Part 2: Charitable Remainder Trusts
By David A. Handler and Alison E. Lothes
Originally written for WealthManagement.com
In 2008, the Internal Revenue Service designated certain transactions with charitable remainder trusts (CRTs) as transactions of interest. The transactions of interest were those in which: (1) a taxable beneficiary transferred appreciated assets to a CRT, (2) the CRT sold the appreciated assets and reinvested the proceeds, and (3) the taxable beneficiary then sold his entire term interest in the CRT. In the transactions, the taxable beneficiary took the position that his basis was a share of the uniform basis of the trust after the reinvestment—which would be the basis of the purchased assets. Therefore, through this series of transactions, the beneficiary obtained the benefit of reinvesting the appreciated assets without being subject to capital gains tax.
When a beneficiary sells his entire interest in a trust, IRC Section 1001(e)(3) applies such that the seller realizes capital gains on the excess of the amount realized from the sale of the trust interest over the seller’s basis in the trust interest. The basis of an interest in a trust is determined under Treasury Regulations Section 1.1014-5, which allocates the adjusted uniform basis using the factors for valuing life estates and remainder interests. The proposed regulations, however, amend Treas. Regs. Section 1.1014-5 to adjust the basis of a term interest in a charitable trust by reducing it by: (1) the amount of undistributed net ordinary income, and (2) undistributed net capital gain. In this manner, the seller’s basis is adjusted to exclude a share of the built-in capital gains, therefore causing the seller to recognize his share of the gain.
The proposed regulation, NPRM REG-154890-03 (Jan. 17, 2014), would apply to sales and dispositions of interests in charitable remainder annuity trusts (CRATs) or charitable remainder unitrusts occurring on or after Jan. 1, 2014.