Private Letter Rulings - Gifts of Bonds from Revocable Trust
GiftLaw Note:
If a trust or estate satisfies a pecuniary legacy with a distribution of appreciated property, the distribution may be treated as a taxable sale or exchange. Donor in this case established a revocable trust during her life. At death the trust owned Series E and Series H bonds. One of the trust provisions was to pay a charitable foundation a certain amount from the trust. The executor proposed paying the charitable foundation using the bonds. While the executor can do this, there is no tax benefit because the trust must recognize the income from the bonds as if they were sold. In fact the IRS views this transaction as the trust distributing cash to the foundation and the foundation purchasing the bonds from the trust. The better planning idea is to specifically state that the foundation is to receive the bonds rather than a specific dollar amount.
DATE: January 15, 1993
This is in response to your letter dated October 12, 1992, concerning the Trust. As trustee, you request a ruling that the Trust can make a nontaxable distribution of certain Series H and Series E United States savings bonds, which have previously unreported increment in value, under the circumstances described below.
The facts submitted disclose that the Grantor funded a revocable trust, the Trust, on or about a. The Grantor died on b, at which time the Trust assets were valued at approximately $ c. Among the Trust assets are Series E bonds and Series H bonds, which were acquired in an exchange of Series E bonds. The Series H bonds have previously unreported increment in value of $ d, while the Series E bonds have unreported increment in value of $ e.
The Trust governing instrument, with amendments, provides that at the death of the Grantor, the trustee shall pay the sum of $ f to Foundation, in trust, for the education of medical students. The trustee proposes satisfying this right to receive a distribution of a specific dollar amount with the Series E and Series H bonds.
If an estate or trust satisfies a pecuniary legacy with a distribution of appreciated property, the distribution may be treated as a taxable sale or exchange. In Kenan v. Commissioner, 114 F.2d 217 (2d Cir. 1940), a testamentary trust transferred appreciated securities in satisfaction of a beneficiary's right to receive a distribution of a specific dollar amount. The court held that the distribution was a taxable exchange, resulting in capital gain to the trust. The securities were considered neither transferred at death nor acquired from a decedent. The court considered the beneficiary as having constructively received the bequest of dollars and as having used that amount to purchase the securities.
In Rev. Rul. 67-74, 1967-1 C.B. 194, the trustee of a trust was required to distribute currently to the beneficiary all of the income of the trust for each year. In one particular taxable year, the trustee distributed, in lieu of cash, stock that was part of the trust corpus and that had a fair market value equal to the income required to be distributed. The Service held that the transaction is treated as though the trustee had actually distributed cash to the beneficiary, who then had purchased the stock from the trustee with the cash. Accordingly, the transfer resulted in a capital gain to the trust equal to the difference between the basis of the stock in the hands of the trustee and the amount of the obligation satisfied by the transfer.
Moreover, section 1.661(a)-2(f)(1) of the Income Tax Regulations provides that if property is paid, credited, or required to be ditributed in kind, no gain or loss is realized by the trust or estate (or the other beneficiaries) by reason of the distribution, unless the distribution is in satisfaction of a right to receive a distribution in a specific dollar amount or in specific property other than that distributed.
Rev. Rul. 58-2, 1958-1 C.B. 236, held that since a taxpayer did not realize the benefit of the increment in value at the time of a transfer of Series E bonds to a revocable trust, the taxpayer was not required to include in his gross income the amount accumulated to the date of the transfer. Under the provisions of section 676 of the Code (pertaining to revocable trusts), the taxpayer (grantor) was still considered owner of the bonds. In essence, the revenue ruling holds that there was no "disposition" of the bonds when they were transferred to the revocable trust. Without a disposition, the grantor was not required to include in gross income the increment in value at the time of the transfer.
Section 691(a)(1) of the Internal Revenue Code provides the general rule that the amount of all items of gross income in respect of a decedent which are not properly includible in respect of the taxable period in which falls the date of his death or a prior period shall be included in the gross income, for the taxable year when received, of: (A) the estate of the decednet, if the right to receive the amount is not acquired by the decedent's estate from the decedent; (B) the person who, by reason of the death of the decedent, acquires the right to receive the amount, if the right to receive the amount is not acquired by the decedent's estate from the decedent; or (C) the person who acquires from the decedent the right to receive the amount by bequest, devise, or inheritance, if the amount is received after a distribution by the decedent's estate of such right.
Section 1.691(a)-1(b) of the regulations defines the term "income in respect of a decedent," in general, as amounts to which a decedent was entitled as gross income but which were not properly includible in computing his taxable income for the taxable year ending with the date of his death or for a previous taxable year under the method of accounting employed by the decedent. Thus, income in respect of a decedent includes all accrued income of a decedent who reported his income by use of the cash receipts and disbursements method.
The increment in value of the Series E bonds actually earned as of the date of the Grantor's death, and the increment in value of the Series E bonds included in the issue price of the Series H bonds represent amounts to which the Grantor was entitled as gross income. However, because the decedent presumably employed the cash receipts and disbursements method of accounting, these amounts were not properly includible in her gross income in computing her taxable income for the taxable year ending with the date of her death or for previous taxable years.
Accordingly, we conclude that (1) the unreported increment in value reflected in the redemption value of the Series E bonds as of the date of the Grantor's death and (2) the unreported increment in value of the Series E bond that constituted part of the consideration paid for the Series H bonds as of the date of the Grantor's death constitute income in respect of a decedent under section 691(a) of the Code. It should be noted that increment in value resulting from increases in the redemption price of the Series E bonds occurring after the Grantor's death does not constitute income in respect of a decedent. All of the unreported increment in value of both the Series E and Series H bonds should be returned as income for the taxable year in which the bonds are disposed of, are redeemed, or have reached final maturity, whichever is earlier.
The trustee of Trust proposes to distribute the Series E and Series H bonds in satisfaction of Foundation's right to receive a distribution of a specific dollar amount of $ f. Such a distribution should be treated as though the trustee actually distributes cash to the Foundation, which then purchases the bonds from the Trust with the cash. Therefore, the transfer of the bonds will result in a disposition of the bonds, requiring the Trust to include in gross income the increment in value of the bonds at the time of the transfer.
Accordingly, we hold that the distribution of the Trust's Series E and Series H bonds in satisfaction of $ f will constitute a disposition for which the Trust must include in gross income the increment in value of the bonds accrued at the date of the distribution.
Except as specifically ruled on above, we express no opinion about the federal law consequences of any aspect of the above-described transaction. This ruling is directed only to the above taxpayer who requested it. Under section 6110(j)(3) of the Code, this ruling may not be cited or used as precedent.
A copy of this letter should be attached to the Trust's federal income tax return for the year of the distribution. Copies are enclosed for that purpose.
Sincerely yours,
Frances D. Schafer
Senior Technician Reviewer
Branch 3
Office of the Assistant
Chief Counsel
(Passthroughs and Special Industries)