Feb 1, 2010 12:00 PM

Sorry, but when there's an installment note, the death of the grantor does trigger gain — and it's IRD

By Carol A. Cantrell

An installment sale to an irrevocable grantor trust is a popular estate-planning tool that allows the grantor to freeze the growth of an appreciating asset by selling it to a grantor trust in return for a promissory note. The sale is ignored for federal income tax purposes, because transactions between a grantor and a trust (all of which is deemed owned by the grantor under Subpart E of Subchapter J of the Internal Revenue Code) are not regarded as sales for federal income tax purposes.¹ But the transfer is taken into account for estate and gift tax purposes. Therefore, all future appreciation inures to the benefit of the trust and is excluded from the grantor's taxable estate. However, if the trust converts to a non-grantor trust (either because the grantor dies or because the grantor powers terminate for another reason), a host of income tax questions arise if the note is still outstanding.

The first question is whether the grantor realizes gain when the trust converts from grantor to non-grantor while the note is still outstanding. If so, who should recognize the gain — the grantor or his estate — and how should that gain be calculated? Should there be a different treatment for conversions caused by the grantor's death than those caused by other reasons? And if gain is realized, does the note qualify for installment sale reporting under IRC Section 453 and thus constitute income in respect of a decedent (IRD) under IRC Section 691 to the extent of any unrecognized gain? And finally, what are the basis and holding period of the note and the property?

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Topics of Interest

Estate Tax	Donor Advised Funds
GSTs	Family Offices
Private Foundations	Life Insurance
2010 Tax Act News	Industry Trends Surveys

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2011 Trust Glossary

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50 years ago, in May 1962, we featured articles such as: "Future of Canadian Trusteeship" by Arthur H. Mingay", "Training Trust Employees" by Ian M. Marr, "What is a Trust Officer?" by Eric J. Brown, and "Selling Services" by Donald I. Webb.

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