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Certain Sales of Interests in CRTs Are Reportable Transactions

Estate Planning Journal

In Notice 2008-99, 1 the IRS identified a specific type of transaction involving charitable remainder trusts ("CRTs") as a transaction of interest for purposes of Reg. 1.6011-4. Therefore, the parties engaging in such transactions must disclose them to the IRS.

Facts

Reg. 1.6011-4 requires that a taxpayer who has participated in a "reportable transaction" must file Form 8886 with the taxpayer's tax return. Failure to file Form 8886 disclosing a reportable transaction may result in penalties of as high as $200,000 under Section 6707A. The five categories of reportable transactions are as follows:

(1) Listed transactions. These are transactions, or substantially similar transactions, that the IRS has identified in a Notice or Regulation as tax avoidance transactions.
(2) Confidential transactions. These are transactions that are offered to taxpayers under conditions of confidentiality.
(3) Transactions with contractual protection. These are transactions in which taxpayers have the right to a refund of fees if the intended tax consequences of the transactions are not achieved.
(4) Loss transactions. These are transactions that result in losses of at least specified dollar amounts, which are claimed by the taxpayers involved as deductions under Section 165.
(5) Transactions of interest. These are transactions that are the same as, or substantially similar to, transactions which the IRS has identified in a Notice or Regulation as a transaction of interest.

The facts of the transaction as set forth in Notice 2008-99 are as follows: Grantor establishes either a charitable remainder annuity trust or a charitable remainder unitrust and contributes appreciated assets to the trust. Next, the charitable trust sells the appreciated assets and reinvests the net proceeds in other assets. Because the charitable trust is generally tax-exempt under Section 664, the sale of the appreciated assets is exempt from income tax, and the trust's basis in the new assets is the price the trust pays for those assets. Next, the grantor and the charitable remainderman sell their respective interests in the charitable trust to an unrelated third party for a price equal to the fair market value of the assets of the charitable trust. The third-party purchaser then terminates the charitable trust and the assets of the trust are distributed to the purchaser.

Analysis

The IRS stated in the Notice that when the grantor and the charitable remainderman of the trust sell their respective interests in the charitable trust, the grantor takes the position that the "no basis rule" of Section 1001(e)(1) (which provides that the seller of a life estate, income interest, or interest for a term of years is not allowed to use any adjusted basis to offset gain on the sale) does not apply because of Section 1001(e)(3) (which provides that the "no basis rule" of Section 1001(e)(1) does not apply if all the interests in the trust are sold in the same transaction). In addition, based on the "uniform basis rule" of Reg. 1.1015-1(b), the grantor takes the position that the adjusted basis of his or her interest in the charitable trust is equal to its allocable portion of the adjusted basis of the reinvested assets rather than its allocable portion of the assets initially contributed to the charitable trust. The consequence of the grantor's claimed tax treatment for the transaction is that the gain on the sale by the charitable trust of the assets initially contributed to the charitable trust is never taxed, and the third-party purchaser receives the assets of the charitable trust with a basis equal to the purchase price of the reinvested assets.

In the Notice, the IRS stated that it was not concerned about the mere creation and funding of charitable trusts or the sale of assets initially contributed to the charitable trust and the reinvestment of the sale proceeds. However, the IRS said that it was concerned about the manipulation of the uniform basis rules to avoid tax on the gain from the sale of the assets initially contributed to the charitable trust. The IRS stated that the type of transaction described in this Notice is the coordinated sale by the grantor and the charitable remainderman of their respective interests in a charitable remainder trust in a transaction claimed to be described in Section 1001(e)(3), following the sale by the charitable trust of the assets initially contributed to the charitable trust. Comments Notice 2008-99 is important because it concerns the use of a popular estate planning vehicle, the charitable remainder trust, which is included by many clients in their lifetime and testamentary estate plans. Practitioners should carefully review this Notice and its reporting requirements before engaging in a transaction of the type described in the Notice or a similar type of transaction. The Notice has retroactive effect since it applies to transactions entered into on or after November 6, 2011.

Frank S. Baldino is an attorney at Lerch, Early & Brewer in Bethesda, Maryland who practices in the areas of estate planning and probate administration and who co-chairs the firm's Estate Planning and Probate Group. He has extensive experience in the areas of estate planning, charitable giving, estate planning for non-U.S. citizens, tax planning with respect to retirement plans and stock options, asset protection planning, business succession planning and estate and trust administration. Frank may be contacted at 301-657-0715 or fsbaldino@lerchearly.com.

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