Sale of Charitable Remainder Trust Interests

Doug H. Moy
November 6, 2008 — 2,486 views  
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The IRS and Treasury Department have identified what they believe may be a tax avoidance transaction involving charitable remainder trusts ("CRT"). In one variation of the transaction, Grantor creates a CRT and contributes appreciated assets ("Appreciated Assets") to the CRT. Grantor retains an annuity or unitrust interest ("term interest") in the CRT and designates a charitable organization described in IRC Sections 170(c), 2055(a) and 2522(a) ("Charity") as the remainder beneficiary. Charity may, but need not, be controlled by Grantor; Grantor may, but need not, reserve the right to change the Charity designated as the remainder beneficiary. In turn, the CRT sells or liquidates the Appreciated Assets and reinvests the net proceeds in other assets ("New Assets"), such as money market funds, marketable securities and/or other assets, often to acquire a diversified portfolio. Because a CRT generally is a tax-exempt entity under IRC Section 664, the sale of Appreciated Assets by the CRT is exempt from income tax; and its basis in the New Assets is the price the CRT pays for those New Assets. Some portion of the CRT’s ordinary income and capital gains may become taxable to Grantor as the periodic annuity or unitrust payments are made by the CRT in accordance with the rules of IRC Section 664 and the regulations thereunder. Then, Grantor and Charity, in a transaction they claim is described in IRC Section 1001(e)(3), sell or otherwise dispose of their respective interests in the CRT to an unrelated third party ("Third Party") for an amount that approximates the fair market value of the assets of the CRT, including the New Assets. The CRT then terminates; and the assets of the CRT, including the New Assets, are distributed to the Third Party.

The Grantor takes the following positions regarding the tax consequences of this transaction. (1) Grantor claims a charitable income tax deduction for the portion of the fair market value of the Appreciated Assets as of the date of the contribution to the CRT which is attributable to the remainder interest. (2) Grantor claims to recognize no gain from the CRT’s sale or liquidation of the Appreciated Assets. (3) When Grantor and Charity sell their respective interests in the CRT to the Third Party, Grantor and Charity take the position that they have sold the entire interest in the CRT within the meaning of IRC Section 1001(e)(3). (4) Because the entire interest in the CRT is sold, Grantor claims that IRC Section 1001(e)(1), which disregards basis in the case of a sale of a term interest, does not apply to the transaction. (5) Grantor also takes the position that, under IRC Section 1001(a) and related provisions, the gain on the sale of Grantor’s term interest is computed by taking into account the portion of uniform basis allocable to Grantor’s term interest under Treas. Reg. Sections1.1014-5 and § 1.1015-1(b) and this uniform basis is derived from the basis of the New Assets, rather than the basis of the Appreciated Assets.

The transaction may use trusts with circumstances that vary from the situation described above. In some variations, a net income with make-up provision charitable remainder unitrust ("NIMCRUT") may be used as the CRT, the CRT may have been in existence for some time prior to the sale of property comprising the CRT estate, the Appreciated Assets already may be in the CRT prior to the commencement of the transaction, the recipient and seller of the term interest may be the Grantor and/or another person or Grantor may contribute the Appreciated Assets to a partnership or other passthrough entity and then contribute the interest in the entity to the CRT.

A result of the claimed tax treatment of the transaction is that the gain on the sale of the Appreciated Assets is never taxed, even though the Grantor receives the Grantor’s share of the appreciated fair market value of those assets. The IRS and Treasury Department are not concerned about the mere creation and funding of a CRT and/or the reinvestment of the contributed appreciated property by the CRT, and such events alone do not constitute the basis for a tax avoidance transaction, but are concerned about the manipulation of the uniform basis rules to avoid tax on gain from the sale or other disposition of appreciated assets. Accordingly, the type of transaction described above includes a coordinated sale or other coordinated disposition of the respective interests of the Grantor or other noncharitable recipient and the Charity in a CRT in a transaction claimed to be described in IRC Section 1001(e)(3), subsequent to the contribution of appreciated assets and the reinvestment of those assets by the CRT. In particular, the IRS and Treasury Department are concerned about Grantor’s claim to an increased basis in the term interest coupled with the termination of the CRT in a single coordinated transaction under IRC Section 1001(e) to avoid tax on gain from the sale or other disposition of the Appreciated Assets.

Persons entering into these transactions on or after November 2, 2006, must disclose the transaction as described in Treas. Reg. Section 1.6011-4. Material advisors who make a tax statement on or after November 2, 2006, with respect to transactions entered into on or after November 2, 2006, have disclosure and list maintenance obligations under IRC Sections 6111 and 6112 [See Treas. Reg. §§ 1.6011-4(h) (Aug. 3, 2007), 301.6111-3(i) (Aug. 3, 2007) and 301.6112-1(g) (Aug. 3, 2007)] [Notice 2008-99, 2008-47 IRB __ (Nov. 24, 2008)].

Doug H. Moy

Doug H. Moy is a nationally recognized author, consulting specialist, seminar instructor and educator. He has an undergraduate degree from Willamette University and a Masters degree from Washington State University. Since 1979, Mr. Moy has consulted to attorneys, tax practitioners and their clients, as well as assisted practitioners representing clients before the IRS Conference of Right and Appeals Division and Settlement Conference Negotiations. He is noted for his ability to communicate his unparalleled knowledge and experience to practitioners at all levels in his field of expertise; namely, estate/gift taxation and planning, with special expertise in living trusts; community property; lottery prize winnings; structured settlement trusts; extricating clients from abusive trust tax shelters; designing effective estate plans; and preparation of Form 706 Estate Tax Returns and 709 Gift Tax Returns. He offers particular assistance and exceptional skill designing creative, practical solutions to challenging and difficult estate planning situations.