I think the distribution to the wife from the CO trust needs to be treated as related party transactions? 

So the trust can deduct the payments to the grantor on Form 1041 if the grantor include the payment as income in her 1040...Then the FL trust is a related party of the CO trust as well, but we can elect whether or not deduct the FL house purchase and make it the 1040 income for the wife...

Gosh this is hard.