[Federal Register Volume 61, Number 74 (Tuesday, April 16, 1996)]
[Proposed Rules]
[Pages 16623-16625]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-8240]



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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 25

[PS-4-96]
RIN 1545-AU12


Sale of Residence From Qualified Personal Residence Trust

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains a proposed regulation 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 proposed regulation also clarifies 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. The proposed 
regulation will affect trusts created after the proposed effective 
date.

DATES: Written comments and outlines of oral comments to be presented 
at the public hearing scheduled for July 24, 1996, must be received by 
July 15, 1996.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (PS-4-96), room 5228, 
Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. In the alternative, submissions may be hand 
delivered between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (PS-
4-96), Courier's Desk Internal Revenue Service, 1111 Constitution 
Avenue NW., Washington, DC 20224. The public hearing will be held in 
the IRS auditorium, Seventh Floor, 7400 Corridor, Internal Revenue 
Building, 1111 Constitution Avenue NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Dale Carlton, (202) 622-3090; concerning submissions and the hearing, 
Evangelista Lee, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in this notice of proposed 
rulemaking has been submitted to the Office of Management and Budget 
for review in accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3507).
    Comments on the collection of information should be sent to the 
Office of Management and Budget, Attn: Desk Officer for the Department 
of the Treasury, Office of Information and Regulatory Affairs, 
Washington, DC 20503, with copies to the Internal Revenue Service, 
Attn: IRS Reports Clearance Officer, T:FP, Washington, DC 20224. 
Comments on the collection of information should be received by June 
17, 1996.
    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 collection of information is in Sec. 25.2702-5. This 
information is required by the IRS to ensure compliance with the 
regulatory requirements. The likely respondents are individuals or 
households. Responses to the collection of information are required to 
obtain favorable gift tax treatment.
    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.
    Estimated total annual reporting/recordkeeping burden: 625 hours. 
The estimated annual burden per respondent varies from 3 hours to 3.25 
hours depending on individual circumstances with an estimated average 
of 3.1 hours.
    Estimated number of respondents: 200.
    Estimated annual frequency of responses: 2.

Background

    This document proposes to amend the Gift Tax Regulations (26 CFR 
part 25) under section 2702 relating to ``personal residence trusts'' 
and ``qualified personal residence trusts.''
    Section 2702(a) provides special valuation rules for determining 
the value of a gift when a transfer is made in trust to or for the 
benefit of a member of the donor's family and the donor retains an 
interest in the trust. Under section 2702(a)(2)(A), the value of any 
retained interest that is not a ``qualified interest'' is treated as 
zero. Therefore, the value of the gift is equal to the full value of 
the property at the time of the transfer. In contrast, the value of a 
retained interest that is a qualified interest is determined under the 
valuation tables prescribed pursuant to section 7520. Section 2702(b) 
provides that a qualified interest means an annuity interest, a 
unitrust interest, or a remainder interest after either an annuity or 
unitrust interest.
    Congress recognized that many people desire to maintain the family 
ownership of their home and pass ownership on to future generations, 
while retaining its use for a period of time. The annuity and unitrust 
requirements are not, however, conducive to the transfer of a 
residence. Accordingly, section 2702(a)(3)(A)(ii) provides an exception 
to the annuity and unitrust requirements. Under this limited exception, 
the grantor's retained interest need not be in one of these forms, but 
rather can take the form of a right to the use and occupancy of the 
residence. Because this is an exception to the general rule of section 
2702, a grantor may take into account not only the value of the 
retained interest, but also any contingent reversionary interest, in 
determining the amount of the gift to the remainderman.
    The requirements of section 2702(a)(3)(A)(ii) are satisfied by a 
personal residence trust and a qualified personal residence trust as 
set forth in the regulations. The governing instruments of these trusts 
must prohibit the trust from holding, for the original duration of the 
term interest, assets other than one residence to be used or held for 
the use as a personal residence of the term holder. In addition, a 
qualified personal residence trust can hold limited amounts of cash for 
certain specified purposes such as the payment of operating expenses 
and expenses for the improvement or replacement of the residence, and 
the trustee is permitted to sell the residence during the original 
duration of the term interest, if certain requirements are satisfied.
    If the trust does not qualify as a personal residence trust or a 
qualified personal residence trust, the grantor's retained interest is 
valued at zero under section 2702. This is the result even where the 
lack of compliance with the requirements in the regulations is the 
result of error or poor advice. As most errors are discovered at the 
time the gift tax return is prepared, the proposed regulation permits 
reformation of the

[[Page 16624]]

trust to be commenced up to 90 days after the gift tax return is due. A 
properly reformed trust will be treated as satisfying the regulatory 
requirements.
    Questions have arisen as to whether it is permissible for the 
grantor to place a personal residence in trust, obtain all the tax 
benefits of a qualified personal residence trust and then purchase the 
residence from the trust. For example, in a transaction described by 
one commentator as the ``bait and switch,'' the grantor places the 
residence in trust with the intention of purchasing the residence from 
the trust just prior to the expiration of the grantor's retained term 
so that cash or other assets pass to the remaindermen in place of the 
residence.
    The Treasury Department and the IRS have previously stated the view 
that Congress intended the personal residence trust exception to enable 
transferors to pass the family home to younger members of the family. 
Preamble to TD 8395, 1992-1 C.B. 316, at 319. Using the ``bait and 
switch'' technique, however, the personal residence trust exception 
could be used to facilitate the transfer of the grantor's other assets 
to future generations. The residence would merely serve as a temporary 
``stand-in'' to avoid the annuity and unitrust requirements of section 
2702. The proposed regulations clarify that the sale of the residence 
to the grantor by the trustee of the personal residence trust or 
qualified personal residence trust is not consistent with Congress' 
intent in enacting section 2702.

Explanation of Provisions

    The proposed regulation provides that a trust that does not comply 
with one or more of the regulatory requirements for qualification as a 
personal residence trust or a qualified personal residence trust, will 
be treated as satisfying those requirements if the trust is reformed by 
judicial reformation (or nonjudicial reformation if effective under 
state law) to comply with the requirements. The reformation must be 
commenced within 90 days of the due date (including extensions) for 
filing the gift tax return reporting the transfer of the residence, 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.
    The proposed regulation also requires that, in order to qualify as 
a personal residence trust or a qualified personal residence trust, the 
trust's 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. 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. For these purposes, the term grantor 
trust is a trust treated as owned by the grantor or the grantor's 
spouse within the meaning of sections 671-677. The term control is 
defined in Sec. 25.2701-2(b)(5) (ii) and (iii).

Proposed Effective Date

    The amendments to Secs. 25.2702-5(b) and (c) are proposed to be 
effective for trusts created after May 16, 1996. Thus, a trust created 
after this date will not satisfy the requirements of a personal 
residence trust or a qualified personal residence trust if the trust 
document does not comply with the regulations, as amended. Such a trust 
would be eligible for reformation under the proposed regulation.
    Notwithstanding the proposed effective date, if the IRS examines a 
pre-effective date trust and finds it inconsistent with the purposes of 
section 2702 or the regulations thereunder, the IRS, by using 
established legal doctrines such as the substance over form doctrine, 
may treat the trust as not qualifying under section 2702. Thus, for 
example, if the grantor actually purchases the residence from the trust 
pursuant to a right or option to purchase that is stated in the trust 
instrument or a collateral document, the IRS may not treat the trust as 
a qualified personal residence trust.

Special Analyses

    It has been determined that this notice of proposed rulemaking 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 Procedures Act (5 U.S.C. 
chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do 
not apply to these regulations and, therefore, a Regulatory Flexibility 
Analysis is not required. Pursuant to section 7805(f) of the Internal 
Revenue Code, this notice of proposed rulemaking will be submitted to 
the Chief Counsel for Advocacy of the Small Business Administration for 
comment on its impact on small business.

Comments and Public Hearing

    Before this proposed regulation is adopted as a final regulation, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) that are submitted timely to the IRS. All 
comments will be available for public inspection and copying. A public 
hearing has been scheduled for July 24, 1996, at 10 a.m. in the 
auditorium, Internal Revenue Building, 1111 Constitution Avenue NW., 
Washington, DC. Because of access restrictions, visitors will not be 
admitted beyond the building lobby more than 15 minutes before the 
hearing starts.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing.
    Persons that wish to present oral comments at the hearing must 
submit written comments by July 15, 1996 and an outline of the topics 
to be discussed and the time to be devoted to each topic. A period of 
10 minutes will be allotted each person for making comments.
    An agenda showing the scheduling of speakers will be prepared after 
the deadline for receiving outlines has passed. Copies of the agenda 
will be available free of charge at the hearing.

Drafting Information

    The principal author of this regulation is Dale Carlton, Office of 
the Assistant Chief Counsel (Passthroughs and Special Industries). 
However, personnel from other offices of the IRS and Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 25

    Gift taxes, Reporting and recordkeeping requirements.

Proposed Amendment to the Regulations

    Accordingly, 26 CFR part 25 is proposed to be 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) is redesignated as paragraph (a)(1) and paragraph 
(a)(2) is added.
    2. In paragraph (b)(1), four new 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:

[[Page 16625]]

Sec. 25.2702-5  Personal residence trusts.

    (a)(1) In general. * * *
    (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. 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.
    (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 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. For purposes 
of this section, a grantor trust is a trust treated as owned by the 
grantor or the grantor's spouse within the meaning of sections 671-677. 
The term 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 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 
original term interest of the trust, or at any time after the original 
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. For purposes of this section, a 
grantor trust is a trust treated as owned by the grantor or the 
grantor's spouse within the meaning of sections 671-677. The term 
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 of this section is revised; and
    2. A new sentence is added at the end of the section, to read as 
follows:


Sec. 25.2702-7  Effective dates.

    Except as provided in this section, Secs. 25.2702-1 through 
25.2702-6 are effective as of January 28, 1992. * * * The fourth 
through seventh sentences of Sec. 25.2702-5(b)(1) and Sec. 25.2702-
5(c)(9) are effective with respect to trusts created after May 16, 
1996.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 96-8240 Filed 4-15-96; 8:45 am]
BILLING CODE 4830-01-U