Final answer:
The trust principal decreases when the sale of trust property results in a capital loss. Additional contributions, receiving lawsuit settlements, or reinvesting undistributed income into the trust principal increase the corpus. The correct option is 'The sale of trust property results in a capital loss.'
Step-by-step explanation:
The trust principal, also known as the corpus or body of the trust, is the original amount of assets put into the trust plus any additions and minus any deductions. This principal either grows or shrinks over the life of the trust based on various activities. Let's examine how different events might impact the trust principal.
When the grantor, the person who creates the trust, makes additional contributions to the trust, they are adding to the corpus, which increases the trust principal rather than decreasing it. Conversely, if the sale of trust property results in a capital loss, this would result in a decrease in the principal value of the trust.
In the event that the trust receives a settlement from a lawsuit, this too would increase the trust's principal value. On the other hand, if the trustee, the person or entity responsible for managing the trust, transfers accumulated income not required to be distributed back into principal, this would also increase the trust's principal as it essentially reinvests the earned income back into the corpus.
Thus, looking at the options provided, the one scenario that leads to a decrease in the trust principal is when the sale of trust property results in a capital loss. This is because the assets of the trust would be sold for less than their purchase price, hence reducing the overall value of the trust principal.