CH.15 – Non-Donative Property Transfers
1) Intrafamily installment sales
Gift or sale &
with family members
with family members
annuity trusts (GRAT)
Joint or split
9) Intentionally defective grantor trust
Fundamental Objectives for these
(E&G) tax exposure.
appreciation potential for the
benefit of younger generation members.
if any, for FIT purposes:
- Capital gains (not ordinary income) treatment
- Deferral of any capital gain recognition.
Leverage on the
e.g., low interest costs for the debt component.
Family Installment Sales
Older family member sells appreciated property to younger family
member (e.g., Maxwell case where a retained interest for estate tax
purposes - § 2036).
- A real sale? Cf., Rev. Rul. 77-299.
- Deferred payments & deferral for
capital gains tax recognition (20%?)
- Eligible for §453 treatment - if not (i) listed stock or (ii)
sale to related party - sells property.
- Subsequent appreciation accrues to the
- Interest is to be paid by buyer to seller? §7872 importance when
low interest rate conditions.
Alternative Approach – Gift Mortgage
Alternative to a family member sale:
- Mortgage the property & retain the indebted property,
subject to the mortgage debt. Cf., “reverse mortgage” situation.
- Make a gift of the borrowed cash received.
- Tax basis step-up (§1014) for the retained property at time of
- Risk of greater value of the mortgaged property at the
time of death (through appreciation) - but offset by existing debt.
Sale to a Grantor Trust
Intentionally defective grantor trust (IDGT), also p. 104:
Trust effective for
transfer tax - to
eliminate estate tax exposure.
2) But, grantor trust for FIT purposes, and, therefore, no
sale for federal income tax purposes. See Rev. Rul. 85-13.
What happens when grantor trust powers are terminated – treated as
a property sale.
But, no estate tax inclusion means no tax basis step-up at
death. If estate below 5.45 mil.?
Sale for a Self-Cancelling Installment
Installment sale from parent to child, but the promissory note
specifies its cancellation at time of the death of the seller:
- Increase the interest (or principal?)
amount to include an actuarial component in payment?
- What inclusion of the transferred
property in the estate for estate tax purposes? None?
- Installment sales treatment?
- Income tax treatment at death? IRD?
- Income recognition to the decedent or estate?
See CCA, p.7 (& next slide).
Sale for a Self-Cancelling Installment
1) Federal estate tax inclusion (Issue 3, p. 13).?
Notes are not included in the gross estate for federal
estate tax purposes.
Moss case – assume arm’s length/real transaction.
2) But, gift for gift tax purposes, when not full
value of the note for transaction value.
Cancelled debt at death
Installment obligations are cancelled at death: Issue – income
tax: (1) IRD (under §691), or (2) an installment debt disposition
recognition (§453B), or (3) no income event?
Tax Court: Income on final income tax return - §453B(f)
cancellation. Issue re the six year S/L?
Tax Court dissent: no income event; Est. of Moss (p.30
re estate tax) – no ownerhsip interest in the notes held at time of death.
Ct. of Appeals: §691(a)(2) applies – an IRD item on the estate’s
first income tax return – when cancellation occurred at death..
Planning the SCIN Transaction
Essential: Clear documentation required – see Costanza, 6th
Circuit, (p. 11), where sloppy administration occurred (but treated as valid).
Include an actuarial premium in the amount being paid to
seller? This is an additional asset includible in the seller’s estate
Alternative: provide a contingent bequest to the note issuers to fund
the unpaid balance on the promissory note owing to decedent?
Gift or Sale/Leaseback
Sale – gain recognition & basis to buyer is fmv.
Gift – carryover tax basis to donee.
Transferor: (1) pays (deductible) rent to the new property owner; (2)
receives interest income & principal if a sale & a capital gains event;
cf., §1239, seller’s cap gain transformed into ordinary income in limited
Transferee: (1) rental income; (2) pays interest expense (& principal),
(3) gets an investment interest expense deduction (& depreciation?) to
offset rent income received, & (4) appreciation.
Tax-free exchanges & family
Code §1031 re gain postponement on like-kind exchanges: is the
exchange eligible for §1031?
Why do this? Exchange high appreciation potential property for income
producing property on tax-free basis? & get gross income.
Hold the replacement property for a tax basis step-up at death - §1014.
See §1031(f) limitation on related party like-kind exchanges when
a sale of the exchange property is then made by the related person.
Objectives in implementing the “private
annuity” transaction? Tax issues:
Gain recognition on
transferred property at
the time of the annuity transaction (or later)?
If deferral, how report the annuity proceeds
for FIT purposes? Annuity income, capital gain and tax basis
inclusion at the time of death of
the annuitant? A retained life interest? Or does annuity
Private annuity a with school for the transfer of
a coop apartment remainder interest.
Minimum (250x, refund feature) & COLI
See reliance on Rev. Rul. 69-74, p.41
Possible elements in each payment:
tax basis recovery,
3) ordinary income (interest),
(a component of the total property
Abandoning “Open Transaction” Treatment
IR 2006-161 (2006), p.43 – announcement & proposed regulations
& an immediate effective date; but, no final regs. (ten years
later). Wait how long for final regs?
Reg. §1.1001-1(j) – receipt of the contract is the “receipt of property.”
Prior Stern case (p.44) & “closed transaction”? §677
(grantor trust issuing a private annuity obligation); not closed here
since no security for assuring payment of annuities. But, Prop. Reg. to
Private annuity transaction by a terminally ill person (assuming
no reg.)? McLendon case, p. 48 – private annuity transaction with a
family trust; transfer of remainder interests in a partnership in exchange for
Actuarial life expectancy: 15 years
Adequate & full consideration? See old Rev. Rul. 80-80
allowing use of tables? 10% survival probability? See Reg. §1.7520-3(b)(3)
– 50% chance of dying within one year; but, rebutted if living for 18 months.
Grantor Retained Annuity Trust
What is the primary tax planning objective for implementing a “GRAT”
(i.e. annuity trust)?
Cf., a “GRIT” (grantor retained income trust).
See Code §2702(a)(2) & (b)(1) – the retained interest
must be a “qualified interest” – or the retained interest is treated as
having zero value (i.e., all value is then transferred as a
“Qualified interest” as defined – a right to receive fixed
amounts payable at least annually.
How long a term? See Obama proposal (2017 budget) re
a possible minimum ten year term.
Income tax – (a)
Grantor trust treatment –
§§674 (P/A) & 677 (discretion to pay all income), &
(b) Rev. Rul. 85-13 treatment – & no gain for asset transfer
for annuity payments.
2) Grantor trust - Qualified for Sub S stock.
3) For gift tax, a “qualified interest” –
right held to receive fixed amounts. Gift tax value excludes
the qualified annuity interest.
4 ) Estate tax - not includible (cf., §2036 Maxwell
case) in grantor’s gross estate – if the grantor survives the term
of the GRAT.
Objective of the “Zeroed-Out”
PLR 9717008 (p.66) – short term (two year) GRAT and payments
to be funded with promissory note. Held: not a qualified
Funded with shares which appreciated and latter annuity payments
were made with shares.
No IRS ruling re a “zeroed out” GRAT (p.73) –
1) The remainder interest must be at least 10
percent of the initial net market value, &
2) Annual annuity not more than 50% of value.
Pay the GRAT with a Promissory
Regs.: A promissory note can not be used to pay the
annual GRAT obligation – the transferor’s retained interest will be valued at
zero (for gift tax purposes). The note is not a “payment.”
The annuity agreement must prohibit the use of a
promissory note to pay the annuity.
Estate Tax Inclusion – Death before GRAT
What value is includible in the gross estate if the grantor dies
before the expiration of the specified term of the GRAT? P.75.
Inclusion in the gross estate of only an amount
necessary to fund the annuity for the remaining term based on §7520
rates. Reg. §20.2036-1(c)(2). P.75.
inclusion of the full value of the trust as measured at the time of death
(possibly occurring under §2039). Only §2036 applies.
Use “staggered GRATs”?
Qualified Personal Residence
Code §2702(a)(3)(A)(ii) – re personal residence trust as an
exception to “qualified interest.”
Choices under the tax regulations:
- Personal residence trust, or,
- Qualified personal residence trust
Valuation of the gift of the remainder interest is based on:
(1) the FMV of the property, (2) the client’s age, and (3) the §7520 interest
rate (120% of mid-term AFR).
What is the “personal residence”?
Adjoining property? Guesthouses? Beach?
This ruling specifies:
other structures) is used for residential
The trust agreement
includes all the required provisions to enable QPRT treatment. See Reg. §25.2702-5(c).
Residential Property Management Issues
QPRT & property managements issues:
Who deals with the maintenance costs?
Real estate taxes? Insurance?
Cost of improvements – who pays?
Who has the replacement cost obligation for a casualty loss if the
loss is not covered by casualty insurance?
Rev. Proc. 2003-42
See sample form for QPRT agreement with one term holder, as
provided by IRS.
“Safe harbor” trust agreement format – the agreement must be “substantially
But, also a possible PLR concerning the status of the residential
property as being QPRT eligible? See p. 83.
What Happens When QPRT Term Ends?
Where does the QPRT trust grantor live after the expiration of the
- Sale of the property back to grantor? No. P.83.
- But, possible lease back (without §2036(a) estate tax
- Use a “return QPRT”? Yes (see PLRs, p. 83) re
beneficiaries creating a QPRT for the benefit of the original donor.
How to reduce the gift tax values?
their interests and put (then discounted) fractional shares into several
QPRTs? See p. 84.
2) Retention of a contingent reversion if
dying within the specified QPRT period – since the asset is included in grantor’s
gross estate in this situation (under §2036). P. 84. This can
reduce the value of the gift to the remainderman.
Retain the QPRT Technique?
See (p, 84) proposal to terminate QPRT exception of Code §
Is this a “loophole”?
Code §2702(c)(2) – two or more family members acquire interests in
property where one interest is a term interest.
The person acquiring the term interest is treated as acquiring the
entire property (less any consideration provided by the other party).
Therefore, the transaction is an entire gift of the property, less
any consideration provided by the remainderman.
This private letter ruling was issued before Code §2702 enactment.
Purchase of condo unit: Parent acquires life interest
& child acquires the remainder interest.
Issue re Code §2036(a) estate tax inclusion.
Result: Inclusion of most of the value.
Problems: (1) failure to use the correct actuarial factor
and (2) borrowings from the parent to purchase the remainder interest.
Joint Purchase of a Personal Residence?
Reg. §25.2702-1(c)(2) states that Code §2702 does not apply to a “transfer
in trust that meets the requirements of §25.2702-5.”
Sale of a Remainder Interest in
Remember the forced widow’s election re the widow’s sale of a
See Reg. §25.2702-4(d), Example 2: Sale by parent of
remainder interest to child, retaining income right for 20 years. Even if
value paid by child is equal to §7520 value, the parent’s retained interest is
not a “qualified interest” and, therefore, the value of the retained interest
is zero. Therefore, a gift of entire property value (less consideration
p. 93 Cf., Gradow case
Transfer by 80 year old person of (1) a remainder interest in preferred
shares in exchange for an annuity and (2) retained the income interest.
Inclusion of full value of shares in the estate?
Tax Court: inclusion of full share value, offset only for
annuity payments received.
3rd Circuit: Held: inclusion of remainder
interest less the value of the annuity (paid for the remainder interest).
Intentionally Defective Grantor Trust
Trust as: (1) an effective transfer to avoid estate tax
(2) defective for income tax purposes.
Purpose of this arrangement?