7974 / How are unit holders taxed?

If the trust is established as a “grantor” trust (that is, a trust under subpart E, subchapter J of Chapter 1 of the Internal Revenue Code, as the prospectus may say), the unit holder is treated as the owner of a part of the trust assets in proportion to his or her investment. In a grantor trust, income, deductions, and credits against tax of the trust are attributed to the investor as if the investor directly owned a share of the securities themselves.¹ (Expenses of the trust that would have been “miscellaneous itemized deductions” had they been incurred by an individual are included with the investor’s miscellaneous itemized deductions for purposes of calculating the investor’s taxation. See Q 733.) Thus, gain on any sale of trust assets by the trust is taxable to the unit holders. What is passed through by the trust depends on the character of its assets. For example, the unit holder may have to reduce basis in the unit to reflect amortization of bond premium, especially in exempt-interest trusts. See Q 7664. The unit holder may also have to reduce basis for accrued interest received, if any, on bonds delivered after payment is made for the unit.

Gain on the sale of a unit by the unit holder is capital gain, to the extent it does not include accrued interest or earned original issue discount. See Q 7650 to Q 7653. For the treatment of capital gain, see Q 702.

If the trust qualifies and makes the election to be taxed as a regulated investment company (see Q 7922 to Q 7935), unit holders will be taxed like shareholders in a mutual fund. See Q 7938 to Q 7951.