What are the key tax implications of creating an irrevocable trust instead of a revocable one? – North Carolina

Short Answer

Under North Carolina law, a revocable trust is ignored for income and estate tax purposes during your life; assets remain yours, are included in your taxable estate at death, and typically receive a step-up in tax basis. An irrevocable trust can remove assets from your taxable estate if you give up control, but funding it is usually a completed gift (gift tax reporting may apply), the trust or its beneficiaries—not you—pay income taxes on its earnings, and assets generally do not get a basis step-up at your death.

Understanding the Problem

In North Carolina, if you want to place real estate into a trust, should you use an irrevocable trust to change tax outcomes, or a revocable trust to keep flexibility? Here, the owner holds residential properties in multiple states and plans to retitle those properties into the trust. The decision affects income taxes, estate taxes, basis at death, and the mechanics of retitling deeds.

Apply the Law

North Carolina follows federal tax concepts for trusts and estates and then applies state rules to determine what income is taxed here. Revocable trusts are typically treated as you for tax purposes while you’re alive. Irrevocable trusts can be structured as “grantor” or “non‑grantor” for income tax; only properly structured, non‑grantor irrevocable trusts with no retained strings typically remove assets from your taxable estate. Trusts holding North Carolina property or benefiting North Carolina residents may have North Carolina filing obligations. Deed transfers are recorded with the county Register of Deeds where each property is located.

Key Requirements

• Estate inclusion: If you keep the right to revoke or significant control, the property remains in your taxable estate; truly giving up control in an irrevocable trust can remove it.
• Income tax status: Revocable and grantor trusts report income to you; non‑grantor irrevocable trusts file their own returns and pay tax on undistributed income.
• North Carolina taxation: North Carolina taxes only the portion of undistributed trust income for the benefit of North Carolina residents or from North Carolina sources.
• Gift tax on funding: Deeding property to an irrevocable trust is usually a completed gift; a federal gift tax return may be required even if no tax is due.
• Basis at death: Assets in your revocable trust typically get a step‑up at your death; assets in a properly structured irrevocable trust generally do not.
• Recording deeds: To fund the trust, you sign and record new deeds in each property’s county (in North Carolina, with the Register of Deeds) showing the trustee’s title.

What the Statutes Say

• North Carolina Gen. Stat. § 36C-6-602 (Revocation or amendment of revocable trust) – A revocable trust remains under the settlor’s control and is treated as the settlor’s property.
• North Carolina Gen. Stat. § 105-160.2 (Income taxation of estates and trusts) – North Carolina taxes a trust only on undistributed net income benefiting North Carolina residents or derived from North Carolina sources.

Analysis

Apply the Rule to the Facts: Funding a revocable trust with your multi‑state properties will not change your current taxes; you’ll keep reporting the income, the properties remain in your taxable estate, and they should receive a basis step‑up at your death. If you instead deed properties into a properly structured irrevocable, non‑grantor trust and retain no control, the transfer is a completed gift (gift tax reporting may apply), you give up the step‑up at death for those assets, and the trust will have its own income tax filings. North Carolina fiduciary tax applies to undistributed income for North Carolina beneficiaries and to North Carolina‑source income (for example, rent from North Carolina property).

Process & Timing

1. Who files: You (as current owner). Where: For North Carolina properties, record with the county Register of Deeds; for out‑of‑state properties, record in the proper county for that state. What: Execute and notarize a deed from you individually to the trustee (using the exact trust name and date); obtain an EIN if creating a non‑grantor irrevocable trust. When: Record deeds as soon as the trust is signed; federal gift tax returns (if required) are generally due by April 15 of the year following the transfer.
2. Set up trust accounts and bookkeeping; if the trust is non‑grantor, file annual federal fiduciary returns and North Carolina fiduciary returns as applicable. Allow time for county recording and title updates, which can vary by county and state.
3. Update insurance, property tax billing, lenders, and tenants (if any). Keep the trust name on all property records to maintain separation.

Exceptions & Pitfalls

• Retained powers in an “irrevocable” trust (like the ability to revoke or control distributions) can pull assets back into your taxable estate and undermine creditor protection.
• Losing the step‑up: Moving appreciated real estate to a non‑grantor irrevocable trust trades potential estate tax savings for loss of basis step‑up; run the numbers before funding.
• Gift reporting traps: A deed into an irrevocable trust is typically a completed gift; you may need a gift tax return even if no tax is due.
• Recording details: Each state has its own deed forms, notarization rules, and transfer/recording taxes; mislabeling trustee capacity or trust name/date can cause rejections.
• State income tax nexus: North Carolina taxes undistributed trust income benefitting North Carolina residents and North Carolina‑source income; trust residency and beneficiary residency can affect filings, and rules may change.
• Lender and HOA consents: Check due‑on‑sale clauses and association covenants before retitling to a trust.

Talk to a Estate Planning Attorney

If you’re deciding between a revocable and an irrevocable trust for multi‑state real estate and need clear tax guidance and a clean deed‑funding plan, 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.