Derivatives Go to Principal
Derivatives can include futures contracts, swap agreements, and other financial instruments whose value is tied to an underlying asset or index. When a trustee engages in these transactions, the question is whether the proceeds count as income for current beneficiaries or principal for remainder beneficiaries. Arizona law answers clearly: unless the trustee is already accounting for the activity under section 14-7412 as part of a business, all receipts and disbursements from derivative transactions are allocated to principal.
To the extent that a trustee does not account under section 14-7412 for transactions in derivatives, the trustee shall allocate to principal receipts from and disbursements made in connection with those transactions.
A.R.S. § 14-7423(A)This default rule makes sense for most trusts. Derivatives are typically used to hedge risk or speculate on price movements, not to generate regular income. Treating them as principal keeps the trust's income stream predictable for beneficiaries who depend on it.
Options Follow the Same Path
Options, whether the trust grants them or acquires them, receive similar treatment. If a trustee grants someone the right to buy trust property, the premium received is allocated to principal. If the trustee pays to acquire an option, that cost comes from principal. Any gain or loss when the option is exercised also goes to principal.
If a trustee grants an option to buy property from the trust, whether or not the trust owns the property when the option is granted, grants an option that permits another person to sell property to the trust or acquires an option to buy property for the trust or an option to sell an asset owned by the trust, and the trustee or other owner of the asset is required to deliver the asset if the option is exercised, an amount received for granting the option must be allocated to principal.
A.R.S. § 14-7423(B)This treatment prevents income beneficiaries from receiving windfall gains from speculative activity while also protecting them from bearing speculative losses. The risk and reward of options trading stays with the principal.
