Setting Aside Income for Wear and Tear
Physical assets lose value over time. Buildings age and equipment wears out. When a trust holds depreciable assets, the income they produce slowly uses up the principal.
Arizona law gives trustees the choice to set aside a reasonable amount from income as a depreciation reserve.
A trustee may transfer to principal a reasonable amount of the net cash receipts from a principal asset that is subject to depreciation but may not transfer any amount for depreciation of that portion of real property used or available for use by a beneficiary as a residence or of tangible personal property held or made available for the personal use or enjoyment of a beneficiary.
A.R.S. § 14-7427(A)The word "may" is important here. This is a choice, not a requirement. A trustee can decide to set aside funds for depreciation or not.
The amount must be reasonable. This means it should reflect actual wear and decline in value. An aggressive deduction that starves income beneficiaries is not allowed.
When Depreciation Transfers Are Not Allowed
The statute carves out three situations where the trustee cannot make depreciation transfers. First, property used as a beneficiary's residence is exempt.
A trust may own a home where a beneficiary lives. In that case, the trustee cannot reduce income to build a depreciation reserve. The same applies to tangible personal property held for a beneficiary's personal use.
Second, depreciation transfers are not allowed during estate administration. Third, section 14-7412 covers assets in a business or farming activity. If the trustee already accounts for the asset under that section, those rules apply instead.
The trustee does not need to hold the transferred amount in a separate fund. It simply becomes part of the trust's principal.
Arizona defines depreciation as a drop in value from wear, tear, decay, or corrosion. It also includes gradual obsolescence of a fixed asset with a useful life of more than one year.