Income Tax Advantages/Disadvantage Con’t

In my previous entry, I indicated that there are, as a general rule, no income tax disadvantages to holding property in a revocable trust. Prior to that, I indicated that a revocable trust does not offer any income tax advantages. Nothwithstanding the above, there is at least one situation that Kansas City estate planning attorneys (as well as other estate planners) should be familiar with in order to avoid causing an inadvertent tax result. This trap for the unwary is titling stock of a closely held corporation in the name of the revocable trust. Under §1244 of the Internal Revenue Code, ordinary loss treatment is available upon a sale or exchange (including a deemed sale when the stock becomes worthless) for shareholders who satisfy the requirements of that Code section. Trusts are not eligible shareholders for purposes of §1244.  Unfortunately, the language of §1244 stock is broad and neither the Code nor the regulations exclude revocable trusts from its ambit.

While policy reasons would suggest that revocable trusts should not be treated the same way as irrevocable trusts under §1244, the plain language of the statute and the regulations will make it difficult to argue that §1244 ordinary loss treatment is available for stock held in a revocable trust.

For titling purposes, the stock can be held in the name of the individual with a transfer on death designation to the trustee of the revocable trust (which will become irrevocable on the death of the grantor). If §1244 loss treatment is not a major consideration (e.g., the taxpayer has a low-basis in the stock which has significantly appreciated) then stock can be titled in the name of the trust as the likelihood of loss upon a sale is quite small. In this later case, the lifetime advantages of placing the stock in the trust will likely outweigh the §1244 considerations.

Income Tax Advantages/Disadvantages to Revocable Trust Revisited

In an earlier entry, I indicated that a revocable trust does not have any income tax advantages.  But does it have any income tax disadvantages?  Generally, the answer to this question is no with a few exceptions.

For example, under prior law the benefits of the one time $125,000 exclusion under former §121 and the two-year “rollover” of gain under former §1034 on the sale of a personal residence that were available to individuals if statutory requirements were met were held to apply to sales during the settlor’s lifetime of a personal residence held under a revocable trust arrangement.  See Priv. Ltr. Rul. 9026036 (March 28, 1990) (holding the §121 exclusion applicable to a sale of a personal residence owned by a revocable trust); Rev. Rul. 66-159, 1996-1CB162 (holding the §1034 “rollover” likewise applicable). Although in 1997, § 1034 was repealed by Congress and §121 was amended to provide for a $500,000 exclusion on the sale of a principal residence ($250,000 for a single person) that can be taken every two years, the benefits of §121 as amended by the 97 Act should remain unaffected by the ownership of a principal residence under a revocable trust agreement.

Other tax areas that remain unaffected by reason of transferring assets to a revocable trust include the following:

(a)    United States Savings Bonds transferred by the Grantor/Settlor to his or her revocable trust should not trigger taxation of the accrued interest.  See Rev. Rul 58-2, 1958-C B 236

(b)   If the grantor has previously sold an asset in exchange for installment obligations, the transfer of these obligations to the grantor’s Revocable trust will not constitute a taxable disposition under § 453B of the Code so that no gain will be triggered upon such transfer.  See Rev Rul. 74-613, 1974-2 C.B. 153.

(c)    Similarly, oil and gas properties may be transferred to the Grantor’s revocable trust without causing loss of percentage depletion.  See Rev Rul. 84-14, 1984-1 C. B. 147

Next time, I will discuss what income tax advantages may be lost, or at least makes it more complicated, when certain assets are transferred to a revocable trust.