unitrust provision so the trustee can pay you a set percentage without liquidating core holdings. Be mindful that if the trustee sells appreciated shares to raise cash, that sale creates capital gains; also, mutual funds may distribute capital gains annually even if you do not sell.

Process & Timing

1. Who files: You (as settlor) with your attorney. Where: Private execution; no court filing is required to amend/restatement a revocable trust. What: Trust amendment or full restatement adding income definitions, power to adjust, and optional total return unitrust authority. When: Complete before transferring the appreciated mutual funds.
2. If you elect a unitrust later: Who files: The trustee if court approval is sought. Where: Clerk of Superior Court in the county of the trust’s principal place of administration. What: Petition to convert to a total return unitrust under state law and adoption of a written unitrust policy. When: After notice to beneficiaries as required; timelines vary by county.
3. Fund the trust: Work with your brokerage to retitle the mutual funds to the trust. Expect institution-specific transfer documents; processing often takes days to a few weeks.

Exceptions & Pitfalls

• Nongrantor status changes taxes: If you later make the trust irrevocable or remove grantor powers, undistributed income can be taxed at trust rates; plan allocations and distributions carefully.
• Sales trigger gains: To raise cash for distributions, selling appreciated shares will create capital gains—even if the trust labels the payout as “income.”
• Mutual fund capital-gain distributions: Funds can pass out capital gains annually; you may owe tax on those even without selling.
• Allocation mechanics matter: Capital gains usually stay in principal; they reach you only if the trust or trustee properly allocates them to income and treats them consistently, in line with governing law.
• State tax exposure: North Carolina taxes undistributed fiduciary income based on beneficiary residency and source rules; administration choices can affect state tax.

Talk to a Estate Planning Attorney

If you’re planning to fund a North Carolina trust with appreciated investments and want reliable income without unnecessary taxes, our firm has experienced attorneys who can help you understand your options and timelines. Call us today at 919-341-7055.

Disclaimer: This article provides general information about North Carolina law based on the single question stated above. It is not legal advice for your specific situation and does not create an attorney-client relationship. Laws, procedures, and local practice can change and may vary by county. If you have a deadline, act promptly and speak with a licensed North Carolina attorney.