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What Defines the Principal Value of An Asset in a Trust?

Updated: Sep 2, 2020

Attorney Thomas B. Burton, with Burton Law LLC, in Eau Claire, Wisconsin answers a reader question with Attorney Matthew Underwood, with Underwood Legal, LLC, in Madison, Wisconsin about how to determine the principal value of an asset held in trust. Attorneys Underwood and Burton also discuss how the trust principal can generate income which is often distributed on an annual basis to trust beneficiaries.




Transcript of Video: What Defines the Principal Value of An Asset in a Trust?

Okay welcome back today you'll see we're

coming to you from the Supreme Court

chambers here in the Wisconsin State

Capitol and I'm joined by my friend

attorney Matthew Underwood Matt thanks

for joining us thanks for having me Tom

and Matt I really appreciate you being

here today because this question comes

from Madison and Matt operates a

boutique estate planning and elder law

firm right in Madison where we both went

to law school so I'll get right into the

question Matt because it's a complex one

and that's why I'm having you answer it

today all right we'll do my best so the

question is what defines the principal

value of an asset and then there's a

bunch of detail and I'm going to just

hit the high points of the detail the

questioner says our income trust is an

asset protecting irrevocable trust which

in the section titled lifetime trust

principal beneficiaries names three

people we selected as our beneficiaries

a section further down separates us from

our assets by stating no payment or

distribution of the principal of the

touched shall be made to us etc. etc.

hence we have access to the income

generated by our assets but no access to

the principal my question what defines

the principal value of an asset

Accountants see the terms principal and

cost basis as synonymous but I suspect

when used in this relation surrounding

asset protection the principal may have

another meaning so that's the question

there Matt and I'll let you try to

unpack it sure so we're dealing with

somebody who has an irrevocable trust and

based on the situation these are

commonly set up when people have assets

that they'd like to protect

in particular protect those assets if

they or their spouse were to go into a

nursing home so what we have here is

somebody who said hey I want to protect

some of my assets from long-term care

costs and they set up an irrevocable

trust which is an income only trust

and what that means is that the in order

to get that long-term care protection

from that irrevocable trust is the

people setting up that trust can't have

direct access to those direct access to

those assets anymore so for example

if I want to set up an irrevocable trust

and I want to protect my house from

long-term care costs I need to put my

house into that trust and then after


five or more years that that house would

be essentially off-limits in terms of

long-term care costs so so the way this

trust is set up is its it prevents the

people setting up that trust from being

able to withdraw principal and when we

say principal what we typically mean is

kind of that core money that went into

that asset so if I purchased a house and

I purchased the house for $100,000 well

that's my principal amount that hundred

thousand dollars that I put in so I mean

in order to get that protection that

trust says well you can't reach

principal is off-limits to you

so that's protecting that principal now

the question comes in is the people who

had set up that trust can access income

so what is income and what is principal

and what can they actually take out of

that irrevocable trust so again

principal is kind of that that starter


money or the money that you put in to

purchase an asset when we talk about

income we're usually looking at things

like interest dividends rent from rental

property if the trust were to own a

business any sort of income that

business generates

could be considered income so one of

the things that we commonly see in that

and I would really caution you know the

person asking the question about this is

we really need to look at the language

in that trust and in how that trust is set

up because chances are that irrevocable

trust tells us what is considered income

and what is considered principal so I

think you know really what we need to do

is start there and see what that trust

says because I often see trusts that

have language in there saying that if

there is income in that trust that if

that income doesn't get taken out during

the year it becomes principal so we can

even have trust where money that's

considered income changes to principal

yeah so we need to be really

careful with that so you know when it

comes to principal one of the other

questions is capital gains so if I

purchase some stock for $100 now that

stock's worth a thousand dollars there's

you know some gains built into that that

investment

sometimes capital gains are treated as

income sometimes they're treated as

principal so again it comes down to

looking at you know what is that

language in the trust and if it's not in

there then we have to look to state law

so this is a pretty in-depth

question but again I'd recommend talk

to either the estate planning

attorney that help them set up the trust

or contacting a different estate

planning attorney who is knowledgeable

at trusts and can kind of walk through

the terms with you and then decide you

know what is income and principal and

one other note on that is that when we

when we help people set up these types

of trusts we're often looking at setting

up no income trust and the reason for

that is when we have an income trust all

of that income would be available to a

nursing home so if we want to protect

not only the principal but we want to

protect the income we're going to need

to also restrict the trust maker's access

to that income so that that's a lot of

very long answer there Tom but but those

are kind of the issues that I see at

least initially on it no that's great

thanks I think you unpacked it well

without knowing more about what the

questioner specifically has in that

trust because a lot of what you pointed

out is it's going to depend

the asset right so in your example if we put

a house in the trust a lot of times

houses don't throw off any income so

then right the principal is just going

to be the value of that house on the

date we sign the deed and transferred it

into the trust but for this guy's

question we need to know more about what

type of asset this is and and the income

it's throwing off and I think what you

were saying there Matt is first we're

going to look at the terms of the trust

itself and then if the trust is unclear

we go to state law

the Wisconsin Trust Code to figure it

out but overall you gave them a great

pathway here and I think the best answer

is sit down like you said with the

lawyer who drafted this trust or if

they're not available another lawyer

like Matt who's right in Madison and can

help you understand it because as he

pointed out that principal can change

to income or the income excuse me can

become principal if it's kept in the

trust so you really want to figure this

out as you move along with that trust so

thanks Matt I appreciate you taking this

hard question today and thank you for

joining us well thanks for having me

Tom

thank you for watching we'll see you

next time!

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Transcript and captions provided for ease of access for the hearing impaired.

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