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Thursday, April 25, 2024
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GiftLaw Pro |
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GiftLaw Note:
In PLR 9114025, the Service permitted undivided interests in real estate to be transferred into limited partnerships and subsequently transferred to charitable remainder unitrusts (CRUTs). The taxpayers created several limited interests and transferred those interests into three CRUTs. The Service permitted the transfer of the undivided interests, provided that there was no use of the jointly held property. In addition, these CRUTs involved an independent trustee.
The primary concern for undivided interests held by both CRUTs and taxpayers centers around the potential to manipulate value in the CRUTs through the sale terms. Specifically, any complex financial transaction that could potentially result in undue benefit to the taxpayer and detriment to the CRUT would violate the self-dealing rules of Sec. 4941. However, if the values are fairly represented and there is no use of the jointly held property, it may be possible to transfer undivided interests directly into a CRUT without the vehicle of the limited partnership.
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This is in reply to a letter dated May 2, 1990, and subsequent correspondence submitted on your behalf, requesting rulings that (1) Trust 1, Trust 2, and Trust 3 (Trusts) will qualify as charitable remainder unitrusts under section 664 of the Internal Revenue Code and the applicable regulations; (2) any income from a rental activity, within the meaning of section 469(c)(2) of the Code and the applicable regulations, received by the Trusts and which is distributed to the unitrust recipients will be treated as income from a rental activity in the hands of the unitrust recipients; (3) that certain actions taken by Trusts, H, and W will not constitute acts of self-dealing within the meaning of section 4941 of the Code and the applicable regulations thereunder; and (4) the ownership of certain limited partnership units will not expose Trusts to tax under section 4943 of the Code.
H and W (also referred to as "Taxpayers") have submitted the following information and representations for our consideration.
Taxpayers own a tract of improved real estate located in State that is operated as a shopping center. H holds an undivided 15% interest in the shopping center as his separate property. W holds an undivided 15% interest in the shopping center as her separate property. H and W also hold an undivided 70% interest in the shopping center as community property.
Taxpayers propose to form a limited partnership (Partnership) under the law of State to which they will contribute their property interests in the shopping center in return for both general and limited partnership interests. Thereafter, Partnership will be considered the owner of the shopping center under state law and for federal tax purposes.
Specifically, H will contribute his 15% undivided interest in the shopping center to Partnership in return for a 15% limited partnership interest which he will own as his separate property. W will contribute her 15% undivided interest in the shopping center to Partnership in return for a 15% limited partnership interest which she will own as her separate property. H and W will also contribute their 70% undivided interest in the shopping center to Partnership in return for a 30% to 40% limited partnership interest and a 30% to 40% general partnership interest (with the two interests to total 70%), both of which they will own as community property.
Taxpayers then propose to create three trusts, the terms of which are set forth in Trust 1, Trust 2, and Trust 3. They intend for Trusts to qualify as charitable remainder unitrusts under section 664 of the Code and the regulations thereunder.
W will transfer the 15% limited partnership interest in Partnership that she will own individually to Trust 1; H will transfer the 15% limited partnership interest in Partnership that he will own individually to Trust 2; and H and W will contribute the limited partnership interest in Partnership that they will own as community property to Trust 3. H and W will, at least for a period of time, retain the general partnership interest in Partnership that they will own as community property. The limited partnership interests received by Trusts will all be freely transferable, without the consent of H or W, or any other person who becomes a general partner in Partnership.
Trust Corp., a State corporation, is expected to act as sole trustee of the three trusts. Taxpayers have no significant interests in Trust Corp. Taxpayers have never been and do not expect to be directors or officers of Trust Corp. If Trust Corp. refuses to act as trustee for Trusts, Taxpayers will select another independent corporate fiduciary as trustee. Neither taxpayers, nor anyone acting on their behalf, has approached any trust company with respect to acting as trustee for Trusts.
Taxpayers anticipate that the applicable law relating to the diversification of trust assets is likely to cause the independent trustee of Trusts to sell all or a portion of each trust's interest in Partnership to an independent third party. Taxpayers will not participate, in any capacity, in the decision to sell or otherwise dispose of the limited partnership interests held by Trusts; that decision will be made solely by the independent trustee of Trusts. It is represented that Trusts will not sell or otherwise transfer the limited partnership interests to a disqualified person, as defined under section 4946 of the Code.
Taxpayers intend to retain the general partnership interest in Partnership that they will own as community property. Taxpayers have not entered into any arrangement or understanding with respect to the sale of any portion of the shopping center or any interests in the limited partnership they propose to create. However, it is possible, if not likely, that any person acquiring the partnership interests held by Trusts will also seek to acquire, or in fact require the Taxpayers to sell, the general partnership interest that Taxpayers will hold as community property.
Alternatively, it is anticipated that the person acquiring the partnership interests held by Trusts will seek to change the form of Partnership, or otherwise to alter the relationship between Taxpayers and Partnership. As an inducement to alter their relationship, the purchaser may grant Taxpayers the right to cause the purchaser to buy their general partnership interest within a certain period of time. The terms and conditions under which Trusts' partnership interests will be acquired and those under which the interests of H and W will be acquired may or may not be the same.
It is specifically represented that the trustee of Trusts will not be under any obligation, either express or implied, to sell or exchange the limited partnership interests in Partnership and to purchase tax-exempt securities.
Taxpayers represent that the income to Trusts that is derived from their ownership of the limited partnership interests in Partnership will constitute income from a rental activity within the meaning of section 469(c)(2) of the Code and section 1.469-1T(e)(3) of the regulations.
I.
Based upon the information submitted and the representations made we conclude that Trusts, as submitted with the May 2, 1990 ruling request, contain provisions set forth in Rev. Rul. 72-395, 1972-2 C.B. 340, as modified by Rev. Rul. 80-123, 1980-1 C.B. 205, and Rev. Rul. 82-128, 1982-2 C.B. 71, and clarified by Rev. Rul. 82-165, 1982-2 C.B. 117.
Therefore, we conclude that Trusts will meet the requirements of a charitable remainder unitrust under section 664 of the Code, provided the Trusts will be valid trusts under applicable local law.
Accordingly, Trusts will qualify as charitable remainder unitrusts, for federal income tax purposes, for any year in which they continue to meet the definition of and function exclusively as charitable remainder unitrusts. For such year, Trusts will be exempt from taxes imposed by Subtitle A of the Code unless they have any unrelated business taxable income as defined in section 512 of the Code and the regulations applicable thereto.
No opinion is expressed as to the federal tax consequences of the formation or operation of Trusts under the provisions of any other section of the Code. This ruling that Trusts will qualify as charitable remainder unitrusts is subject to the condition that there are no changes in the law that would cause Trusts to be disqualified. No opinion is expressed as to any amendments to the provisions of Trusts.
II.
The unitrust amount payable under the terms of each Trust is an amount described in section 664(d)(3) of the Code. Thus, the trustee is to pay to the unitrust beneficiaries the amount of the trust income (as defined in section 643(b)), if such amount is less than the fixed unitrust percentage described in section 664(d)(2)(A), and any amount of the trust income which is in excess of the fixed amount required to be distributed under section 664(d)(2)(A), to the extent that the aggregate paid in prior years was less than the aggregate of such required amounts.
Section 664(b) of the Code describes the character of the amounts distributed by a charitable remainder unitrust to the unitrust beneficiary. Under section 664(b)(1), the amounts distributed are first considered amounts of income (other than gains, and amounts treated as gains, from the sale or other disposition of capital assets) includible in gross income to the extent of such income of the trust for the year and such undistributed income of the trust for prior years.
Section 1.664-1(d)(1)(11) of the Income Tax Regulations provides that the determination of the character of amounts distributed shall be made at the end of the taxable year of the trust. Amounts treated as paid from one of the categories of income shall be treated as consisting of the same proportion of each class of items included in such category as the total of the current and accumulated income of that category bears to the total of the current and accumulated income for that category.
Provided the income that Trusts derive from their ownership of the limited partnership interests in Partnership constitutes income from a rental activity within the meaning of section 469(c)(2) of the Code, we conclude that such income, to the extent it is treated as distributed to the unitrust beneficiaries under the characterization rules of section 664(b) and the regulations thereunder, will similarly be treated as income from a rental activity in the hands of the unitrust beneficiaries. We specifically do not rule on the tax treatment of any losses generated by Trusts' ownership of the limited partnership interests in Partnership.
III.
Section 4947(a)(2) of the Code applies, with certain exceptions and modifications, the provisions of sections 507, 508(e), 4941, 4943, 4944, and 4945 to certain split interest trusts, as though they were private foundations. The trust treated as a private foundation under this section is one not exempt from tax under section 501(a), not all of the unexpired interests in which are devoted to purposes described in section 170(c)(2)(B), and which has amounts in trust for which a deduction was allowed under, inter alia, section 170.
Section 4941 of the Code imposes an excise tax on acts of self-dealing between a disqualified person, as defined in section 4946, and a private foundation (or a split interest trust treated as a private foundation, pursuant to section 4947(a)(2)).
Section 4941(d)(1)(E) of the Code defines "self-dealing" to include any direct or indirect transfer to, or use by or for the benefit of, a disqualified person of the income or assets of private foundation.
Section 101(1)(2)(E) of the Tax Reform ACt of 1969, Pub. L. No. 91-172, 83 stat. 533 (1969), provides that section 4941 shall not apply to use of property in which a private foundation and a disqualified person have a joint or common interest if the interests of both were acquired before October 9, 1969. See also section 53.4941(d)-4(e)(1) of the Foundation and Similar Excise Tax Regulations. This provision contains a limited exception to application of section 4941, and indicates that a disqualified person's use of jointly-owned property after October 9, 1969, will be self-dealing.
Section 53.4941(d)-2(f)(1) of the regulations further explains the "catch-all" self-dealing definition in section 4941(d)(1)(E) of the Code. The regulation provides, in part, that a foundation's purchase or sale of stock or other securities shall be an act of self-dealing if made in an attempt to manipulate the price of the securities to a disqualified person's advantage.
Section 4946(a)(1)(A) of the Code defines "disqualified person," for purposes of the private foundation excise tax provisions, as including a person who is, with respect to a private foundation, a substantial contributor to the foundation, within the meaning of section 507(d)(2). Under section 4946(a)(1)(F), a partnership is a "disqualified person," if substantial contributors (or certain other disqualified persons) own more than 35% of the profits interests.
Section 507(d)(2)(A) defines "substantial contributor" as:
"[A]ny person who contributed or bequeathed an aggregate amount of more than $5,000 to the private foundation, if such amount is more than 2 percent of the total contributions and bequests received by the foundation before the close of the taxable year of the foundation in which the contribution or bequest is received by the foundation from such person. In the case of a trust, the term "substantial contributor" also means the creator of the trust."
Since H and W are disqualified persons with respect to the trusts to which each will contribute, they are subject to the self-dealing rules in section 4941. It has been represented that any purchaser of the limited partnership interests owned by Trusts will not be a disqualified person with respect to Trusts. Thus, under section 4941(d)(1)(E), Trusts'sale or other disposition of their limited partnership interests to a purchaser will be self-dealing only if the transaction is "use by or for the benefit of" H or W, of property of Trusts.
The "property" of the Trusts involved here consists of interests in Partnership, contributed by H and W. Holding and use of separate interests in a limited partnership is not the use of jointly-owned property addressed by section 101(1)(2)(E) of the Tax Reform Act of 1969. Moreover, provided Trusts' independent trustee acts independently of H and W in disposing of Trusts' limited partnership interests, there is also no use of the Trusts' property (partnership interests) by or for the benefit of H or W. The situation is thus distinguishable from that discussed in section 53.4941(d)-2(f)(1) of the regulations, of a foundation's manipulating the price of securities to the advantage of a disqualified person. That H and W may benefit from separate transactions with the purchaser of Trust's partnership interests does not change this result.
Therefore, we conclude that the sale by Trusts of all or a portion of their limited partnership interests in Partnership (without any sale by H or W of any portion of their interests in Partnership) will not be self-dealing under section 4941 of the Code. We further conclude that the sale by Trusts of all of their interests in Partnership will not be self-dealing under section 4941 of the Code if H and W, simultaneously with the sale by Trusts, enter into a limited partnership arrangement with the purchaser under which H and W are given the right to sell (or will be obliged to sell) their interests in Partnership at a later time and under different conditions.
IV.
Section 4943(a) of the Code imposes an excise tax on a private foundation's "excess business holdings" in a business enterprise.
Section 4947(b)(3)(B) of the Code says section 4943 does not apply to a trust described in section 4947(a)(2), if a deduction was allowed, inter alia, under section 170, for amounts payable under the terms of the trust to every remainder beneficiary, but not to any income beneficiary.
Since Trusts are charitable remainder unitrusts described in section 664 of the Code (for which a deduction is allowed under section 170, pursuant to section 170(f)(2)(A)), they are also trusts described in section 4947(a)(2). Thus, the restrictions of Chapter 42 of the Code apply to them, as provided in section 4947.
The excess business holdings provisions of section 4943 of the Code do not apply to Trusts because each trust is within the exception provided in section 4947(b)(3)(B).
Therefore, we conclude that the ownership of limited partnership interests in Partnership by Trusts will not expose Trusts to tax under section 4943 of the Code.
A copy of this letter should be attached to the federal tax return for the taxable year that Trusts are established. A copy is enclosed for that purpose.
This ruling letter is directed only to the taxpayer who requested it. Section 6110(j)(3) of the Code provides that it may not be used or cited as precedent. Temporary or final regulations pertaining to one or more of the issues addressed in this ruling have not yet been adopted. Therefore, this ruling will be modified or revoked by adoption of temporary or final regulations to the extent the regulations are inconsistent with any conclusion in the ruling. See section 8.04 of Rev. Proc. 90-1, 1990-1 I.R.B. 8. However, when the criteria in section 8.05 of Rev. Proc. 90-1 are satisfied, a ruling is not revoked or modified retroactively, except in rare or unusual circumstances.
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