IRS 1041 Schedule D: Reporting Capital Gains & Losses

Fiduciaries, like executors and trustees, must report the financial activities of the estate or trust they manage. When the entity sells an asset such as stock, bonds, or real estate, any capital gain or loss must be reported to the IRS. This is done using Schedule D of Form 1041, the U.S. Income Tax Return for Estates and Trusts. This schedule is used to calculate and summarize these transactions, ensuring they are properly accounted for as part of the entity’s taxable income.

Information Needed to Complete Schedule D

To complete Schedule D, a fiduciary must gather information for each asset sold during the tax year. This includes a property description, acquisition date, sale date, and the gross sales price. A key piece of information is the asset’s cost basis, which is the value used to calculate the gain or loss. The method for determining basis depends on how the estate or trust acquired the property.

For property inherited from a decedent, the “step-up in basis” rule applies. This rule adjusts the asset’s cost basis to its fair market value on the date of the owner’s death. For example, if a person bought stock for $10,000 and it was worth $100,000 on the day they died, the estate’s basis becomes $100,000. The $90,000 of appreciation that occurred during the decedent’s life is not subject to capital gains tax.

A “carryover basis” rule applies to assets gifted to a trust before the grantor’s death. With this rule, the trust’s basis in the gifted property is the same as the donor’s original adjusted basis. This directly impacts the amount of taxable gain when the trust sells the asset.

The holding period determines if a gain or loss is short-term (held one year or less) or long-term (held more than one year). This classification is important because long-term capital gains are taxed at lower rates. For 2025, estates and trusts pay a 0% rate on long-term gains up to $3,250. The rate is 15% for gains between $3,250 and $15,900, and 20% for gains exceeding $15,900.

Step-by-Step Guide to Filling Out Schedule D

After determining the basis and holding period for all transactions, the fiduciary can complete Schedule D. It is necessary to first complete Form 8949, Sales and Other Dispositions of Capital Assets. The summary totals from Form 8949 are then transferred to the appropriate sections of Schedule D.

Part I of Schedule D is for short-term capital gains and losses from assets held for one year or less. The preparer enters summary totals from Form 8949 and includes any short-term gains from other sources, like partnerships. Any short-term capital loss carryovers from the prior year are also reported here, and all amounts are combined to calculate the net short-term result on line 7.

Part II mirrors this process for long-term capital gains and losses from assets held for more than one year. Totals from Form 8949 are entered along with long-term gains from other sources and any long-term capital loss carryovers. The figures are then combined to determine the net long-term capital gain or loss on line 15.

Part III summarizes the schedule by combining the net short-term result from Part I and the net long-term result from Part II. This calculation determines the total net capital gain or loss for the estate or trust. This final figure, found on line 19, is then carried to line 4 of the main Form 1041.

Allocating Gains and Impact on Form 1041

Once the net capital gain is calculated on Schedule D, the fiduciary must determine if the gain will be retained by the entity or distributed to beneficiaries. This decision is governed by Distributable Net Income (DNI), which is calculated on Schedule B of Form 1041. DNI sets the maximum amount of a distribution that is taxable to the beneficiaries.

Capital gains are usually excluded from the DNI calculation and are taxed at the trust or estate level. This is because capital gains are typically considered an addition to the entity’s principal, not income. However, capital gains can be included in DNI and passed to beneficiaries in certain situations if permitted by the trust document or local law.

Capital gains can be included in DNI if:

• The governing instrument or local law directly allocates capital gains to income.
• The fiduciary follows a consistent practice of treating capital gains as part of distributions.
• The gains are actually paid to the beneficiary during the year, such as when a trust terminates.

If capital gains are properly allocated to a beneficiary, they are reported on the beneficiary’s Schedule K-1 (Form 1041). The trust or estate then receives a distribution deduction for the amount passed through. This mechanism shifts the tax liability for the gains to the beneficiaries and prevents the same income from being taxed at both the entity and beneficiary levels.

Handling Capital Losses

If Schedule D results in a net capital loss, an estate or trust cannot pass the loss to beneficiaries in a normal year. Instead, the entity must use the loss to offset its own income. An estate or trust can deduct up to $3,000 of net capital losses against its ordinary income annually on Form 1041.

If the net capital loss exceeds the $3,000 limit, the unused portion is carried over to subsequent tax years. This capital loss carryover retains its character as short-term or long-term. It can be used to offset future capital gains or, if none exist, to deduct up to $3,000 per year against ordinary income until the loss is fully used.

An exception applies during the final year of an estate or trust. Upon termination, any unused capital loss carryovers are passed to the beneficiaries who succeed to the property. The beneficiaries can then use these carryover losses on their personal income tax returns, subject to the same limitations. This provision ensures the deductions are not lost when the entity terminates.