Taxation & Estate Planning

IRS TARGETS SALE OF CHARITABLE TRUST INTEREST TRANSACTION

By Charles Rubin

Taxpayers often use charitable remainder trusts to avoid current tax on appreciated property. This is usually accomplished by the contribution of appreciated property to a charitable remainder trust, and then the trust sells the asset. Since the trust is tax-exempt, no current income tax is due on the sale. However, under the tiered income rules, as distributions are made to the grantor, those gains will be taxable to the grantor. Therefore, such planning is usually a deferral mechanism, not a tax elimination mechanism.

Some taxpayers have gone further. After the trust sells the property, the grantor and the charitable remainder beneficiary sell their trust interests to a third party. The grantor claims a stepped-up basis in his or her retained interest in the trust, and thus that there is no gain on the sale. The grantor also claims to avoid the uniform basis rules (which would apply a $0 basis to the grantor's interest) by reason of the combined sale with the remainderman. Thus, the grantor effectively gets a large chunk of change equal to the retained value of his or her trust interest, without incurring any income tax - and the gain on the sale of the contributed property is never taxed.

In a recent Notice, the IRS has indicated that it does not believe that the grantor gets the step-up in basis from the sale of the property by the charitable remainder trust. However, it has gone further than just making its views public - it has declared such transactions to be a "transaction of interest." As a transaction of interest, persons entering into these transactions on or after November 2, 2006, must disclose the transaction to the IRS. Further, 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. Failure to comply with such requirements can result in significant penalties.

Notice 2008-99, October 31, 2008

Full post as published by Rubin on Tax on November 12, 2008 (boomark / email).