[Federal Register Volume 66, Number 140 (Friday, July 20, 2001)]
[Rules and Regulations]
[Pages 37897-37902]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-17972]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8956]
RIN 1545-AY25


Recognition of Gain on Certain Transfers to Certain Foreign 
Trusts and Estates

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations under section 684 of 
the Internal Revenue Code relating to recognition of gain on certain 
transfers to certain foreign trusts and estates. The regulations affect 
United States persons who transfer property to foreign trusts and 
estates.

DATES: Effective Date: These regulations are effective July 20, 2001.
    Applicability Date: These regulations are applicable to transfers 
of property to foreign trusts and foreign estates after August 7, 2000.

FOR FURTHER INFORMATION CONTACT: Karen A. Rennie-Quarrie, (202) 622-
3880 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document contains final regulations relating to the Income Tax 
Regulations (CFR part 1) under section 684 of the Internal Revenue Code 
(Code). On August 7, 2000, Treasury and the IRS published a notice of 
proposed rulemaking (REG-108522-00) in the Federal Register (65 FR 
48198) under section 684 of the Code relating to gain recognition on 
transfers of property by U.S. persons to foreign trusts and estates. 
Comments responding to the notice of proposed rulemaking were received 
and a public hearing was held on November 8, 2000. After consideration 
of all comments, the proposed regulations are adopted as final 
regulations as revised by this Treasury decision.

Explanation of Provisions

I. Comments and Changes to Sec. 1.684-1: Recognition of Gain on 
Transfers to Certain Foreign Trusts and Estates

    Under the proposed regulations, a U.S. person who transfers 
property to a foreign trust or estate generally must recognize gain 
immediately even if deferral might otherwise be permitted under another 
provision of the Code.
    One commenter questioned the authority for the conclusion in 
Sec. 1.684-1(d) Example 4 that a U.S. person must recognize gain 
immediately upon the transfer of appreciated property to a foreign 
trust in exchange for a private annuity. The general rule in section 
684(a) provides, in part, that the transfer to the foreign trust is 
treated as a sale or exchange for an amount equal to the fair market 
value of the property transferred and the transferor must recognize the 
gain in the property, except as provided in regulations. The language 
of section 684(a) does not provide for any deferral of this gain. 
Moreover, the legislative history of former section 1491 (the 
predecessor of section 684 regarding transfers of property by U.S. 
persons to foreign trusts) makes it clear that Congress did not look 
favorably upon deferral in the context of transfers to foreign trusts 
in exchange for private annuities: ``The committee believes that any 
policy in favor of permitting deferral of tax in private annuity 
transactions should not apply to a private annuity transaction with a 
foreign trust.'' S. Rep. No. 94-938, at 217, n.5 (1976). Therefore, 
Treasury and the IRS do not believe it would be appropriate to adopt 
regulations that would permit deferral in such a case. The final 
regulations retain Example 4 without modification.

II. Comments and Changes to Sec. 1.684-2: Transfers

    The proposed regulations define the term transfer broadly to mean 
any direct, indirect, or constructive transfer. Section 1.684-2(e) of 
the proposed regulations provides that if any portion of a foreign 
trust is treated as owned by a U.S. person and such portion ceases to 
be treated as owned by such U.S. person, the U.S. person is treated as 
having transferred the assets of such portion to a foreign trust 
immediately before the trust is no longer treated as owned by the U.S. 
person. Section 1.684-2(e)(2) Example 2 illustrates this rule in the 
case of the death of the grantor.
    One commenter questioned the authority for the position that death 
is a transfer to which section 684 applies. Section 684(a) expressly 
applies to ``any

[[Page 37898]]

transfer of property by a United States person to a foreign estate or 
trust'' (emphasis added). Section 679 also generally applies to 
transfers of property by U.S. persons to foreign trusts. In the case of 
section 679, however, section 679(a)(2)(A) specifically excepts 
transfers by reason of death from the application of the general rule 
of section 679. This exception implies that Congress believed that, 
unless otherwise excepted, a transfer by reason of death would be a 
transfer to which section 679 applied. Because Congress provided no 
exception in section 684 for transfers by reason of death, it follows 
that section 684 applies to such transfers. Additional support for this 
conclusion is found in the information reporting rules in section 
6048(a)(3)(A)(ii), which provides that a ``reportable event'' includes 
``the transfer of any money or property (directly or indirectly) to a 
foreign trust by a United States person, including a transfer by reason 
of death'' (emphasis added). Although section 684 generally applies to 
transfers by reason of death, Sec. 1.684-3(c) provides an exception to 
the general rule of gain recognition in the case of certain transfers 
at death.
    One commenter requested guidance concerning a transfer of property 
by a domestic trust (that is not treated as owned by another person) to 
a foreign trust as a result of the testamentary exercise of a limited 
power of appointment with respect to the domestic trust. Treasury and 
the IRS believe that, under general principles regarding limited powers 
of appointment, the domestic trust, and not the holder of the limited 
power of appointment, is the transferor of the property. Accordingly, 
the domestic trust must recognize gain under the general rule of 
Sec. 1.684-1(a) unless an exception applies. The final regulations do 
not include any special rules for such transfers.
    One commenter asked about the interaction of Sec. 1.684-2(d) and 
Sec. 1.684-2(e) in the context of an actual transfer of property from a 
foreign trust that is treated as owned by a U.S. person to either a 
foreign charitable organization or a U.S. charity. Under Sec. 1.684-
2(d) of the proposed regulations, if any portion of a trust is treated 
as owned by a U.S. person, a transfer of property from that portion of 
the trust to a foreign trust is treated as a transfer from the owner. 
Under Sec. 1.684-2(e) of the proposed regulations, if a portion of a 
foreign trust that is treated as owned by a U.S. person ceases to be 
treated as owned by the U.S. person, the U.S. person is treated as 
having transferred the assets of that portion of the trust to a foreign 
trust immediately before such portion is no longer treated as owned by 
the U.S. person.
    The commenter noted that Sec. 1.684-2(e) of the proposed regulation 
could be read to apply in situations where a portion of a foreign trust 
ceases to be treated as owned by a U.S. person because of an actual 
transfer of property from the trust. The final regulations clarify that 
Sec. 1.684-2(e) does not apply (and that Sec. 1.684-2(d) may apply) 
when any portion of a trust ceases to be owned by a U.S. person by 
reason of an actual transfer of property from the trust. As a result, 
the general rule of gain recognition under Sec. 1.684-1(a) would not 
apply to an actual transfer by a foreign trust that is treated as owned 
by a U.S. person to a foreign charitable trust that meets the 
requirements of Sec. 1.684-3(b), or to a U.S. charity, even if the 
transfer causes the portion of the trust to cease to be owned by the 
U.S. person.

III. Comments and Changes to Sec. 1.684-3: Exceptions to the General 
Rule of Gain Recognition

    Section 1.684-3(a) of the proposed regulations provides that a U.S. 
person who transfers property to a foreign trust is not required to 
recognize gain on the transfer to the extent that any person is treated 
as the owner of the trust under section 671. One commenter questioned 
whether the term any person includes foreign persons. Although not 
specifically addressed in the final regulations, it is understood that 
the term any person includes foreign as well as U.S. persons.
    Section 1.684-3(b) of the proposed regulations provides an 
exception for transfers to a foreign trust that has already received a 
ruling or determination letter from the IRS recognizing the trust's tax 
exempt status under section 501(c)(3), provided that the letter has 
been neither revoked nor modified. Commenters questioned the 
requirement that a foreign trust obtain a ruling or determination 
letter from the IRS recognizing the trust's tax exempt status under 
section 501(c)(3). They assert that the requirement may interfere with 
a U.S. person's ability to make contributions to a foreign charitable 
entity that may not be familiar with U.S. tax laws and may not have any 
reason to obtain a determination letter from the IRS. They suggest that 
the final regulations require only that the U.S. transferor disclose to 
the IRS, at such time and in such manner as the IRS may provide, that 
the transfer has been made and that the U.S. transferor believes the 
transferee is an organization described in section 501(c)(3).
    In response to commenters' concerns, the final regulations 
eliminate the requirement that the foreign trust receive a ruling or 
determination letter from the IRS recognizing the trust's tax exempt 
status under section 501(c)(3). The final regulations provide, instead, 
that the general rule of gain recognition does not apply to any 
transfer of property to a foreign trust that is described in section 
501(c)(3) (without regard to the requirements of section 508(a)). 
However, taxpayers should be aware that, under Notice 97-34 (1997-1 
C.B. 422), the U.S. transferor has a reporting obligation on Form 3520 
with respect to such a transfer, unless the foreign trust has received 
a ruling or determination letter from the IRS recognizing the trust's 
tax exempt status under section 501(c)(3). Moreover, if the IRS 
subsequently determines that the foreign trust is not described in 
section 501(c)(3), the exception will not apply and the U.S. transferor 
will be required to recognize gain as of the time of the original 
transfer, and may be subject to interest and penalties, if applicable.
    Section 1.684-3(c) of the proposed regulations provides an 
exception for transfers of property by reason of the death of the U.S. 
transferor if both of the following requirements are satisfied: (1) The 
property is included in the U.S. transferor's gross estate for Federal 
estate tax purposes, and (2) the basis of the property in the hands of 
the foreign trust is determined under section 1014(a). One commenter 
questioned whether section 684 would apply in the case of an individual 
who is a U.S. person for income tax purposes, but a non-domiciliary for 
estate tax purposes, with the result that the property of the 
individual would be entitled to a step-up in basis, but would not be 
included in the individual's gross estate. The final regulations 
eliminate the requirement that the property be included in the U.S. 
transferor's gross estate and allow the exception to apply as long as 
the basis of the property in the hands of the foreign trust is 
determined under section 1014(a).
    Another commenter requested that the final regulations confirm that 
section 1032 applies to provide for nonrecognition of gain on issuer 
stock transferred to a foreign trust. The commenter noted that under 
former section 1491, no excise tax was imposed on a transfer of stock 
by a foreign corporation to a foreign trust if the corporation was not 
required to recognize gain on the transfer under section 1032. See 
Notice 97-18 (1997-1 C.B. 389, Sec. II.A.1). In response to this 
comment, Sec. 1.684-3(e) of the final regulations provides a new 
exception

[[Page 37899]]

for transfers of stock (including treasury stock) by a domestic 
corporation to a foreign trust if the domestic corporation is not 
required to recognize gain on the transfer under section 1032.
    Commenters also suggested that contributions by U.S. persons to 
foreign compensatory trusts described in sections 402(b), 404(a)(4), or 
404A should be exempt from gain recognition under section 684. Treasury 
and the IRS have considered the proposed exception but do not believe 
it is consistent with the intended purpose of section 684. Accordingly, 
the final regulations do not include an exception for transfers to 
foreign compensatory trusts. However, the exception for transfers of 
stock to which section 1032 would apply may be available in appropriate 
cases for transfers of stock of a domestic parent company to a foreign 
compensatory trust set up by a foreign subsidiary.
    Another commenter requested an exception for transfers of life 
insurance contracts to foreign trusts. The commenter noted that the 
proceeds of life insurance contracts do not generally give rise to any 
taxable gain if held by a U.S. individual or trust. Congress has 
recognized that life insurance contracts might be used to effectuate 
inappropriate outbound transfers of property. As part of the repeal of 
section 1491 in 1997, Congress enacted section 1035(c), which provides 
regulatory authority to deny the nonrecognition treatment given to 
exchanges of life insurance contracts under section 1035(a) where the 
exchange has the effect of transferring property to any person other 
than a U.S. person. Public Law 105-34, Sec. 1131(b)[(c)](1). Because of 
the potential for abuse and the lack of a compelling reason for 
creating an exception for offshore transfers of life insurance 
contracts, Treasury and the IRS have concluded that such an exception 
is not warranted.

IV. Comments and Changes to Sec. 1.684-4: Outbound Migration of 
Domestic Trusts

    Section 1.684-4 of the proposed regulation provides that if a U.S. 
person transfers property to a domestic trust and, for any reason, the 
domestic trust becomes a foreign trust, the domestic trust will be 
deemed to have transferred all of its assets to a foreign trust and the 
domestic trust must immediately recognize gain. The proposed 
regulations do, however, incorporate the relief for inadvertent 
migrations that is set forth in Sec. 301.7701-7(d)(2).
    One commenter suggested that the final regulations should extend 
the inadvertent migration rules of Sec. 301.7701-7(d)(2) to apply to 
Sec. 301.7701-7(f), which deals with the election by certain trusts to 
remain domestic trusts. Under Sec. 301.7701-7(d)(2), in the event of an 
inadvertent change in any person that has the power to make a 
substantial decision of the trust that would cause the domestic or 
foreign residency of the trust to change (e.g., an inadvertent change 
from a U.S. trustee to a foreign trustee by reason of the U.S. 
trustee's death), the trust is allowed 12 months to make necessary 
changes to avoid a change in the trust's residency (e.g., the 
replacement of the foreign successor trustee with a U.S. successor 
trustee). The commenter suggests that a trust with an election in force 
under Sec. 301.7701-7(d)(2) should be allowed a similar amount of time 
to make necessary changes if a U.S. trustee is inadvertently replaced 
by a foreign trustee.
    The final regulations do not include such a rule. Under 
Sec. 301.7701-7(f), a trust generally can elect to remain a domestic 
trust if it was in existence on August 20, 1996, and it was treated as 
a domestic trust on August 19, 1996. Section 301.7701-7(f)(4)(ii) 
provides that such an election terminates if subsequent changes are 
made to the trust that result in the trust no longer having any 
reasonable basis for being treated as a domestic trust under section 
7701(a)(30) prior to its amendment by the Small Business Job Protection 
Act of 1996 (SBJP Act), Pub. L. 104-188, 110 Stat. 1755. Whereas the 
``control test'' of section 7701(a)(30)(E)(ii), as enacted by the SBJP 
Act, contains a relatively bright-line test for purposes of determining 
a trust's status, thereby necessitating the inadvertent migration rule 
of Sec. 301.7701-7(d)(2), the determination of domestic or foreign 
status prior to the SBJP Act was governed by less objective criteria.
    Under pre-SBJP Act law, an inadvertent short-term replacement of a 
domestic trustee by a foreign trustee would not necessarily cause a 
change in the trust's status. Accordingly, a specific inadvertent 
migration rule for Sec. 301.7701-7(f) is not appropriate. Instead, as 
set forth in Sec. 301.7701-7(f)(4)(ii), an election under 
Sec. 301.7701-7(f) will not be terminated unless the trust has no 
reasonable basis for being treated as a domestic trust under pre-SBJP 
Act law.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It also has 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 the 
regulations do not impose a collection of information on small 
entities, 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 
Chief Counsel for Advocacy of the Small Business Administration for 
comment on its impact on small businesses.

Drafting Information

    The principal author of these regulations is Karen A. Rennie-
Quarrie of the Office of Associate Chief Counsel (International). 
However, other personnel from the IRS and Treasury Department 
participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
entries in numerical order to read in part as follows:

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

    Section 1.684-1 also issued under 26 U.S.C. 643(a)(7) and 
684(a).
    Section 1.684-2 also issued under 26 U.S.C. 643(a)(7) and 
684(a).
    Section 1.684-3 also issued under 26 U.S.C. 643(a)(7) and 
684(a).
    Section 1.684-4 also issued under 26 U.S.C. 643(a)(7) and 
684(a).
    Section 1.684-5 also issued under 26 U.S.C. 643(a)(7) and 
684(a). * * *


    Par. 2. Sections 1.684-1, 1.684-2, 1.684-3, 1.684-4 and 1.684-5 are 
added under the undesignated centerheading ``Miscellaneous'' to read as 
follows:


Sec. 1.684-1  Recognition of gain on transfers to certain foreign 
trusts and estates.

    (a) Immediate recognition of gain--(1) In general. Any U.S. person 
who transfers property to a foreign trust or foreign estate shall be 
required to recognize gain at the time of the transfer equal to the 
excess of the fair market value of the property transferred over the 
adjusted basis (for purposes of determining gain) of such property in 
the hands of the U.S. transferor unless an exception applies under the 
provisions of Sec. 1.684-3. The amount of

[[Page 37900]]

gain recognized is determined on an asset-by-asset basis.
    (2) No recognition of loss. Under this section a U.S. person may 
not recognize loss on the transfer of an asset to a foreign trust or 
foreign estate. A U.S. person may not offset gain realized on the 
transfer of an appreciated asset to a foreign trust or foreign estate 
by a loss realized on the transfer of a depreciated asset to the 
foreign trust or foreign estate.
    (b) Definitions. The following definitions apply for purposes of 
this section:
    (1) U.S. person. The term U.S. person means a United States person 
as defined in section 7701(a)(30), and includes a nonresident alien 
individual who elects under section 6013(g) to be treated as a resident 
of the United States.
    (2) U.S. transferor. The term U.S. transferor means any U.S. person 
who makes a transfer (as defined in Sec. 1.684-2) of property to a 
foreign trust or foreign estate.
    (3) Foreign trust. Section 7701(a)(31)(B) defines foreign trust. 
See also Sec. 301.7701-7 of this chapter.
    (4) Foreign estate. Section 7701(a)(31)(A) defines foreign estate.
    (c) Reporting requirements. A U.S. person who transfers property to 
a foreign trust or foreign estate must comply with the reporting 
requirements under section 6048.
    (d) Examples. The following examples illustrate the rules of this 
section. In all examples, A is a U.S. person and FT is a foreign trust. 
The examples are as follows:

    Example 1. Transfer to foreign trust. A transfers property that 
has a fair market value of 1000X to FT. A's adjusted basis in the 
property is 400X. FT has no U.S. beneficiary within the meaning of 
Sec. 1.679-2, and no person is treated as owning any portion of FT. 
Under paragraph (a)(1) of this section, A recognizes gain at the 
time of the transfer equal to 600X.
    Example 2. Transfer of multiple properties. A transfers property 
Q, with a fair market value of 1000X, and property R, with a fair 
market value of 2000X, to FT. At the time of the transfer, A's 
adjusted basis in property Q is 700X, and A's adjusted basis in 
property R is 2200X. FT has no U.S. beneficiary within the meaning 
of Sec. 1.679-2, and no person is treated as owning any portion of 
FT. Under paragraph (a)(1) of this section, A recognizes the 300X of 
gain attributable to property Q. Under paragraph (a)(2) of this 
section, A does not recognize the 200X of loss attributable to 
property R, and may not offset that loss against the gain 
attributable to property Q.
    Example 3. Transfer for less than fair market value. A transfers 
property that has a fair market value of 1000X to FT in exchange for 
400X of cash. A's adjusted basis in the property is 200X. FT has no 
U.S. beneficiary within the meaning of Sec. 1.679-2, and no person 
is treated as owning any portion of FT. Under paragraph (a)(1) of 
this section, A recognizes gain at the time of the transfer equal to 
800X.
    Example 4. Exchange of property for private annuity. A transfers 
property that has a fair market value of 1000X to FT in exchange for 
FT's obligation to pay A 50X per year for the rest of A's life. A's 
adjusted basis in the property is 100X. FT has no U.S. beneficiary 
within the meaning of Sec. 1.679-2, and no person is treated as 
owning any portion of FT. A is required to recognize gain equal to 
900X immediately upon transfer of the property to the trust. This 
result applies even though A might otherwise have been allowed to 
defer recognition of gain under another provision of the Internal 
Revenue Code.
    Example 5. Transfer of property to related foreign trust in 
exchange for qualified obligation. A transfers property that has a 
fair market value of 1000X to FT in exchange for FT's obligation to 
make payments to A during the next four years. FT is related to A as 
defined in Sec. 1.679-1(c)(5). The obligation is treated as a 
qualified obligation within the meaning of Sec. 1.679-4(d), and no 
person is treated as owning any portion of FT. A's adjusted basis in 
the property is 100X. A is required to recognize gain equal to 900X 
immediately upon transfer of the property to the trust. This result 
applies even though A might otherwise have been allowed to defer 
recognition of gain under another provision of the Internal Revenue 
Code. Section 1.684-3(d) provides rules relating to transfers for 
fair market value to unrelated foreign trusts.


Sec. 1.684-2  Transfers.

    (a) In general. A transfer means a direct, indirect, or 
constructive transfer.
    (b) Indirect transfers--(1) In general. Section 1.679-3(c) shall 
apply to determine if a transfer to a foreign trust or foreign estate, 
by any person, is treated as an indirect transfer by a U.S. person to 
the foreign trust or foreign estate.
    (2) Examples. The following examples illustrate the rules of this 
paragraph (b). In all examples, A is a U.S. citizen, FT is a foreign 
trust, and I is A's uncle, who is a nonresident alien. The examples are 
as follows:

    Example 1. Principal purpose of tax avoidance. A creates and 
funds FT for the benefit of A's cousin, who is a nonresident alien. 
FT has no U.S. beneficiary within the meaning of Sec. 1.679-2, and 
no person is treated as owning any portion of FT. In 2004, A decides 
to transfer additional property with a fair market value of 1000X 
and an adjusted basis of 600X to FT. Pursuant to a plan with a 
principal purpose of avoiding the application of section 684, A 
transfers the property to I. I subsequently transfers the property 
to FT. Under paragraph (b) of this section and Sec. 1.679-3(c), A is 
treated as having transferred the property to FT.
    Example 2. U.S. person unable to demonstrate that intermediary 
acted independently. A creates and funds FT for the benefit of A's 
cousin, who is a nonresident alien. FT has no U.S. beneficiary 
within the meaning of Sec. 1.679-2, and no person is treated as 
owning any portion of FT. On July 1, 2004, A transfers property with 
a fair market value of 1000X and an adjusted basis of 300X to I, a 
foreign person. On January 1, 2007, at a time when the fair market 
value of the property is 1100X, I transfers the property to FT. A is 
unable to demonstrate to the satisfaction of the Commissioner, under 
Sec. 1.679-3(c)(2)(ii), that I acted independently of A in making 
the transfer to FT. Under paragraph (b) of this section and 
Sec. 1.679-3(c), A is treated as having transferred the property to 
FT. Under paragraph (b) of this section and Sec. 1.679-3(c)(3), I is 
treated as an agent of A, and the transfer is deemed to have been 
made on January 1, 2007. Under Sec. 1.684-1(a), A recognizes gain 
equal to 800X on that date.

    (c) Constructive transfers. Section 1.679-3(d) shall apply to 
determine if a transfer to a foreign trust or foreign estate is treated 
as a constructive transfer by a U.S. person to the foreign trust or 
foreign estate.
    (d) Transfers by certain trusts--(1) In general. If any portion of 
a trust is treated as owned by a U.S. person, a transfer of property 
from that portion of the trust to a foreign trust is treated as a 
transfer from the owner of that portion to the foreign trust.
    (2) Examples. The following examples illustrate the rules of this 
paragraph (d). In all examples, A is a U.S. person, DT is a domestic 
trust, and FT is a foreign trust. The examples are as follows:

    Example 1. Transfer by a domestic trust. On January 1, 2001, A 
transfers property which has a fair market value of 1000X and an 
adjusted basis of 200X to DT. A retains the power to revoke DT. On 
January 1, 2003, DT transfers property which has a fair market value 
of 500X and an adjusted basis of 100X to FT. At the time of the 
transfer, FT has no U.S. beneficiary as defined in Sec. 1.679-2 and 
no person is treated as owning any portion of FT. A is treated as 
having transferred the property to FT and is required to recognize 
gain of 400X, under Sec. 1.684-1, at the time of the transfer by DT 
to FT.
    Example 2. Transfer by a foreign trust. On January 1, 2001, A 
transfers property which has a fair market value of 1000X and an 
adjusted basis of 200X to FT1. At the time of the transfer, FT1 has 
a U.S. beneficiary as defined in Sec. 1.679-2 and A is treated as 
the owner of FT1 under section 679. On January 1, 2003, FT1 
transfers property which has a fair market value of 500X and an 
adjusted basis of 100X to FT2. At the time of the transfer, FT2 has 
no U.S. beneficiary as defined in Sec. 1.679-2 and no person is 
treated as owning any portion of FT2. A is treated as having 
transferred the property to FT2 and is required to recognize gain of 
400X, under Sec. 1.684-1, at the time of the transfer by FT1 to FT2.

    (e) Deemed transfers when foreign trust no longer treated as owned 
by a U.S. person--(1) In general. If any portion of a foreign trust is 
treated as

[[Page 37901]]

owned by a U.S. person under subpart E of part I of subchapter J, 
chapter 1 of the Internal Revenue Code, and such portion ceases to be 
treated as owned by that person under such subpart (other than by 
reason of an actual transfer of property from the trust to which 
Sec. 1.684-2(d) applies), the U.S. person shall be treated as having 
transferred, immediately before (but on the same date that) the trust 
is no longer treated as owned by that U.S. person, the assets of such 
portion to a foreign trust.
    (2) Examples. The following examples illustrate the rules of this 
paragraph (e). In all examples, A is a U.S. citizen and FT is a foreign 
trust. The examples are as follows:

    Example 1. Loss of U.S. beneficiary.--(i) On January 1, 2001, A 
transfers property, which has a fair market value of 1000X and an 
adjusted basis of 400X, to FT. At the time of the transfer, FT has a 
U.S. beneficiary within the meaning of Sec. 1.679-2, and A is 
treated as owning FT under section 679. Under Sec. 1.684-3(a), 
Sec. 1.684-1 does not cause A to recognize gain at the time of the 
transfer.
    (ii) On July 1, 2003, FT ceases to have a U.S. beneficiary as 
defined in Sec. 1.679-2(c) and as of that date neither A nor any 
other person is treated as owning any portion of FT. Pursuant to 
Sec. 1.679-2(c)(2), if FT ceases to be treated as having a U.S. 
beneficiary, A will cease to be treated as owner of FT beginning on 
the first day of the first taxable year following the last taxable 
year in which there was a U.S. beneficiary. Thus, on January 1, 
2004, A ceases to be treated as owner of FT. On that date, the fair 
market value of the property is 1200X and the adjusted basis is 
350X. Under paragraph (e)(1) of this section, A is treated as having 
transferred the property to FT on January 1, 2004, and must 
recognize 850X of gain at that time under Sec. 1.684-1.
    Example 2. Death of grantor. (i) The initial facts are the same 
as in paragraph (i) of Example 1.
    (ii) On July 1, 2003, A dies, and as of that date no other 
person is treated as the owner of FT. On that date, the fair market 
value of the property is 1200X, and its adjusted basis equals 350X. 
Under paragraph (e)(1) of this section, A is treated as having 
transferred the property to FT immediately before his death, and 
generally is required to recognize 850X of gain at that time under 
Sec. 1.684-1. However, an exception may apply under Sec. 1.684-3(c).
    Example 3. Release of a power. (i) On January 1, 2001, A 
transfers property that has a fair market value of 500X and an 
adjusted basis of 200X to FT. At the time of the transfer, FT does 
not have a U.S. beneficiary within the meaning of Sec. 1.679-2. 
However, A retains the power to revoke the trust. A is treated as 
the owner of the trust under section 676 and, therefore, under 
Sec. 1.684-3(a), A is not required to recognize gain under 
Sec. 1.684-1 at the time of the transfer.
    (ii) On January 1, 2007, A releases the power to revoke the 
trust and, as of that date, neither A nor any other person is 
treated as owning any portion of FT. On that date, the fair market 
value of the property is 900X, and its adjusted basis is 200X. Under 
paragraph (e)(1) of this section, A is treated as having transferred 
the property to FT on January 1, 2007, and must recognize 700X of 
gain at that time.

    (f) Transfers to entities owned by a foreign trust. Section 1.679-
3(f) provides rules that apply with respect to transfers of property by 
a U.S. person to an entity in which a foreign trust holds an ownership 
interest.


Sec. 1.684-3  Exceptions to general rule of gain recognition.

    (a) Transfers to grantor trusts. The general rule of gain 
recognition under Sec. 1.684-1 shall not apply to any transfer of 
property by a U.S. person to a foreign trust to the extent that any 
person is treated as the owner of the trust under section 671. Section 
1.684-2(e) provides rules regarding a subsequent change in the status 
of the trust.
    (b) Transfers to charitable trusts. The general rule of gain 
recognition under Sec. 1.684-1 shall not apply to any transfer of 
property to a foreign trust that is described in section 501(c)(3) 
(without regard to the requirements of section 508(a)).
    (c) Certain transfers at death. The general rule of gain 
recognition under Sec. 1.684-1 shall not apply to any transfer of 
property by reason of death of the U.S. transferor if the basis of the 
property in the hands of the foreign trust is determined under section 
1014(a).
    (d) Transfers for fair market value to unrelated trusts. The 
general rule of gain recognition under Sec. 1.684-1 shall not apply to 
any transfer of property for fair market value to a foreign trust that 
is not a related foreign trust as defined in Sec. 1.679-1(c)(5). 
Section 1.671-2(e)(2)(ii) defines fair market value.
    (e) Transfers to which section 1032 applies. The general rule of 
gain recognition under Sec. 1.684-1 shall not apply to any transfer of 
stock (including treasury stock) by a domestic corporation to a foreign 
trust if the domestic corporation is not required to recognize gain on 
the transfer under section 1032.
    (f) Certain distributions to trusts. For purposes of this section, 
a transfer does not include a distribution to a trust with respect to 
an interest held by such trust in an entity other than a trust or an 
interest in certain investment trusts described in Sec. 301.7701-4(c) 
of this chapter, liquidating trusts described in Sec. 301.7701-4(d) of 
this chapter, or environmental remediation trusts described in 
Sec. 301.7701-4(e) of this chapter.
    (g) Examples. The following examples illustrate the rules of this 
section. In all examples, A is a U.S. citizen and FT is a foreign 
trust. The examples are as follows:

    Example 1. Transfer to owner trust. In 2001, A transfers 
property which has a fair market value of 1000X and an adjusted 
basis equal to 400X to FT. At the time of the transfer, FT has a 
U.S. beneficiary within the meaning of Sec. 1.679-2, and A is 
treated as owning FT under section 679. Under paragraph (a) of this 
section, Sec. 1.684-1 does not cause A to recognize gain at the time 
of the transfer. See Sec. 1.684-2(e) for rules that may require A to 
recognize gain if the trust is no longer owned by A.
    Example 2. Transfer of property at death: Basis determined under 
section 1014(a). (i) The initial facts are the same as Example 1.
    (ii) A dies on July 1, 2004. The fair market value at A's death 
of all property transferred to FT by A is 1500X. The basis in the 
property is 400X. A retained the power to revoke FT, thus, the value 
of all property owned by FT at A's death is includible in A's gross 
estate for U.S. estate tax purposes. Pursuant to paragraph (c) of 
this section, A is not required to recognize gain under Sec. 1.684-1 
because the basis of the property in the hands of the foreign trust 
is determined under section 1014(a).
    Example 3. Transfer of property at death: Basis not determined 
under section 1014(a).
    (i) The initial facts are the same as Example 1.
    (ii) A dies on July 1, 2004. The fair market value at A's death 
of all property transferred to FT by A is 1500X. The basis in the 
property is 400X. A retains no power over FT, and FT's basis in the 
property transferred is not determined under section 1014(a). Under 
Sec. 1.684-2(e)(1), A is treated as having transferred the property 
to FT immediately before his death, and must recognize 1100X of gain 
at that time under Sec. 1.684-1.
    Example 4. Transfer of property for fair market value to an 
unrelated foreign trust. A sells a house with a fair market value of 
1000X to FT in exchange for a 30-year note issued by FT. A is not 
related to FT as defined in Sec. 1.679-1(c)(5). FT is not treated as 
owned by any person. Pursuant to paragraph (d) of this section, A is 
not required to recognize gain under Sec. 1.684-1.


Sec. 1.684-4  Outbound migrations of domestic trusts.

    (a) In general. If a U.S. person transfers property to a domestic 
trust, and such trust becomes a foreign trust, and neither trust is 
treated as owned by any person under subpart E of part I of subchapter 
J, chapter 1 of the Internal Revenue Code, the trust shall be treated 
for purposes of this section as having transferred all of its assets to 
a foreign trust and the trust is required to recognize gain on the 
transfer under Sec. 1.684-1(a). The trust must also comply with the 
rules of section 6048.
    (b) Date of transfer. The transfer described in this section shall 
be deemed to occur immediately before, but on the same date that, the 
trust

[[Page 37902]]

meets the definition of a foreign trust set forth in section 
7701(a)(31)(B).
    (c) Inadvertent migrations. In the event of an inadvertent 
migration, as defined in Sec. 301.7701-7(d)(2) of this chapter, a trust 
may avoid the application of this section by complying with the 
procedures set forth in Sec. 301.7701-7(d)(2) of this chapter.
    (d) Examples. The following examples illustrate the rules of this 
section. In all examples, A is a U.S. citizen, B is a U.S. citizen, C 
is a nonresident alien, and T is a trust. The examples are as follows:

    Example 1. Migration of domestic trust with U.S. beneficiaries. 
A transfers property which has a fair market value of 1000X and an 
adjusted basis equal to 400X to T, a domestic trust, for the benefit 
of A's children who are also U.S. citizens. B is the trustee of T. 
On January 1, 2001, while A is still alive, B resigns as trustee and 
C becomes successor trustee under the terms of the trust. Pursuant 
to Sec. 301.7701-7(d) of this chapter, T becomes a foreign trust. T 
has U.S. beneficiaries within the meaning of Sec. 1.679-2 and A is, 
therefore, treated as owning FT under section 679. Pursuant to 
Sec. 1.684-3(a), neither A nor T is required to recognize gain at 
the time of the migration. Section 1.684-2(e) provides rules that 
may require A to recognize gain upon a subsequent change in the 
status of the trust.
    Example 2. Migration of domestic trust with no U.S. 
beneficiaries. A transfers property which has a fair market value of 
1000X and an adjusted basis equal to 400X to T, a domestic trust for 
the benefit of A's mother who is not a citizen or resident of the 
United States. T is not treated as owned by another person. B is the 
trustee of T. On January 1, 2001, while A is still alive, B resigns 
as trustee and C becomes successor trustee under the terms of the 
trust. Pursuant to Sec. 301.7701-7(d) of this chapter, T becomes a 
foreign trust, FT. FT has no U.S. beneficiaries within the meaning 
of Sec. 1.679-2 and no person is treated as owning any portion of 
FT. T is required to recognize gain of 600X on January 1, 2001. 
Paragraph (c) of this section provides rules with respect to an 
inadvertent migration of a domestic trust.


Sec. 1.684-5  Effective date.

    Sections 1.684-1 through 1.684-4 apply to transfers of property to 
foreign trusts and foreign estates after August 7, 2000.

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.

    Approved: July 9, 2001.
Mark Weinberger,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 01-17972 Filed 7-19-01; 8:45 am]
BILLING CODE 4830-01-P