Residence Sale

[Kram BergGold]

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.

[Lion]

What kind of trust?

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

[Bird Legs]

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.

[Bees Knees]

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:

[Bees Knees]

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.

[Bees Knees]

...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

[Kram BergGold]

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.

[S T]

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