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    Residence Sale

    My client asked me "if we sell our primary residence to a trust, set up with our children as beneficiary's, will this sale qualify for the section 121 exclusion"? I would think the answer is yes but I just want to be sure before I get back to them.

    #2
    What kind of trust?

    Irrevocable? Who's the trustees? Do related party rules come into play with sec. 121?

    Comment


      #3
      Residence in Trust

      How do you sell your residence to a trust? If a trust is set up, where does it get
      the money to buy the house?
      I am very slow thinking these days and have a difficult time understanding some
      things.

      Comment


        #4
        It is not simple. As a matter of fact, it is quite complicated. IRS Letter Ruling 200104005 addresses this very issue and the end result is a portion may be taxable and a portion may be excludable under Section 121.

        I will post the entire ruling so you can see what all is involved in sorting this one out:

        Comment


          #5
          IRS Letter Ruling 200104005

          This responds to your letter of Date 4 requesting a ruling on whether
          gain from the sale of your client's principal residence would be excluded
          under section 121 of the Internal Revenue Code ("Code").


          FACTS

          Taxpayer and his wife, Decedent, established the Trust on Date 1. The
          Residence was transferred to the Trust shortly after it was established.
          The Residence was used by Taxpayer and Decedent as their principal
          residence from the time it was purchased until the death of Decedent on
          Date 2. Taxpayer continued to use the Residence as his principal residence
          from Date 2 until Date 3, having lived at the Residence for greater than
          thirty years, when it became necessary for him to move out of the
          Residence and into an assisted living facility. Taxpayer can no longer
          maintain the Residence and therefore intends to sell the property.

          The Trust was revocable by Taxpayer and Decedent from the time that it
          was established until the death of Decedent, at which time the Trust was
          divided into two Trusts, Trust A and Trust B, each for the benefit of
          Taxpayer. Trust A, which remains revocable by Taxpayer, was allocated all
          of Taxpayer's interest in the community estate plus a portion of
          Decedent's interest in the community estate in order to satisfy the
          maximum Marital Deduction formula provided for in the Trust. The balance
          of the community estate was allocated to Trust B, which is irrevocable,
          including one hundred percent of the Residence.

          Section 3.2.2 of Trust B provides that the Trustor shall have the power
          to withdraw from the principal of Trust B in each calendar year such
          amount as shall not exceed Five Thousand Dollars ($5,000.00) or five
          percent (5%) of the then aggregate market value of all property included
          in the principal of Trust B, whichever is greater. The surviving Trustor
          shall exercise such power in each year by serving written notice of the
          amount to be so withdrawn on the Trustee. Such power shall be non-
          cumulative so that any amount which the surviving Trustor was entitled to
          but did not withdraw in any one calendar year may not be withdrawn in any
          succeeding calendar year. This type of power in a trust is commonly
          referred to as a "five or five" power.

          Section 3.2.3 of Trust B provides that the Trustee shall pay to or
          apply for the benefit of the beneficiary, during his or her lifetime, in
          monthly or other convenient installments, but no less often than annually,
          all of the net income of Trust.

          Section 5.12 of Trust B provides that the beneficiary shall have the
          right to occupy all real property in the trust estate that was being used
          for residential purposes. The beneficiary, in his or her discretion, may
          direct the Trustee to sell any such property and replace it with or rent
          or lease another residence selected by the beneficiary of comparable or
          lower value.


          OWNERSHIP REQUIREMENT FOR SECTION 121 PURPOSES

          Section 121(a) of the Code provides that a taxpayer's gross income will
          not include gain from the sale or exchange of property if, during the 5-
          year period ending on the date of the sale or exchange, such property has
          been owned and used by the taxpayer as the taxpayer's principal residence
          for periods aggregating two years or more.

          Section 121(b)(1) of the Code provides that the amount of gain excluded
          from gross income under section 121(a) with respect to any sale or
          exchange will not exceed $250,000 ($500,000 for certain joint returns, see
          section 121(b)(2)).

          Rev. Rul. 66-159, 1966-1 C.B. 162, considers whether the gain realized
          from the sale of trust property used by the grantor as the grantor's
          principal residence qualifies for the deferment and rollover of gain into
          a replacement residence under section 1034 of the Code. The ruling holds
          that because the grantor is treated as the owner of the entire trust under
          sections 676 and 671 of the Code, the sale by the trust will be treated
          for federal income tax purposes as if made by the grantor

          Rev. Rul. 85-45, 1985-1 C.B. 183, considers whether gain realized from
          the sale of trust property used by a beneficiary of a trust as the
          beneficiary's residence qualifies for the one-time exclusion of gain from
          the sale of a residence under section 121 of the Code. The ruling holds
          that because the beneficiary is treated as the owner of the entire trust
          under sections 678 and 671 of the Code, the sale by the trust will be
          treated for federal income tax purposes as if made by the beneficiary.


          OWNERSHIP OF TRUST PROPERTY FOR INCOME TAX PURPOSES

          Section 678 provides that a person other than the grantor shall be
          treated as the owner of any portion of a trust with respect to which (1)
          such person has a power exercisable solely by himself to vest corpus or
          the income therefrom in himself, or (2) such person has previously
          partially released or otherwise modified such a power and after the
          release or modification retains such control as would, within the
          principles of sections 671 to 677 inclusive, subject a grantor of a trust
          to treatment as the owner thereof.

          Section 677 provides that the grantor of a trust shall be treated as
          the owner of any portion of the trust whose income without the approval or
          consent of any adverse party is, or, in the discretion of the grantor or a
          nonadverse party, or both, may be distributed to the grantor

          In Rev. Rul. 67-241, 1967-2 C.B. 225, the beneficiary of a trust held a
          noncumulative power, exercisable solely by the beneficiary, to withdraw
          certain amounts of corpus annually from the trust. Rev. Rul. 67-241
          concludes that, for each year that this demand power is held, section
          678(a)(1) treats the beneficiary as the owner of that portion of the trust
          which is subject to this demand power, whether or not it is exercised.


          RULING

          We conclude that Taxpayer's five or five power is a power to vest in
          Taxpayer a portion of the corpus of Trust B. Until the power is exercised,
          released, or allowed to lapse, Taxpayer will be treated as the owner for
          each year of that portion of Trust B that is subject to the power to
          withdraw under section 678(a)(1). To the extent that Taxpayer exercises
          the five or five power during a calendar year, such withdrawal shall be
          deemed to have been made from Taxpayers pro rata share of each asset of
          Trust B corpus that he is treated as owning.

          For each year that Taxpayer fails to exercise the five or five power,
          he will be deemed to have partially released the power to withdraw the
          portion of the trust corpus subject to that power under section 678(a)(2).
          After each succeeding year in which Taxpayer fails to exercise his power,
          he will be treated as the owner of an increasing portion of the corpus of
          the trust. The annual increase of the portion of the corpus of Trust B of
          which Taxpayer will be treated as the owner is the product of the amount
          which he could withdraw multiplied by a fraction, the numerator of which
          is the portion of the trust corpus that he is not already treated as
          owning, and the denominator of which is the total trust corpus from which
          the withdrawal could be made.

          Comment


            #6
            ...continued...

            Section 671 provides that where a grantor or other person is treated as
            the owner of any portion of a trust, the income, deductions, and credits
            against tax of the trust attributable to such portion of the trust shall
            be included by the grantor or other person in computing his taxable income
            and credits.

            Section 1.671-3(a) of the Income Tax Regulations provides that a deemed
            owner of corpus must include his or her share of the capital gains
            realized by the trust if allocable to the portion of corpus which that
            person is deemed to own.

            Section 1.671-3(a)(3) provides that if a person is treated as owning an
            undivided fractional share of trust corpus or an interest represented by a
            dollar amount, then a pro rata share of each such item of capital gain
            shall be allocated to that person.


            Therefore, Taxpayer must include, in computing his tax liability, items
            of income, deductions, and credits that are attributable to that portion
            of the corpus of Trust B which Taxpayer is treated as owning. Also, as the
            owner of an undivided fractional share of the corpus of Trust B, Taxpayer
            shall be allocated a pro rata share of each item of any capital gain
            realized by Trust B.

            Taxpayer has also asked whether he is treated as an owner of an
            additional portion of Trust B as a result of section 5.12 of Trust B.
            Under section 5.12 of Trust B, Taxpayer has the right to occupy all real
            property in the trust estate that was being used for residential purposes.
            Pursuant to section 5.12 of Trust B, Taxpayer, in his discretion, may also
            direct the Trustee to sell any such property and replace it with, or rent
            or lease another residence selected by Taxpayer, of comparable or lower
            value. However, this right is not a power to vest corpus in Taxpayer and
            thus, does not result in his being treated as an owner of any additional
            portion of the corpus of Trust B undersection 678(a)(1). Furthermore,
            Taxpayers right to occupy the residence is limited to his lifetime under
            the terms of section 5.12 of Trust B. The sale by the trust of any assets
            subject to that right does not result in a disposition of any interest
            represented by that right. Therefore, Taxpayer continues to have the same
            rights regarding property used for residential purposes held by Trust B.

            Based on the facts as represented and the relevant law as set forth
            above, we conclude that if Trust B sells the Residence, the gain on the
            Residence would be taxable to Trust B, as the owner of the corpus, not
            Taxpayer, except to the extent Taxpayer is deemed the owner of a portion
            of the property pursuant to his 5 or 5 power. As Taxpayer would be taxed
            on the gain from the sale of the Residence, only to the extent of his
            ownership pursuant to his 5 or 5 power in the Residence, section 121 shall
            only apply to the portion of the Residence attributable to the 5 or 5
            power.

            Except as specifically ruled upon above, no opinion is expressed or
            implied regarding the income tax consequences of the Trust, any
            transaction, or any item discussed or referenced in this letter.

            This ruling is directed only to the taxpayer(s) requesting it. Section
            6110(k)(3) of the Code provides that it may not be used or cited as
            precedent.


            Sincerely,
            Pamela W. Fuller
            Acting Assistant to the Branch Chief,
            Branch 1
            Administrative Provisions and Judicial
            Practice Division
            Last edited by Bees Knees; 08-25-2006, 03:04 PM.

            Comment


              #7
              Bees, not on point

              Bees, my scenario is different and simplier than the one you described. My client owns and lives in the house. He is planning to not be living in it for more than 3 years but may want to come back to it. He wants to sell it to a trust that has been set up for his children and claim his $500,000 exclusion (he is married). The trust will take a mortgage to buy the house and use the rental income to make the mortgage payments and pay other bills. If he ever moves back into the house he will make payments of rent to the trust. My guess is, if the trust is a revocable trust set up by the Dad then this won't work. But what if the trust is irrevocable? I am waiting for my clienet to tell me which it is.

              Comment


                #8
                Trust

                I know you stated you don't have all of the facts yet, but a question would be WHAT type of Trust???

                I think another question would be "who" is your client obtaining the information from for this scenario??

                Sandy

                Comment

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