GST Tax Exemption Preserved in Sale of Farm

In Private Letter Ruling 201509002 (released Feb. 27, 2015), the Internal Revenue Service ruled that a proposed sale of a farm owned by two trusts wouldn’t cause the trusts to lose their generation-skipping transfer (GST) tax exemption.  The IRS also determined that the trusts’ beneficiaries wouldn’t incur gift tax liability and wouldn’t have to include the trust assets in their   gross estates.

The Terms of the Trusts

On a certain date, a grantor (Grantor 1) established an irrevocable trust (Trust 1) for himself, his wife and his lineal descendants.  The grantor and his wife subsequently died.  Trustee 1 was the corporate trustee of Trust 1.

On a different date, a grantor (Grantor 2) set up a revocable trust (Trust 2) for himself.  On a later date, he amended Trust 2 to pay income in equal shares for life to his daughter (who was Grantor 1’s wife (Spouse)) and his son.  On that same date, he also released his right to further amend or revoke Trust 2.  Subsequently, a court divided Trust 2 into two irrevocable, equal trusts: one for the benefit of Spouse (Trust 3) and her descendants and one for the benefit of Grantor 2’s child and his descendants.  Trustee 2 was the corporate trustee of Trust 3.  Grantor 2 died thereafter.

Trust 1 provided that: 1) the trustees were to pay the net income for the benefit of Grantor 1’s issue, per stirpes; and 2) it would terminate 21 years after the death of the survivor of Grantor 1’s three children.  Trust 3 provided that 1) the trustees were to pay the net income to Spouse’s issue, per stirpes; and 2) it would terminate 21 years after the death of the last surviving lineal descendant of Grantor 2 living at the time of Grantor 2’s death. 

The beneficiaries of Trust 1 and Trust 3, who were essentially the same, asked the IRS to rule on the gift, estate and GST tax consequences of a proposed sale of a farm owned by Trust 1 and Trust 3.

The Proposed Sale

Trust 1 and Trust 3 owned a farm, of which Trust 1 owned a certain amount of acres and Trust 3 owned a certain amount of acres.  The acres were mostly contiguous.  Trust 1 and Trust 3 acquired the acreages at different times, and some of the parcels were land-locked.  As such, access from a public road was possible only through easements over acreage owned by the other trust.  The trustees of both trusts wanted to sell the property in a coordinated sale.  The property, which was zoned for agricultural, residential and public land use, was subject to restrictions and not serviced by public water and sewers. 

The intended purchaser was a limited partnership owned by a lineal descendant of both Grantor 1 and Grantor 2.  The lineal descendant was also the trustee of a trust that’s a current beneficiary of Trust 1 and a contingent beneficiary of Trust 3.  He’s also a licensed real estate broker and developer of residential real estate.

The trustees, along with the beneficiaries, negotiated an agreement of sale.  Separate counsel represented the parties.  The sales price was consistent with two independent appraisals and recent sales in the area.  On closing, Trust 1 would receive a certain percent of the purchase price, and Trust 3 would receive a certain percent of the purchase price. 

The trusts’ obligations were conditioned on: 1) court approval of the sale; 2) the beneficiaries of Trust 1 and Trust 3 completing certain conditions in the event Trust 1 terminates before the close; 3) the beneficiaries of Trust 1 and Trust 3 approving and ratifying the sale; and 4) a favorable PLR.

No Loss of GST Tax-Exempt Status

The beneficiaries of Trust 1 and Trust 3 requested three rulings.  First, they asked whether carrying out the sale would constitute an addition to either Trust 1 or Trust 3; cause either trust to lose its GST tax-exempt status; or subject distributions from Trust 1 or Trust 3 to GST tax.  The IRS said “no” to all three questions under this first part of the ruling.  Under Internal Revenue Code Section 2601, a GST tax applies to a trust, except for one that’s irrevocable on Sept. 25, 1985 and in which no addition was made after that date.  Treasury Regulations Section 26.2601-1(b)(4)(i)(D)(1) provides that a judicial reformation won’t cause an exempt trust to be subject to GST tax if the modification doesn’t shift a beneficial interest in the trust to any beneficiary who occupies a lower generation than the person who held the interest prior to the modification, and the modification doesn’t extend the time for vesting of any beneficial interest in the trust beyond the original trust period.  To determine a shift in beneficial interest, one must measure the effect of the trust on the date of the modification against the effect of the trust before the modification.  Moreover, modifications that are administrative won’t be considered as shifting a beneficial interest.

In the instant case, Trust 1 and Trust 3 were irrevocable prior to Sept. 25, 1985 and as such, are exempt from GST tax.  Furthermore, the sale of the farm would be administrative in nature and won’t shift a beneficial interest in Trust 1 or Trust 3 to any beneficiary occupying a lower generation.  And, the sale wouldn’t extend the vesting of any beneficial interest in either trust beyond their original periods.  Therefore, the sale wouldn’t be an addition to Trust 1 or Trust 3 to cause either of them to lose their tax-exempt status, and distributions wouldn’t be subject to GST tax.

No Gift Tax Liability

The beneficiaries next asked whether the proposed sale was a taxable gift.  IRC Section 2501 imposes a tax on the transfer of any property by gift.  Under IRC Section 2512(b), when property is transferred for less than adequate and full consideration, the amount by which the value of the property exceeds the consideration is deemed a gift.  A sale of property made in the ordinary course of business will be considered made for adequate consideration (Treas. Regs. Section 25.2512-8).

In the instant case, the trustees obtained two independent appraisals of the farm’s value, and the sales price was consistent with both the appraisals and other sales in the area.  The corporate trustees negotiated the terms of the sale at arm’s length, and separate counsel represented each of the parties.  To get court approval, the trustees would have to show that the sale was fair, reasonable and at arm’s length. 

The IRS concluded that, provided the court approves the sale and finds that it’s fair, reasonable and at arm’s length, the beneficiaries of Trust 1 or Trust 3 didn’t make a taxable gift to the proposed purchaser or any other beneficiary.  

No Inclusion in Beneficiaries’ Gross Estate

Under IRC Section 2036(a), the value of a gross estate includes the value of all property in which a decedent makes a transfer by trust, under which he maintains possession or enjoyment for life or the right to receive income from the property.  Sections 2035 through 2038 have similar provisions.  In this case, the trustees of Trust 1 and Trust 3 want to sell the farm to a limited partnership owned by one beneficiary for a sum certain.  The farm’s acreage is an asset of each trust, and the beneficiaries wouldn’t be transferring any assets to either Trust 1 or Trust 3.  Accordingly, the beneficiaries aren’t “transferors” under the relevant sections of the IRC.  Thus, the sale wouldn’t cause any beneficiary to be required to include in his taxable estate trust assets owned by Trust 1 or Trust 3, unless such assets were distributed to such beneficiary prior to his death.