How to Deduct Interest and Taxes for a Decedent, Estate, or Trust
When preparing a decedent’s final income tax Form 1040, or an estate or trust’s Form 1041, you may deduct certain types of interest and taxes. Interest paid on mortgages and stock margin accounts may be deducted, as can real estate tax and state and local income tax.
What types of interest can be deducted
Whether you’re responsible for filing a Form 1040 or a Form 1041, the following types of interest are deductible:
Interest paid on a mortgage that is secured by real estate (including interest on home equity lines of credit)
Interest that you pay for a stock margin account
Personal interest paid on such things as credit card debts, unsecured loans, or unpaid tax bills is never deductible.
But wait! This rule has an exception. If you elect to pay the estate tax under Section 6166 (that’s an election to spread out the payment of the estate taxes owed over a ten-year period), you get to deduct that interest on Form 1041, even though it’s interest on an unpaid tax bill.
Why? Even though it’s so-called personal interest, it’s an interest payment that arises only because you’re dealing with an estate (or a successor-in-interest trust). You can deduct expenses the estate or trust incurs for being an estate or trust. The fact that only an estate or trust can pay Section 6166 interest overrides the rule that personal interest is nondeductible.
What types of taxes can be deducted
Generally speaking, taxes in a trust or estate refer to real estate taxes and state and local income taxes. Although individuals also have the option of deducting state and local sales taxes instead of income taxes, that option doesn’t exist in the estate/trust environment.
Just as you get to do on Schedule A, you can deduct the actual amounts you paid as taxes during the estate or trust’s tax year in Form 1041. Remember, you get the deduction only for amounts you actually paid, so don’t include estimated taxes you paid in the first month of the following tax year.
Pick up your fourth quarter estimated tax payment from the prior tax year if you paid it in the current year. Also, if you applied an overpayment from last year’s return to this year’s, pick up the overpayment not only as income (if you deducted it in the prior year) on line 8 of Form 1041 but also as a deduction on line 11.