Short Answer

In North Carolina, transferring appreciated mutual funds into a revocable “grantor” trust usually is not a taxable event and does not trigger capital gains; you keep your original cost basis and keep reporting income on your personal return. Funding an irrevocable trust is generally a completed gift for federal gift tax purposes, uses carryover basis (no step-up until and unless the assets are included in your estate), and the trust may owe federal and North Carolina income tax on undistributed income. Filing obligations and tax results depend on the trust’s design and administration.

Understanding the Problem

In North Carolina, can you move appreciated mutual funds into a trust, keep receiving the income during life, and avoid an immediate tax bill? You want to benefit your children and correct drafting mistakes in your existing documents. The key decision point is whether the trust is revocable and taxed to you, or irrevocable and taxed as a separate taxpayer.

Apply the Law

North Carolina generally follows federal rules for taxing trusts and their beneficiaries. For revocable or other “grantor” trusts, the transfer-in is typically ignored for income tax purposes, you keep your basis, and you report the trust’s dividends and capital gains on your individual return. For nongrantor irrevocable trusts, funding is usually a completed gift (no immediate gain recognition on an in-kind transfer), the trust uses your carryover basis, and the trust files its own federal and North Carolina fiduciary returns on undistributed income. North Carolina taxes undistributed trust income consistent with state rules tied to residency and source; beneficiaries generally pick up distributed income only to the extent of DNI.

Key Requirements

• Trust status (grantor vs. nongrantor): A revocable or otherwise grantor trust is ignored for income tax; a nongrantor irrevocable trust is a separate taxpayer.
• Type of transfer: In-kind retitling of mutual funds into a trust does not by itself realize capital gains; gains arise when the trust or you sell.
• Basis and step-up: Funding carries over your basis; assets includible in your taxable estate generally receive a post-death basis adjustment, while completed gifts typically do not.
• Filing and payment: Nongrantor trusts file IRS Form 1041 and NC Form D-407 for undistributed income; beneficiaries report distributed income up to DNI.
• Administration and allocation: Trustees must follow North Carolina’s principal-and-income rules, including how to allocate taxes and distributions between income and principal.

What the Statutes Say

• North Carolina Gen. Stat. § 105-160.2 (Tax on estates and trusts) – Imposes NC income tax on estates and trusts consistent with federal Subchapter J concepts.
• North Carolina Gen. Stat. § 37A-5-505 (Taxes; entity distributions; adjustments) – Addresses how trustees allocate taxes and receipts between income and principal.
• North Carolina Gen. Stat. § 36C-4-416 (Modify trust to achieve tax objectives) – Allows court modification of trust terms to meet tax goals when appropriate.

Analysis

Apply the Rule to the Facts: Because you want lifetime income, a revocable or other grantor-style trust usually fits: moving appreciated mutual funds into it should not trigger gain, you keep the same basis, and you keep reporting dividends and gains personally. If your trust is (or becomes) an irrevocable nongrantor trust for your children, your transfer is typically a completed gift using carryover basis; the trust then reports and pays tax on undistributed income, and your beneficiaries report what’s distributed up to DNI.

Process & Timing

1. Who files: For a grantor trust, you file your individual return; no separate trust filing for income is required. For a nongrantor trust, the trustee files IRS Form 1041 and NC D-407 (Fiduciary Income Tax Return). Where: IRS and North Carolina Department of Revenue. What: Form 1041; NC Form D-407; beneficiaries may receive K-1s. If you make a completed gift to an irrevocable trust, you may need to file IRS Form 709 (Gift Tax Return). When: Trust returns are due the 15th day of the 4th month after the trust’s year-end; NC extensions via D-410P. Gift returns are generally due by April 15 of the following year.
2. Coordinate an in-kind transfer with your custodian to retitle the mutual funds to the correct trust name and EIN (if nongrantor). In-kind retitling avoids selling the positions and realizing gain.
3. Maintain basis records. After funding, the trustee accounts for income and capital gains, allocates taxes between income and principal under North Carolina rules, and issues K-1s if distributions are made.

Exceptions & Pitfalls

• Grantor vs. nongrantor status drives tax results. Drafting missteps (for example, unintended powers) can shift the trust into or out of grantor status and change who pays the tax.
• Basis and step-up differ. Completed gifts to irrevocable trusts keep your basis and typically forgo a post-death basis step-up unless the assets are includible in your estate.
• Residency and administration matter. North Carolina taxes undistributed trust income consistent with statutes tied to residency and source; where the trust is administered and who benefits can affect NC taxation.
• Distribution and allocation rules. Capital gains usually stay at the trust level unless properly allocated; trustees must follow NC principal-and-income rules when charging taxes and expenses.
• Wrong form of transfer. Asking the custodian to sell before retitling can trigger avoidable gains; request an in-kind transfer instead.
• Fixing drafting mistakes. If your documents don’t meet your tax objectives, courts can modify certain terms to achieve tax goals under North Carolina law.

Conclusion

In North Carolina, moving appreciated mutual funds into a revocable grantor trust generally does not trigger tax and keeps your current basis, with you continuing to report the income. Funding an irrevocable nongrantor trust is typically a completed gift using carryover basis, and the trust (or its beneficiaries) reports income depending on distributions. To proceed, confirm the trust’s tax status and arrange an in-kind retitling with your custodian; if the trust will be nongrantor, plan to file Form 1041 and NC D-407 by the standard deadlines.

Talk to a Estate Planning Attorney

If you’re dealing with funding a trust with appreciated mutual funds and want to preserve tax efficiency and your lifetime income, 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.