Matching the Source Classification
Trust structures sometimes involve layered arrangements. A family trust might hold an interest in another trust, or a trust might be named as a beneficiary of a decedent's estate. When money flows from one entity to another, the receiving trustee needs to know how to classify it.
A trustee shall allocate to income an amount received as a distribution of income from a trust or an estate in which the trust has an interest other than a purchased interest and shall allocate to principal an amount received as a distribution of principal from such a trust or estate.
A.R.S. § 14-7411The rule is logical. If the distributing trust or estate characterizes the payment as income, the receiving trust treats it as income. If the source labels it as principal, it stays principal. This preserves the intended balance between income beneficiaries and remainder beneficiaries across both entities.
The Purchased Interest Exception
There is one important distinction. This matching rule applies only to interests the trust acquired by gift, inheritance, or original creation. If a trustee purchased an interest in another trust as an investment, different rules apply. In that case, the trustee looks to the entity receipt rules under A.R.S. 14-7410 or the asset-backed security provisions under A.R.S. 14-7424 instead.
This exception makes practical sense. A purchased trust interest is an investment decision, and the purchase price already reflects both income and principal components. Applying the same matching rule would distort the accounting. For families with multiple trusts or beneficiaries receiving distributions from an estate during administration, understanding this classification ensures that each beneficiary receives their proper share. Experienced estate planning counsel can help structure these arrangements so the accounting flows correctly from the start.
