Thursday, April 25, 2024
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GiftLaw Note: The Service in this PLR approved the transfer of tangible personal property into a unitrust. A rancher desired to give cattle to the trust. Because he is a cash basis taxpayer and has no basis in the cattle, there is no charitable deduction under the Sec. 170(e) reduction for gift of ordinary income asset rule. However, he will be able to bypass recognition of the ordinary gain so long as the trust does not conduct an active business and thereby violate the UBI rules. For this reason the trustee will not be engaging in efforts to "fatten the cattle for market," but rather will merely maintain them and sell as soon as is reasonable.
This is in response to your letters dated May 11, 1993, and July 20, 1993, requesting a ruling on behalf of A, an individual, concerning certain tax consequences of the proposed transactions described below.

A intends to execute a charitable remainder unitrust agreement with C. A will be designated as the donor and C, a nonprofit corporation, will be the sole trustee.

The trust agreement will provide that in each taxable year of the trust, C will distribute an "annual amount" which is the sum of--

(i) the lesser of--

(a) an amount equal to a specified fixed percentage (as yet to be determined, but not less than five percent) of the net fair market value of the trust assets as determined as of the valuation date for the taxable year (the "unitrust amount"), or

(b) the trust income for the taxable year as defined in section 643(b) of the Internal Revenue Code ("Code") and the regulations thereunder, and

(ii) the trust income for the taxable year in excess of the unitrust amount for the taxable year to the extent that the aggregate of the amounts actually paid in prior taxable years is less than the aggregate of the unitrust amounts for such prior taxable years.

The annual amount will be paid to A each year during his life. Following the death of A, the annual amount will be paid to B for her remaining life if she survives A. At the death of the survivor of A and B, the trust will terminate, and its assets will be distributed to C. However, if C is not described in sections 170(b)(1)(A), 170(c), 2055(a) and 2522(a) of the Code at the time for such distribution, the assets of the trust will be distributed to one or more organizations described in those Code sections.

It is represented that the trust agreement contains all of the governing instrument provisions for a charitable remainder unitrust required by section 1.664-3 of the Income Tax Regulations and Rev. Rul. 72-395, 1972-2 C.B. 340, as modified.

A is a sole proprietor engaged in the business of cattle ranching and farming. In these operations, he raises cattle to be sold for beef ("slaughter cattle") and crops. The crops and the slaughter cattle are sold to customers in the ordinary course of his business. As a first step in a plan to wind up and retire from his ranching and farming operation, A will fund the unitrust with separate irrevocable transfers of slaughter cattle and crops with a total value of approximately X. These two transfers will take place within a period of several weeks, and both transfers will occur in 1993.

The trust agreement will permit A to make additional contributions to the unitrust at any time. A anticipates that he will transfer additional farming and ranching assets to the proposed unitrust in another series of transfers that will probably take place in about two years. That second series of transfers will occur as part of A's completion of his plan to wind up and retire from his ranching and farming operation. The items to be transferred at that time will include more slaughter cattle and crops, and also breeding cattle and farm machinery that A has used in his ranching and farming operations. (A is not in the business of selling either breeding cattle or farm machinery.) Although not all of these transfers will occur at one time, it is represented that they will all take place within a period of several months.

A is a cash-basis taxpayer who has deducted all costs incurred in raising the slaughter cattle and crops for the years in which such costs were incurred. A will claim no income tax charitable contribution deduction for any transfer of slaughter cattle, crops, breeding stock or farm machinery (collectively "farm items") to the unitrust.

C will have complete discretion as to whether and when to sell any farm items transferred to the proposed unitrust. It is likely that any quantity of farm items that is received by the unitrust in a particular transfer will be sold by the trustee in a single transaction, or at most two transactions, shortly after such farm items are transferred to the trust. However, at the time of a transfer to the unitrust, neither A nor C will be under any legally binding obligations to sell the transferred farm items.

The proposed unitrust will not take over any operations of A's farm whose farmland and buildings will continue to be owned by the donor, who may retire and discontinue farming in a few years. If C decides to sell any slaughter cattle or crops that A has transferred to the unitrust, it will hire an agent that will try to find a buyer for the items in question at an attractive price. This is a method often used by farmers in selling the agricultural products they raise. It is also one of the fastest and most economical ways of liquidating such items. C will arrange for the slaughter cattle to be fed and cared for on a strictly maintenance basis (i.e., it will not be engaging in efforts to "fatten them for market") from the time it receives them until a sale occurs. If C decides to sell breeding stock, it will sell them at a single auction after arranging for them to be fed and cared for from the time it receives them until the auction. It will use a similar procedure for disposing of any farm machinery it decides to sell. Thus, it is represented that the unitrust will not engage in regularly carried on sales of the farm items as a dealer and that the farm items to be sold are not held by the unitrust for sale to customers in the ordinary course of any unitrust business. It is also represented that the sales of donated farm items will not involve property that is debt-financed under section 514 of the Code.

Specifically you have requested the following rulings:
  1. A will not recognize any gross income on the transfers of farm items to the unitrust.
  2. Costs and expenses that the donor has incurred in raising slaughter cattle and crops transferred to the unitrust and that are properly deducted under section 162 of the Code or another Code section are allowable as deductions in the year such expenses are paid or incurred, whether or not that year is the year in which such items are transferred to the unitrust.
  3. A will not recognize any gross income on sale by the unitrust of farm items that A has transferred to the unitrust.
  4. The unitrust will not have unrelated business taxable income under sections 511 through 514 of the Code on sales of farm items that A has transferred to it.
  5. Annual distributions from the unitrust to A and B will have income tax characteristics, in the hands of the recipient, determined under section 1.664-1(d)(1) of the regulations.
  6. A will not recognize any self-employment income under section 1402 of the Code on the transfers of farm items to the unitrust.
  7. A will not recognize any self-employment income under section 1402 of the Code on sales by the unitrust of farm items that A has transferred to the unitrust.
  8. No portion of any annual distribution from the unitrust to A will be included in computing his self-employment income under section 1402 of the Code.

RULING REQUEST NO. 1


Revenue Ruling 55-531, 1955-2 C.B. 520, holds, in part, that the fair market value of agricultural or manufactured products held for sale in the ordinary course of business that are made the subject of a gift is not includible in the gross income of the donor for federal income tax purposes. Revenue Ruling 55-138, 1955-1 C.B. 223 reached a similar conclusion with respect to charitable contributions of farm or other inventory products. The holdings in these revenue rulings are based upon the decisions in Mamie F. Farrier v. Commissioner, 15 T.C. 277, (1950), acq. 1955-1 C.B. 4, and Elsie SoRelle, et al. v. Commissioner 22 T.C. 459 (1954), acq. 1955-1 C.B. 6.

In Farrier the court held that the fair market value of cattle given by the taxpayer to her daughter did not represent taxable income to the donor. There was no contract for sale of the cattle or thought of their sale at the time the gift was made. The donor made a gift of the property before realization of any income thereon.

In SoRelle the court held that the taxpayer, who prior to harvest had given a parcel of land with its mature wheat crop to each of his four children, did not realize income to the extent of the fair market value of the wheat. The court stated, in effect, that the transaction under consideration constituted an actual completed and bona fide gift of income producing property carrying with it the unharvested wheat crop. When the wheat was harvested and later sold, the income resulting therefrom belonged to the children and was taxable to them and not to the donor.

In the case at hand at the time of the transfers of the farm items, the items will not already have been sold. A is transferring the farm items, not the proceeds from the sale of the items. The transfer of the farm items does not result in an anticipatory assignment of income. Thus, based upon the representations made and the general rules exemplified by the authorities cited above, A will not recognize any gross income on the transfers of the farm items.

RULING REQUEST NO. 2


Section 170(e)(1) of the Code provides that the amount of any charitable contribution of certain ordinary income and capital gain property shall be reduced by the sum of (A) the amount of gain which would not have been long-term capital gain if the property had been sold at its fair market value and (B) in the case of certain tangible personal property, the amount of gain which would have been long-term capital gain if the property had been sold at its fair market value.

Section 1.170A-1(c)(4) of the regulations provides that if costs and expenses incurred in producing or acquiring contributed property are, under the method of accounting used, properly deducted under section 162 or other section of the Code, such costs and expenses will be allowed as deductions for the taxable year in which they are paid or incurred, whether or not that year is the year of the contribution. In accordance with this regulation, we conclude that the section 162 expenses are deductible regardless of whether they are incurred in the year of the contribution. As indicated in section 1.170A-1(c)(4), any such deductions are not treated under any section of the Code as resulting in any basis for the contributed property. Thus, the contributed property will have no basis for purposes of applying section 170(e)(1). See Treas. Reg. section 1.170A-1(c)(4), Examples 5 and 6.

RULING REQUEST NO. 3


In Rev. Rul. 78-197, 1978-1 C.B. 83, the Internal Revenue Service announced that it will treat the proceeds of a redemption of stock under facts similar to those in Palmer v. Commissioner, 62 T.C. 684 (1974), acq. on this issue 1978-2 C.B. 2, aff'd on another issue, 523 F.2d 1308 (8th Cir. 1976), as income to the donor only if the donee is legally bound or can be compelled by the corporation to surrender the shares for redemption. In Palmer the taxpayer-donor had voting control of both a corporation and a tax-exempt private foundation. Pursuant to a single plan, the taxpayer donated shares of the corporation to the foundation and then caused the corporation to redeem the stock from the foundation.

In Blake v. Commissioner, 697 F.2d 473 (2nd Cir. 1982), the court, in dicta, questioned the Service's acquiescence in Palmer in Rev. Rul. 78-197, suggesting that a mere understanding between the contributing shareholder and the charity concerning the fact that the contributed stock would be redeemed should be enough to treat the shareholder as having received redemption proceeds. Rev. Rul. 78-197 remains in effect, however.

Although in the case at hand there is some expectation that C will sell the farm items at such time as their value can be realized, C will be under no legally binding obligation to do so at the time the farm items are transferred to the unitrust. Thus, based upon the representations made and the principle enunciated in the authorities cited above, A will not recognize any income on a sale by the unitrust of farm items that he has transferred to it.

RULING REQUEST NO. 4


Section 511(b) of the Code imposes income tax on any unrelated business taxable income.

Section 512 of the Code provides that unrelated business taxable income is income derived by an organization from an "unrelated business" (as defined in section 513) that is "regularly carried on" by it.

Section 512(b)(5) of the Code and section 1.512(b)-1(d) of the regulations exclude from unrelated business taxable income all gains from the sale, exchange, or other disposition of property, unless the property is stock in trade or other property of a kind which would be properly includible in inventory if on hand at the close of the taxable year or unless the property is property held primarily for sale to customers in the ordinary course of the business.

Section 513 of the Code defines an unrelated business as one that does not contribute directly to the accomplishment of exempt purposes (aside from raising funds).

Section 1.513-1(a) of the regulations indicates that unrelated business taxable income is income from a business, which is "regularly carried on" by the organization, and the conduct of which is not substantially related (other than through the production of funds) to the organization's performance of its exempt purposes.

Section 1.513-1(c)(2)(iii) of the regulations indicates that business is not "regularly carried on" in the case of intermittent income-producing activities that occur so infrequently that neither their recurrence nor the manner of their conduct will cause them to be regarded as a business regularly carried on. See also the discussion of a similar principle in Robert L. and Judith W. Adam v. Commissioner, 60 T.C. 996 (September 27, 1973), Acq. 1974-1 C.B. 1.

Section 514 of the Code imposes tax on any unrelated business taxable income derived from any unrelated property that is debt-financed property, as defined in that section, including mortgaged property.

In this case, in regard to sections 511, 512, and 513 of the Code, occasional sales by the unitrust to dispose of the farm items described will not be "regularly carried on" within the meaning of section 512(a)(1) because such sales will be infrequent and intermittent. In addition, the farm items are the types of properties whose income from sales is excludible from unrelated business taxable income pursuant to section 512(b)(5), described above. Also, as to section 514, these transactions will not involve debt-financed property. Therefore, the unitrust's receipts of the proceeds from any sales of the farm items will not result in any unrelated business taxable income to the unitrust under sections 511 through 514.

Accordingly, under sections 511, 512, 512(b)(5), 513, and 514 of the Code, the unitrust will not have any unrelated business taxable income on its sales, under the circumstances described, of the farm items that the donor may transfer to it.

RULING REQUEST NO. 5


Section 1.664-1(d)(1) of the regulations provides, generally, that annuity or unitrust amounts paid by a charitable remainder trust described in section 664 of the Code shall be treated as having the following characteristics in the hands of the recipients:

(1) Ordinary income, to the extent of the sum of the trust's ordinary income for the taxable year of the trust and its undistributed ordinary income for prior years.

(2) Capital gain, to the extent of the trust's undistributed capital gain, determined on a cumulative net basis.

(3) Other income, to the extent of the sum of the trust's other income for the taxable year and its undistributed other income for prior years. (4) Distribution of trust corpus.

The Service does not ordinarily rule on the qualification of trusts as charitable remainder trusts under section 664 of the Code. See section 4.01(39) of Rev. Proc. 93-3, 1993-1 I.R.B. 71, 79. However, assuming without ruling that the governing instrument of the proposed trust will meet all of the requirements for a charitable remainder unitrust under section 664, the unitrust amounts distributed from the trust will have income tax characteristics, in the hands of A and B, determined under section 1.664-1(d)(1) of the regulations.

RULING REQUEST NO. 6


A will not recognize any self-employment income under section 1402 of the Code on the transfer of farm items to the unitrust, provided the proposed trust meets the requirements of section 664 and the regulations thereunder and A does not recognize any gross income on the transfer.

RULING REQUEST NO. 7


A will not recognize any self-employment income under section 1402 of the Code on sales by the unitrust of farm items, provided the proposed trust meets the requirements of section 664 and the regulations thereunder and A does not recognize any gross income on the sales.

RULING REQUEST NO. 8


Provided the proposed trust meets the requirements of section 664, no portion of any annual distribution from the unitrust to A will be included in computing self-employment income under section 1402 of the Code.

A copy of this letter should be attached to the federal income tax return of A for the taxable year in which the unitrust is initially funded.

This ruling is directed only to the taxpayer who requested it. Section 6110(j)(3) of the Code provides that a ruling may not be used or cited as precedent.

Sincerely yours,
Assistant Chief Counsel
(Income Tax and Accounting)
By ____
Peter J. Frederick
Assistant to the Chief, Branch 4

Related Topics On Rawhide Unitrust

4.3.3  Tangible Personal Property Unitrust:    There are a number of assets that constitute ordinary income potential and are tangible personal property. Works of art created by an artist, farm products raised by a farmer and most cattle owned by a rancher would generate ordinary income upon sale. In addition, equipment, vehicles, aircraft and other items that are subject to depreciation would generate gain recaptured as ordinary income upon sale. All of these assets may be appropriate candidates for a tangible personal property unitrust.



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