Sale of Residence From Qualified Personal Residence Trust

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 25 and 602

[TD 8743]

RIN 1545-AU12

Sale of Residence From Qualified Personal Residence Trust

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

-----------------------------------------------------------------------

SUMMARY: This document contains final regulations permitting the

reformation of a personal residence trust or a qualified personal

residence trust in order to comply with the applicable requirements for

such trusts. The final regulations also provide that the governing

instruments of such trusts must prohibit the sale of a residence held

in the trust to the grantor of the trust, the grantor's spouse, or an

entity controlled by the grantor or the grantor's spouse.

DATES: The regulations are effective December 23, 1997.

FOR FURTHER INFORMATION CONTACT: Lane Damazo (202) 622-3090 (not a

toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in these final regulations

has been reviewed and approved by the Office of Management and Budget

in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under

control number 1545-1485. Responses to this collection of information

are required in order to ensure the proper collection of the gift tax.

An agency may not conduct or sponsor, and a person is not required

to respond to, a collection of information unless the collection of

information displays a valid control number.

The estimated annual burden per respondent/recordkeeper varies from

3 hours to 3.25 hours, depending on individual circumstances, with an

estimated average of 3.1 hours.

Comments concerning the accuracy of this burden estimate and

suggestions for reducing this burden should be sent to the Internal

Revenue Service, Attn: IRS Reports Clearance Officer T:FP, Washington,

DC 20224, and to the Office of Management and Budget, Attention: Desk

Officer for the Department of the Treasury, Office of Information and

Regulatory Affairs, Washington, DC 20503.

Books or records relating to this collection of information must be

retained as long as their contents may become material in the

administration of any internal revenue law. Generally, tax returns and

tax return information are confidential, as required by 26 U.S.C. 6103.

Background

On April 16, 1996, the IRS published in the Federal Register a

notice of proposed rulemaking (formerly PS-004-96) at 61 FR 16623. The

IRS received written and oral comments on the proposed regulations and

held a public hearing on July 24, 1996. This document adopts final

regulations with respect to this notice of proposed rulemaking.

Comments with respect to Sec. 25.2702-5(a)(2) indicated that the

procedure permitting reformation of trust instruments will be helpful

to taxpayers and practitioners. It was suggested that an additional

reformation period be made available for trusts for which the gift tax

return due date had passed before the regulations became effective.

Accordingly, under the final regulations, the trustees of trusts

created before January 1, 1997, are granted a 90-day period after these

regulations become final in which to reform the trust.

Some of the comments concerning the amendments to Sec. 25.2702-5(b)

and (c) agreed that the restrictions in the proposed regulations on the

sale of the personal residence after the termination of the grantor's

retained interest in a personal residence trust or a qualified personal

residence trust further the intent of Congress in enacting section

2702(a)(3)(A)(ii). Other comments stated that the restrictions were not

supported by the statute. Treasury and the IRS continue to believe that

these regulations are consistent with the intent of Congress and carry

out the purpose of the personal residence exception to section 2702.

Other comments suggested that the final regulations should contain

an exception permitting the sale of the residence to the grantor if the

need arises. Treasury and the IRS believe, however, that a rule of this

nature is not necessary, since a grantor may lease the residence after

the retained term from a trust or individual to which the

[[Page 66988]]

residence passes after the expiration of the initial term. The right to

lease the residence may be expressly set forth in the trust document

creating the personal residence trust. If the residence is leased for

its fair market value rental, the grantor will not retain the economic

benefit of the property for purposes of section 2036(a), since the

grantor will be paying adequate consideration for the use of the

property. However, if the residence is leased from a trust that is a

grantor trust with respect to the grantor, the IRS under some

circumstances may contend that the grantor has retained the economic

benefit of the property.

Commentators raised a concern that because the regulations prohibit

the transfer of the residence to the grantor, or the grantor's spouse,

etc., the trust could not provide for a reversionary interest or a

testamentary power of disposition, taking effect at the grantor's death

prior to the expiration of the trust term, nor could the trust provide

for a remainder interest in fee for the grantor's spouse (e.g.,

remainder outright to spouse, or remainder to child, but if child

predeceases termination of the trust, then to spouse.) The final

regulations permit dispositions to the spouse.

Finally, commentators objected to the statement in the preamble to

the proposed regulations to the effect that if the IRS finds a pre-

effective date trust to be inconsistent with the purposes of section

2702, the IRS, by established legal doctrines, may treat the trust as

non-qualifying. Treasury and the IRS wish to clarify that the IRS will

apply these regulations only to post-effective date trusts.

Nevertheless, Treasury and the IRS have the authority to apply

established legal doctrines to disqualify a pre-effective date trust in

cases where the statutory purpose has clearly been violated.

Special Analyses

It has been determined that this Treasury decision is not a

significant regulatory action as defined in EO 12866. Therefore, a

regulatory assessment is not required. It has also been determined that

section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)

does not apply to these regulations, and, because these regulations do

not impose on small entities, a collection of information requirement,

the Regulatory Flexibility Act (5 U.S.C. chapter 6), does not apply.

Therefore, a Regulatory Flexibility Analysis is not required. Pursuant

to section 7805(f) of the Internal Revenue Code, the Notice of Proposed

Rulemaking preceding these regulations was submitted to the Small

Business Administration for comment on their impact on small business.

Drafting Information

The principal author of these regulations is Dale Carlton, Office

of the Chief Counsel, IRS. Other personnel from the IRS and Treasury

Department participated in their development.

List of Subjects

26 CFR Part 25

Gift taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 25 is amended as follows:

PART 25--GIFT TAX; GIFTS MADE AFTER DECEMBER 31, 1954

Paragraph 1. The authority citation for part 25 continues to read

in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 25.2702-5 is amended as follows:

1. Paragraph (a) heading and text are redesignated as paragraph

(a)(1) heading and text and paragraph (a)(2) is added.

2. In paragraph (b)(1), five sentences are added after the third

sentence.

3. Paragraph (c)(5)(ii)(C) is revised.

4. Paragraph (c)(9) is added.

The additions and revisions read as follows:

Sec. 25.2702-5 Personal residence trusts.

(a) * * *

(2) Modification of trust. A trust that does not comply with one or

more of the regulatory requirements under paragraph (b) or (c) of this

section will, nonetheless, be treated as satisfying these requirements

if the trust is modified, by judicial reformation (or nonjudicial

reformation if effective under state law), to comply with the

requirements. In the case of a trust created after December 31, 1996,

the reformation must be commenced within 90 days after the due date

(including extensions) for the filing of the gift tax return reporting

the transfer of the residence under section 6075 and must be completed

within a reasonable time after commencement. If the reformation is not

completed by the due date (including extensions) for filing the gift

tax return, the grantor or grantor's spouse must attach a statement to

the gift tax return stating that the reformation has been commenced or

will be commenced within the 90-day period. In the case of a trust

created before January 1, 1997, the reformation must be commenced

within 90 days after December 23, 1997 and must be completed within a

reasonable time after commencement.

(b) * * * (1) * * * In addition, the trust does not meet the

requirements of this section unless the governing instrument prohibits

the trust from selling or transferring the residence, directly or

indirectly, to the grantor, the grantor's spouse, or an entity

controlled by the grantor or the grantor's spouse, at any time after

the original duration of the term interest during which the trust is a

grantor trust. For purposes of the preceding sentence, a sale or

transfer to another grantor trust of the grantor or the grantor's

spouse is considered a sale or transfer to the grantor or the grantor's

spouse; however, a distribution (for no consideration) upon or after

the expiration of the original duration of the term interest to another

grantor trust of the grantor or the grantor's spouse pursuant to the

express terms of the trust will not be considered a sale or transfer to

the grantor or the grantor's spouse if such other grantor trust

prohibits the sale or transfer of the property to the grantor, the

grantor's spouse, or an entity controlled by the grantor or the

grantor's spouse. In the event the grantor dies prior to the expiration

of the original duration of the term interest, this paragraph (b)(1)

does not apply to the distribution (for no consideration) of the

residence to any person (including the grantor's estate) pursuant to

the express terms of the trust or pursuant to the exercise of a power

retained by the grantor under the terms of the trust. Further, this

paragraph (b)(1) does not apply to any outright distribution (for no

consideration) of the residence to the grantor's spouse after the

expiration of the original duration of the term interest pursuant to

the express terms of the trust. For purposes of this paragraph (b)(1),

a grantor trust is a trust treated as owned in whole or in part by the

grantor or the grantor's spouse pursuant to sections 671 through 678,

and control is defined in Sec. 25.2701-2(b)(5)(ii) and (iii). * * *

* * * * *

(c) * * *

(5) * * *

(ii) * * *

(C) Sale proceeds. The governing instrument may permit the sale of

the residence (except as set forth in paragraph (c)(9) of this section)

and may permit the trust to hold proceeds from

[[Page 66989]]

the sale of the residence, in a separate account.

* * * * *

(9) Sale of residence to grantor, grantor's spouse, or entity

controlled by grantor or grantor's spouse. The governing instrument

must prohibit the trust from selling or transferring the residence,

directly or indirectly, to the grantor, the grantor's spouse, or an

entity controlled by the grantor or the grantor's spouse during the

retained term interest of the trust, or at any time after the retained

term interest that the trust is a grantor trust. For purposes of the

preceding sentence, a sale or transfer to another grantor trust of the

grantor or the grantor's spouse is considered a sale or transfer to the

grantor or the grantor's spouse; however, a distribution (for no

consideration) upon or after the expiration of the retained term

interest to another grantor trust of the grantor or the grantor's

spouse pursuant to the express terms of the trust will not be

considered a sale or transfer to the grantor or the grantor's spouse if

such other grantor trust prohibits the sale or transfer of the property

to the grantor, the grantor's spouse, or an entity controlled by the

grantor or the grantor's spouse. In the event the grantor dies prior to

the expiration of the retained term interest, this paragraph (c)(9)

does not apply to the distribution (for no consideration) of the

residence to any person (including the grantor's estate) pursuant to

the express terms of the trust or pursuant to the exercise of a power

retained by the grantor under the terms of the trust. Further, this

paragraph (c)(9) does not apply to an outright distribution (for no

consideration) of the residence to the grantor's spouse after the

expiration of the retained trust term pursuant to the express terms of

the trust. For purposes of this paragraph (c)(9), a grantor trust is a

trust treated as owned in whole or in part by the grantor or the

grantor's spouse pursuant to sections 671 through 678, and control is

defined in Sec. 25.2701-2(b)(5)(ii) and (iii).

* * * * *

Par. 3. Section 25.2702-7 is amended as follows:

1. The first sentence is revised.

2. A sentence is added at the end of the section.

The revision and addition read as follows:

Sec. 25.2702-7 Effective dates.

Except as provided in this section, Secs. 25.2702-1 through

25.2702-6 apply as of January 28, 1992. * * * The fourth through eighth

sentences of Sec. 25.2702-5(b)(1) and Sec. 25.2702-5(c)(9) apply with

respect to trusts created after May 16, 1996.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 4. The authority citation for part 602 continues to read as

follows:

Authority: 26 U.S.C. 7805.

Par. 5. In Sec. 602.101, paragraph (c) is amended by adding an

entry in numerical order to the table to read as follows:

Sec. 602.101 OMB Control numbers.

* * * * *

(c) * * *

------------------------------------------------------------------------

Current OMB

CFR part or section where identified and described control No.

------------------------------------------------------------------------

* * * * *

25.2702-5.................................................. 1545-1485

* * * * *

------------------------------------------------------------------------

Michael P. Dolan,

Acting Commissioner of Internal Revenue.

Approved: December 4, 1997.

Donald C. Lubick,

Acting Assistant Secretary of the Treasury.

[FR Doc. 97-33356 Filed 12-22-97; 8:45 am]

BILLING CODE 4830-01-U