Bulletin No. 1996–7 778/20047/28MAY96/A29-001 … · 778/20047/28MAY96/A29-001 3 Bulletin No. 1996–7 February 12, ... examining officers when they have merit, ... digests of revenue

SEQ 0224 JOB A29-001-005 PAGE-0003 COVER REVISED 28MAY96 AT 10:52 BY LR DEPTH: 66.04 PICAS WIDTH 46 PICAS COMPOSITE COLOR

778/20047/28MAY96/A29-001

3

Bulletin No. 1996–7February 12, 1996

HIGHLIGHTSOF THIS ISSUE

These synopses are intended only as aids to the reader inidentifying the subject matter covered. They may not berelied upon as authoritative interpretations.

INCOME TAX

PS–2–95, page 50.Proposed regulations under section 731 relating to thetreatment of a distribution of marketable securities by apartnership. A public hearing will be held on April 3,1996.

T.D. 8642, page 4.Final regulations under sections 704 and 737 of theCode relating to the recognition of gain or loss bycontributing partner on distribution of contributedproperty or other property.

ESTATE TAX

T.D. 8644, page 16.Final regulations relating to generation-skipping transfertax.

ADMINISTRATIVE

Del. Order 232 (Rev. 2), page 49.The authority to modify or rescind a Taxpayer Assist-

ance Order (TAO) is limited only to the Commissioner,Deputy Commissioner, or Taxpayer Ombudsman. Del.Order 232 (Rev. 1) superseded.

Del. Order 239 (Rev. 1), page 49.The Taxpayer Ombudsman is delegated the authority toissue Taxpayer Assistance Orders (TAO) to intervene onbehalf of taxpayers that make a positive action withrespect to taxpayer cases; to prepare an annual reportof the most significant problems taxpayers face whenconducting business with IRS and suggest solutionswhere applicable; and to establish a system to track theService’s response to changes suggested in the annualreport. Del. Order 239 amended.

Notice 96–10, page 47.Books and records; imaging systems. This noticeprovides a proposed revenue procedure regarding theuse by taxpayers of an imaging system to satisfy therequirement of section 6001 of the Code to maintainbooks and records.

Announcement 96–8, page 56.Publication 595, Tax Guide for Commercial Fishermen,is corrected.

Finding Lists begin on page 60.Announcement of Disbarments and Suspensions begins on page 57.

SEQ 0225 JOB A29-002-002 PAGE-0002 MISSION REVISED 28MAY96 AT 10:52 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS COMPOSITE COLOR

778/20047/28MAY96/A29-002

2

Mission of the ServiceThe purpose of the Internal Revenue Service is tocollect the proper amount of tax revenue at the leastcost; serve the public by continually improving the

quality of our products and services; and perform in amanner warranting the highest degree of publicconfidence in our integrity, efficiency and fairness.

Statement of Principlesof Internal RevenueTax AdministrationThe function of the Internal Revenue Service is toadminister the Internal Revenue Code. Tax policyfor raising revenue is determined by Congress.

With this in mind, it is the duty of the Service tocarry out that policy by correctly applying the lawsenacted by Congress; to determine the reasonablemeaning of various Code provisions in light of theCongressional purpose in enacting them; and toperform this work in a fair and impartial manner,with neither a government nor a taxpayer point ofview.

At the heart of administration is interpretation of theCode. It is the responsibility of each person in theService, charged with the duty of interpreting thelaw, to try to find the true meaning of the statutoryprovision and not to adopt a strained construction inthe belief that he or she is ‘‘protecting the revenue.’’The revenue is properly protected only when we as-certain and apply the true meaning of the statute.

The Service also has the responsibility of applyingand administering the law in a reasonable,practical manner. Issues should only be raised byexamining officers when they have merit, neverarbitrarily or for trading purposes. At the sametime, the examining officer should never hesitateto raise a meritorious issue. It is also importantthat care be exercised not to raise an issue or toask a court to adopt a position inconsistent withan established Service position.

Administration should be both reasonable andvigorous. It should be conducted with as littledelay as possible and with great courtesy andconsiderateness. It should never try to overreach,and should be reasonable within the bounds of lawand sound administration. It should, however, bevigorous in requiring compliance with law and itshould be relentless in its attack on unreal taxdevices and fraud.

SEQ 0226 JOB A29-002-002 PAGE-0003 MISSION REVISED 28MAY96 AT 10:52 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS COMPOSITE COLOR

778/20047/28MAY96/A29-002

3

IntroductionThe Internal Revenue Bulletin is the authoritativeinstrument of the Commissioner of Internal Revenue forannouncing official rulings and procedures of theInternal Revenue Service and for publishing TreasuryDecisions, Executive Orders, Tax Conventions, legisla-tion, court decisions, and other items of generalinterest. It is published weekly and may be obtainedfrom the Superintendent of Documents on a subscrip-tion basis. Bulletin contents of a permanent nature areconsolidated semiannually into Cumulative Bulletins,which are sold on a single-copy basis.

It is the policy of the Service to publish in the Bulletinall substantive rulings necessary to promote a uniformapplication of the tax laws, including all rulings thatsupersede, revoke, modify, or amend any of thosepreviously published in the Bulletin. All publishedrulings apply retroactively unless otherwise indicated.Procedures relating solely to matters of internalmanagement are not published; however, statements ofinternal practices and procedures that affect the rightsand duties of taxpayers are published.

Revenue rulings represent the conclusions of theService on the application of the law to the pivotal factsstated in the revenue ruling. In those based onpositions taken in rulings to taxpayers or technicaladvice to Service field offices, identifying details andinformation of a confidential nature are deleted toprevent unwarranted invasions of privacy and to complywith statutory requirements.

Rulings and procedures reported in the Bulletin do nothave the force and effect of Treasury DepartmentRegulations, but they may be used as precedents.Unpublished rulings will not be relied on, used, or citedas precedents by Service personnel in the disposition ofother cases. In applying published rulings and proce-dures, the effect of subsequent legislation, regulations,court decisions, rulings, and procedures must beconsidered, and Service personnel and others con-cerned are cautioned against reaching the sameconclusions in other cases unless the facts andcircumstances are substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.This part includes rulings and decisions based onprovisions of the Internal Revenue Code of 1986.

Part II.—Treaties and Tax Legislation.This part is divided into two subparts as follows:Subpart A, Tax Conventions, and Subpart B, Legislationand Related Committee Reports.

Part III.—Administrative, Procedural, and Miscellanous.To the extent practicable, pertinent cross references tothese subjects are contained in the other Parts andSubparts. Also included in this part are Bank SecrecyAct Administrative Rulings. Bank Secrecy Act Admin-istrative Rulings are issued by the Department of theTreasury’s Office of the Assistant Secretary(Enforcement).

Part IV.—Items of General Interest.With the exception of the Notice of Proposed Rulemak-ing and the disbarment and suspension list included inthis part, none of these announcements are consoli-dated in the Cumulative Bulletins.

The first Bulletin for each month includes an index forthe matters published during the preceding month.These monthly indexes are cumulated on a quarterlyand semiannual basis, and are published in the firstBulletin of the succeeding quarterly and semi-annualperiod, respectively.

The Bulletin Index-Digest System, a research andreference service supplementing the Bulletin, may beobtained from the Superintendent of Documents on asubscription basis. It consists of four Services: ServiceNo. 1, Income Tax; Service No. 2, Estate and GiftTaxes; Service No. 3, Employment Taxes; Service No.4, Excise Taxes. Each Service consists of a basicvolume and a cumulative supplement that provides (1)finding lists of items published in the Bulletin, (2)digests of revenue rulings, revenue procedures, andother published items, and (3) indexes of Public Laws,Treasury Decisions, and Tax Conventions.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

For sale by the Superintendent of Documents U.S. Government Printing Office, Washington, D.C. 20402.

SEQ 0227 JOB A29-003-005 PAGE-0004 PT 1 PGS 4- REVISED 28MAY96 AT 10:52 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS COMPOSITE COLOR

778/20047/28MAY96/A29-003

4

Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

Section 704.—Partner’s DistributiveShare

26 CFR 1.704–4: Distribution on contributedproperty.

T.D. 8642

DEPARTMENT OF THE TREASURYInternal Revenue Service26 CFR Part 1

Recognition of Gain or Loss byContributing Partner on Distributionof Contributed Property or OtherProperty

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document containsfinal regulations relating to the recogni-tion of gain or loss on certain distribu-tions of contributed property by apartnership under section 704(c)(1)(B)of the Internal Revenue Code of 1986(Code). This document also containsfinal regulations relating to the recogni-tion of gain on certain distributions to acontributing partner under section 737.The final regulations affect partnershipsand their partners and are necessary toprovide guidance for complying withthe applicable tax law.

EFFECTIVE DATE: January 9, 1995.

FOR FURTHER INFORMATIONCONTACT: Stephen J. Coleman, (202)622-3060 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

The Revenue Reconciliation Act of1989 added section 704(c)(1)(B) andsection 704(c)(2) to the Internal Reve-nue Code. Section 704(c)(1)(B) pro-vides that, in the case of a distributionof contributed property to anotherpartner within five years of its contri-bution, the contributing partner mustrecognize gain or loss in an amountequal to the gain or loss the partnerwould have been allocated under sec-tion 704(c)(1)(A) on a sale of the

property by the partnership at its fairmarket value at the time of the distri-bution. Section 704(c)(2) provides anexception for distributions of certainlike-kind property.

The Energy Policy Act of 1992added section 737 to the Code. Section737 requires a partner who contributesappreciated property to recognize gainon a subsequent distribution of otherproperty to the contributing partner tothe extent of the lesser of (i) the netprecontribution gain on property con-tributed by the partner, or (ii) theexcess of the value of the distributedproperty over the adjusted basis of thepartner’s interest in the partnership.

On January 9, 1995, a notice of pro-posed rulemaking (PS–76–92; PS–51–93 [1995–1 C.B. 1001]) under section704(c)(1)(B) and section 737 was pub-lished in the Federal Register (60 FR2352). Written comments responding tothis notice were received. No publichearing was held because no hearingwas requested. After consideration ofall comments received, the proposedregulations under section 704(c)(1)(B)and section 737 are adopted as revisedby this Treasury decision.

Summary of Significant Commentsand Revisions

The significant comments on theproposed regulations and the revisionsmade in the final regulations arediscussed below.

A. Section 704(c)(1)(B)

Determination of Gain and Loss

The proposed regulations providethat section 704(c)(1)(B) applies onlyto a distribution that is properly charac-terized as a distribution to a partneracting in the capacity of a partnerwithin the meaning of section 731 andsection 737, and not to a transaction ordistribution that is subject to provisionsother than section 731(a) or section737. Comments requested that the pro-vision be clarified. The final regula-tions clarify that section 704(c)(1)(B)applies only to the extent that a trans-action is a distribution under section731. References to transactions anddistributions not subject to section704(c)(1)(B) have been deleted.

One commentator suggested certainclarifying revisions to the proposedregulations’ definition of fair marketvalue. The definition in the proposedregulations, however, is identical to thedefinition of fair market value in the704(b) regulations, and distributedproperty should have the same fairmarket value for purposes of determin-ing gain and loss under section704(c)(1)(B) and determining capitalaccount adjustments under section704(b). The final regulations thereforeadopt the definition in the proposedregulations without change.

The proposed regulations providethat the amount of gain or lossresulting from a distribution of part-nership property is determined as if thedistributed property had been sold bythe partnership to the distributee part-ner. As a result, if built-in loss propertyis distributed to a partner that holdsmore than a 50 percent interest inpartnership capital or profits, the built-in loss that otherwise would be recog-nized is disallowed under section707(b)(1)(A). One commentator sug-gested that section 704(c)(1)(B) wasintended to address disguised salesbetween partners and that, therefore, aloss should be disallowed on a distribu-tion only if it would be disallowed on adirect sale between the partners. Sec-tion 704(c)(1)(B), however, respects theform of the transaction as between thepartnership and a partner and does notrecast the transaction as a disguisedsale. See H.R. Rep. No. 247, 101stCong., 1st Sess. 406 (1989). The finalregulations therefore adopt the pro-posed regulations without change.

Several of the provisions in theproposed regulations refer to distribu-tions that are part of ‘‘the same plan orarrangement.’’ Commentators requestedclarification of this term. The referenceto distributions that are part of thesame plan or arrangement was intendedto reflect the fact that distributions ofmultiple properties to one partner ordistributions of different properties tomore than one partner over a period oftime may be treated as part of the samedistribution under general principles oftaxation, such as the step transactiondoctrine. The final regulations removethe reference to ‘‘same plan or arrange-ment’’ and refers to distributions thatare part of the same distribution. Thischange is made for simplification only


778/20047/28MAY96/A29-003

5

and is not intended as a substantivechange to the scope of a distributionfor tax purposes. As under current law,distributions do not need to be contem-poraneous to be part of the samedistribution.

Several comments were received re-garding the effect of a partnershiptermination under section 708(b)(1)(B).One comment suggested that it was notclear whether property that had pre-viously been contributed to the part-nership (and was therefore alreadysubject to a five-year period) wassubject to a new five-year period afterthe termination. The final regulationsclarify that a new five-year period doesnot begin to the extent of any pre-termination gain or loss that wouldhave been allocated to a contributingpartner under section 704(c)(1)(A) on asale of contributed property imme-diately before the termination.

The legislative history of section704(c)(1)(B) indicates that a con-structive termination does not changethe application of section 704(c) to pre-contribution gain or loss on propertycontributed to the partnership beforetermination. One comment read thislegislative history as possibly suggest-ing that a pro rata distribution isdeemed to occur under section 708(b)-(1)(B) for section 704(c)(1)(A) pur-poses, but a different distribution isdeemed to occur for section 704(c)(1)-(B) purposes. The comment expressedconcern about the complexity of such asystem. Section 704(c)(1)(B), however,does not require or impose such a‘‘hybrid system.’’ The amount of gainor loss under section 704(c)(1)(B) isdetermined by reference to the amountof gain or loss that would have beenallocated to the partner under section704(c)(1)(A) if the property had beensold. Thus, property of a partnershiptha t t e rmina tes under sec t ion708(b)(1)(B) is deemed to be dis-tributed to the partners in the samemanner for both sections.

Another comment suggested it wasunclear whether section 704(c)(1)(B)could apply to property that had notbeen contributed by a partner to thepartnership prior to the termination.The final regulations confirm that anew five-year period begins for allproperty that is deemed contributed tothe new partnership after the termina-tion (which would include property notactually contributed to the partnership),except to the extent that such built-ingain or loss would have been allocated

to the contributing partner under sec-tion 704(c)(1)(A) on a sale of thecontributed property immediately be-fore the termination.

Commentators also requested guid-ance on the interaction of section708(b)(1)(B) and section 704(c) ingeneral. The IRS and Treasury recog-nize the need for additional guidanceon this issue, but such guidance isbeyond the scope of these regulations.The IRS and Treasury are considering aseparate project involving the interac-tion of section 704(c) and section708(b)(1)(B) and invite additional com-ments and suggestions regarding theproject.

Exceptions

The proposed regulations providethat section 704(c)(1)(B) does notapply to property contributed to thepartnership on or before October 3,1989. One commentator requested anexception for property required to becontributed under a binding contractentered into on or before October 3,1989. The statutory effective dateprovisions, however, do not contain abinding contract exception. Accord-ingly, the final regulations adopt theproposed regulations without change.

One commentator suggested an addi-tional exception for distributions of anundivided interest in property. Thefinal regulations provide that section704(c)(1)(B) does not apply to such adistribution to the extent that thedistributed interest does not exceed theundivided interest contributed by thedistributee partner.

One commentator also requested anadditional exception for distributions offungible property because the partnersmay not be able to track the specificcontributed property. The final regula-tions do not provide such an exception.Contributed property may be fungiblefrom an economic perspective, but suchproperty is generally not fungible fortax purposes because each contributedproperty will have its own individualtax basis.

The proposed regulations provide anexception for distributions of section704(c) property to a noncontributingpartner in liquidation of the partnershipif the contributing partner receives aninterest in the contributed property andthe built-in gain or loss in that propertyis equal to or greater than the built-ingain or loss that would have otherwise

been allocated to the contributing part-ner. One commentator suggested thatthe exception more clearly indicate theamount of built-in gain or loss thatmust be reflected in the property dis-tributed to the contributing partner. Thefinal regulations clarify that the amountof the built-in gain or loss must beequal to the gain or loss that wouldhave been allocated to the contributingpartner under section 704(c)(1)(A) ifthe contributed property had been soldimmediately before the distribution.

One commentator also suggested ex-panding this exception to apply to theextent of the built-in gain or loss in theproperty distributed to the contributingpartner. This comment is not adoptedin the final regulations. The exceptionwas intended to apply only in thelimited situation in which a partnershipliquidates and the value of the contrib-uted property exceeds the contributingpartner’s capital account. In that situa-tion, the portion of the contributedproperty in excess of the contributingpartner’s capital account would have tobe distributed to another partner,thereby triggering section 704(c)(1)(B).The exception allows a partner to avoidsection 704(c)(1)(B) in this situation,so long as the built-in gain or loss inthe property distributed to the contrib-uting partner is at least equal to thegain or loss that would have beenallocated to the contributing partnerunder section 704(c)(1)(A) if the con-tributed property had been sold imme-diately before the distribution.

Special Rules

The proposed regulations provide aspecial rule under section 704(c)(2) forsituations in which the partnershipdistributes like-kind property to a con-tributing partner within a specifiedperiod of the distribution of the prop-erty contributed by that partner. Underthis rule, the gain or loss that otherwisewould have been recognized on the dis-tribution of the contributed property isreduced by the amount of the con-tributing partner’s built-in gain or lossin the distributed like-kind property.One commentator criticized this rule asinconsistent with the statutoryprovision.

Section 704(c)(2) provides that‘‘[u]nder regulations prescribed by theSecretary, . . . to the extent of the valueof the [like-kind property distributed tothe contributing partner, the calculation


778/20047/28MAY96/A29-003

6

of the contributing partner’s gain orloss attributable to the distribution ofthe contributed property] shall be [de-termined] as if the contributing partnerhad contributed to the partnership the[like-kind] property.’’ This provision isgenerally intended to treat the contrib-uting partner as if the partner hadexchanged the contributed property forlike-kind property in a nontaxableexchange outside of the partnership.This allows the contributing partner toavoid recognition of gain or loss undersection 704(c)(1)(B) on the distributionof the contributed property to anotherpartner because the contributing partneris treated as having contributed thelike-kind property, not the property thatis actually distributed to the otherpartner.

If the contributing partner, however,had engaged in a like-kind exchangeoutside of the partnership, the partner’sbuilt-in gain or loss in the like-kindproperty received would have been thesame as the property that was surren-dered. The rule in the proposed regula-tions reflects this result by limiting theapplication of section 704(c)(2) to theextent that the built-in gain or loss inthe contributed property is not pre-served in the like-kind property dis-tributed to the contributing partner. TheIRS and Treasury continue to believethat the regulations properly implementCongress’ objective with respect to thisprovision. Therefore, the regulationsare finalized without change.

One commentator also suggested aclarification of the interaction of thelike-kind exception and the disguisedsale rules of 707(a)(2)(B). The pro-posed regulations provide that the like-kind exception reduces any gain thatwould have otherwise been recognizedunder section 704(c)(1)(B). The pro-posed regulations also provide thatsection 704(c)(1)(B) applies only to adistribution to a partner within themeaning of section 731. There is nosuggestion in section 704(c)(2) or theproposed regulations that the like-kindexception was intended as an exceptionto the disguised sale provisions. Thefinal regulations confirm that the dis-guised sale provisions can apply to adistribution, even if the distributionwould otherwise have qualified for thesection 704(c)(2) like-kind exception.

Anti-Abuse Rule

Commentators made several sugges-tions for clarifying or modifying the

anti-abuse rule in the proposed regula-tions. In particular, these commentatorsrequested clarification of the relation-ship between this rule and the generalpartnership anti-abuse rule in Treas.Reg. section 1.701–2. The general anti-abuse regulation is a rule of generalapplicability that provides general prin-ciples to be applied in interpreting andapplying all of the provisions of sub-chapter K. In certain situations, how-ever, more specific anti-abuse rules areneeded to carry out the purpose of aparticular provision. The final regula-tions therefore adopt the rule in thep r o p o s e d r e g u l a t i o n s w i t h o u tmodification.

B. Section 737

Determination of Gain

The final regulations are clarified toprovide that section 737 applies only tothe extent that a transaction is adistribution under section 731. In ac-cordance with section 737(d)(2), thefinal regulations also provide that sec-tion 737 does not apply to the extentthat section 751(b) applies to thedistribution.

Net Precontribution Gain

The proposed regulations providethat a distributee partner’s net pre-contribution gain is determined withoutregard to the like-kind exception ofsection 704(c)(2) in situations in whichthe contributed property is not actuallydistributed to another partner. Onecommentator suggested deleting thisprovision as superfluous. The finalregulations adopt the proposed regula-tions without change. This provisionclarifies that section 737 does notcontain a like-kind exception similar tothe exception in section 704(c)(2).Section 737 applies even if the prop-erty received by the partner is of alike-kind with the contributed property.

Character of Gain

One commentator suggested that theproposed regulations fail to clarifywhether there are two groups (ordinaryand capital) for purposes of determin-ing the character of a partner’s netprecontribution gain or whether theremay be an additional section 1231group or section 1245 and section 1250groups. The final regulations adopt theproposed regulations without change.

The proposed regulations providethat character for purposes of a part-ner’s net precontribution gain is deter-mined as if the contributed propertywere sold to an unrelated third party.As a result, all of the provisions thatare relevant in determining the charac-ter of gain or loss on a sale arerelevant in determining the character ofthe net precontribution gain. For exam-ple, if the sale of property would haveresulted in part capital gain and partordinary income, the character of thenet precontribution gain for that prop-erty is part ordinary and part capital.The same approach applies in deter-mining the allocation of any adjustmentto the partnership’s basis in partnershipproperty as a result of gain recognizedby the distributee partner. A basisadjustment attributable to gain treatedas capital gain under section 1231would be allocated to the property thatentered into the calculation of theamount of section 1231 gain.

One commentator also suggested thatthe proposed regulations do not clarifywhether character is determined at thepartnership or the partner level. Thisdetermination may be important insituations such as section 1231 wherethe character of the gain or loss maydepend on the partner’s particular taxcircumstances. The final regulationsclarify that the character of the gain orloss is determined at the partnershiplevel for this purpose.

Exceptions

One commentator suggested addingan exception for certain divisive trans-actions in which the contributing part-ner continued to own an indirectinterest in the contributed property. Thefinal regulations add a new exceptionunder which section 737 does not applyto a transfer of contributed property bya transferor partnership to a transfereepartnership, followed by a distributionof an interest in the transferee part-nership (and no other property) to thecontributing partner in complete liqui-dation of the partner’s interest.

This exception is added because thedistributee partner has simply convertedan interest in the transferor partnershipinto an interest in a transferee part-nership that holds the same contributedsection 704(c) property. The limitationson this exception ensure that thepartner’s basis in the transferee part-nership attributable to the contributed


778/20047/28MAY96/A29-003

7

property is the same as the partner’sbasis in the transferor partnership at-tributable to that property. This allowsa partnership to engage in a divisivesplit-up transaction, while preventingany avoidance of section 737 thatmight occur as a result of the basisallocation rules for non-liquidatingdistributions.

The proposed regulations providethat section 737 does not apply to anincorporation of a partnership otherthan an incorporation involving anactual distribution of partnership prop-erty to the partners. One commentatorsuggested that this distinction betweenmethods of incorporation creates anunnecessary trap for the unwary andmay have a chilling effect on theconversion of partnerships into S cor-porations. The final regulations adoptthe proposed regulations withoutchange. The form of incorporationchosen by the partners is respected forFederal tax purposes and, as a result,the distribution of property in connec-tion with the incorporation is treated asa distribution for purposes of section737.

One commentator suggested an addi-tional exception for distributions of anundivided interest in property similar tothat described with respect to theregulations under section 704(c)(1)(B).The final regulations provide a compar-able rule under section 737.

Anti-Abuse Rule

Commentators made several sugges-tions regarding the anti-abuse rule inthe proposed regulations. These sugges-tions are essentially the same as thecomments regarding the anti-abuse rulein the section 704(c)(1)(B) regulations,and thus the comments are discussedabove.

Effective Date

These regulations are effective fordistributions by a partnership to apartner on or after January 9, 1995.

Special Analyses

It has been determined that thisTreasury decision is not a significantregulatory action as defined in EO12866. Therefore, a regulatory assess-ment is not required. It has also beendetermined that section 553(b) of theAdministrative Procedure Act (5 U.S.C.

chapter 5) and the Regulatory Flex-ibility Act (5 U.S.C. chapter 6) do notapply to these regulations and, there-fore, a Regulatory Flexibility Analysisis not required. Pursuant to section7805(f) of the Internal Revenue Code,the notice of proposed rulemakingpreceding these regulations was submit-ted to the Chief Counsel for Advocacyof the Small Business Administrationfor comment on its impact on smallbusiness.

Drafting Information

Several persons from the Office ofChief Counsel and the Treasury De-partment participated in the develop-ment of these regulations.

* * * * * *

Adoption of Amendments to theRegulations

Accordingly, 26 CFR part 1 isamended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citationfor part 1 is amended by adding thefollowing citation:

Authority: 26 U.S.C. 7805 * * * Section 1.704–4 also issued under 26U.S.C. 704(c) * * *

Par. 2. Section 1.704–4 is added toread as follows:

§1.704–4 Distribution of contributedproperty.

(a) Determination of gain and loss—(1) In general. A partner that contrib-utes section 704(c) property to apartnership must recognize gain or lossunder section 704(c)(1)(B) and thissection on the distribution of suchproperty to another partner within fiveyears of its contribution to the part-nership in an amount equal to the gainor loss that would have been allocatedto such partner under section704(c)(1)(A) and §1.704–3 if the dis-tributed property had been sold by thepartnership to the distributee partner forits fair market value at the time of thedistribution. See §1.704–3(a)(3)(i) for adefinition of section 704(c) property.

(2) Transactions to which section704(c)(1)(B) applies. Section 704(c)-(1)(B) and this section apply only tothe extent that a distribution by a

partnership is a distribution to a partneracting in the capacity of a partnerwithin the meaning of section 731.

(3) Fair market value of property.The fair market value of the distributedsection 704(c) property is the price atwhich the property would change handsbetween a willing buyer and a willingseller at the time of the distribution,neither being under any compulsion tobuy or sell and both having reasonableknowledge of the relevant facts. Thefair market value that a partnershipassigns to distributed section 704(c)property will be regarded as correct,provided that the value is reasonablyagreed to among the partners in anarm’s-length negotiation and the part-ners have sufficiently adverse interests.

(4) Determination of five-yearperiod—(i) General rule. The five-yearperiod specified in paragraph (a)(1) ofthis section begins on and includes thedate of contribution.

(ii) Section 708(b)(1)(B) termina-tions. A termination of the partnershipunder section 708(b)(1)(B) begins anew five-year period for each partnerwith respect to the built-in gain andbuilt-in loss property that the partner isdeemed to recontribute to a newpartnership following the termination,but only to the extent that the pre-termination built-in gain or loss, if any,on such property would not have beenallocated to the contributing partnerunder section 704(c)(1)(A) and §1.704–3 on a sale of the contributed propertyto an unrelated party immediatelybefore the termination. See §1.704–3(a)(3)(ii) for the definitions of built-ingain and built-in loss on section 704(c)property.

(5) Examples. The following exam-ples illustrate the rules of this para-graph (a). Unless otherwise specified,partnership income equals partnershipexpenses (other than depreciation de-ductions for contributed property) foreach year of the partnership, the fairmarket value of partnership propertydoes not change, all distributions bythe partnership are subject to section704(c)(1)(B), and all partners areunrelated.

Example 1. Recognition of gain. (i) OnJanuary 1, 1995, A, B, and C form partnershipABC as equal partners. A contributes $10,000cash and Property A, nondepreciable real prop-erty with a fair market value of $10,000 and anadjusted tax basis of $4,000. Thus, there is abuilt-in gain of $6,000 on Property A at the timeof contribution. B contributes $10,000 cash andProperty B, nondepreciable real property with a


778/20047/28MAY96/A29-003

8

fair market value and adjusted tax basis of$10,000. C contributes $20,000 cash.

(ii) On December 31, 1998, Property A andProperty B are distributed to C in completeliquidation of C’s interest in the partnership.

(iii) A would have recognized $6,000 of gainunder section 704(c)(1)(A) and §1.704–3 on thesale of Property A at the time of the distribution($10,000 fair market value less $4,000 adjustedtax basis). As a result, A must recognize $6,000of gain on the distribution of Property A to C. Bwould not have recognized any gain or lossunder section 704(c)(1)(A) and §1.704–3 on thesale of Property B at the time of distributionbecause Property B was not section 704(c)property. As a result, B does not recognize anygain or loss on the distribution of Property B.

Example 2. Effect of post-contribution de-preciation deductions. (i) On January 1, 1995, A,B, and C form partnership ABC as equalpartners. A contributes Property A, depreciableproperty with a fair market value of $30,000 andan adjusted tax basis of $20,000. Therefore, thereis a built-in gain of $10,000 on Property A. Band C each contribute $30,000 cash. ABC usesthe traditional method of making section 704(c)allocations described in §1.704–3(b) with respectto Property A.

(ii) Property A is depreciated using thestraight-line method over its remaining 10-yearrecovery period. The partnership has bookdepreciation of $3,000 per year (10 percent ofthe $30,000 book basis), and each partner isallocated $1,000 of book depreciation per year(one-third of the total annual book depreciationof $3,000). The partnership has a tax deprecia-tion deduction of $2,000 per year (10 percent ofthe $20,000 tax basis in Property A). This $2,000tax depreciation deduction is allocated equallybetween B and C, the noncontributing partnerswith respect to Property A.

(iii) At the end of the third year, the bookvalue of Property A is $21,000 ($30,000 initialbook value less $9,000 aggregate book deprecia-tion) and the adjusted tax basis is $14,000($20,000 initial tax basis less $6,000 aggregatetax depreciation). A’s remaining section704(c)(1)(A) built-in gain with respect to Prop-erty A is $7,000 ($21,000 book value less$14,000 adjusted tax basis).

(iv) On December 31, 1997, Property A isdistributed to B in complete liquidation of B’sinterest in the partnership. If Property A hadbeen sold for its fair market value at the time ofthe distribution, A would have recognized $7,000of gain under section 704(c)(1)(A) and §1.704–3(b). Therefore, A recognizes $7,000 of gain onthe distribution of Property A to B.

Example 3. Effect of remedial method. (i) OnJanuary 1, 1995, A, B, and C form partnershipABC as equal partners. A contributes PropertyA1, nondepreciable real property with a fairmarket value of $10,000 and an adjusted taxbasis of $5,000, and Property A2, nondepreciablereal property with a fair market value andadjusted tax basis of $10,000. B and C eachcontribute $20,000 cash. ABC uses the remedialmethod of making section 704(c) allocationsdescribed in §1.704–3(d) with respect to PropertyA1.

(ii) On December 31, 1998, when the fairmarket value of Property A1 has decreased to$7,000, Property A1 is distributed to C in acurrent distribution. If Property A1 had been soldby the partnership at the time of the distribution,ABC would have recognized the $2,000 of

remaining buil t - in gain under sect ion704(c)(1)(A) on the sale (fair market value of$7,000 less $5,000 adjusted tax basis). All of thisgain would have been allocated to A. ABCwould also have recognized a book loss of$3,000 ($10,000 original book value less $7,000current fair market value of the property). Bookloss in the amount of $2,000 would have beenallocated equally between B and C. Under theremedial method, $2,000 of tax loss would alsohave been allocated equally to B and C to matchtheir share of the book loss. As a result, $2,000of gain would also have been allocated to A asan offsetting remedial allocation. A would haverecognized $4,000 of total gain under section704(c)(1)(A) on the sale of Property A1 ($2,000of section 704(c) recognized gain plus $2,000remedial gain). Therefore, A recognizes $4,000of gain on the distribution of Property A1 to Cunder this section.

(b) Character of gain or loss—(1)General rule. Gain or loss recognizedby the contributing partner under sec-tion 704(c)(1)(B) and this section hasthe same character as the gain or lossthat would have resulted if the dis-tributed property had been sold by thepartnership to the distributee partner atthe time of the distribution.

(2) Example. The following exampleillustrates the rule of this paragraph (b).Unless otherwise specified, partnershipincome equals partnership expenses(other than depreciation deductions forcontributed property) for each year ofthe partnership, the fair market value ofpartnership property does not change,all distributions by the partnership aresubject to section 704(c)(1)(B), and allpartners are unrelated.

Example. Character of gain. (i) On January 1,1995, A and B form partnership AB. Acontributes $10,000 and Property A, nondepre-ciable real property with a fair market value of$10,000 and an adjusted tax basis of $4,000, inexchange for a 25 percent interest in partnershipcapital and profits. B contributes $60,000 cashfor a 75 percent interest in partnership capitaland profits.

(ii) On December 31, 1998, Property A isdistributed to B in a current distribution.Property A is used in a trade or business of B.

(iii) A would have recognized $6,000 of gainunder section 704(c)(1)(A) on a sale of PropertyA at the time of the distribution (the differencebetween the fair market value ($10,000) and theadjusted tax basis ($4,000) of the property at thattime). Because Property A is not a capital assetin the hands of Partner B and B holds more than50 percent of partnership capital and profits, thecharacter of the gain on a sale of Property A toB would have been ordinary income undersection 707(b)(2). Therefore, the character of thegain to A on the distribution of Property A to Bis ordinary income.

(c) Exceptions—(1) Property con-tributed on or before October 3, 1989.Section 704(c)(1)(B) and this section

do not apply to property contributed tothe partnership on or before October 3,1989.

(2) Certain liquidations. Section704(c)(1)(B) and this section do notapply to a distribution of an interest insection 704(c) property to a partnerother than the contributing partner in aliquidation of the partnership if—

(i) The contributing partner receivesan interest in the section 704(c) prop-erty contributed by that partner (and noother property); and

(ii) The built-in gain or loss in theinterest distributed to the contributingpartner, determined immediately afterthe distribution, is equal to or greaterthan the built-in gain or loss on theproperty that would have been allo-cated to the contributing partner undersection 704(c)(1)(A) and §1.704–3 on asale of the contributed property to anunrelated party immediately before thedistribution.

(3) Section 708(b)(1)(B) termination.Section 704(c)(1)(B) and this sectiondo not apply to a deemed distributionof property caused by a termination ofthe partnership under section 708(b)(1)-(B). See paragraph (a)(4)(ii) of thissection for a special rule regarding anew five-year period for certain prop-erty deemed contributed to a newpartnership following a termination ofthe par tnersh ip under sec t ion708(b)(1)(B). See also §1.737–2(a) fora similar rule in the context of section737.

(4) Complete transfer to anotherpartnership. Section 704(c)(1)(B) andthis section do not apply to a transferby a partnership (transferor partnership)of all of its assets and liabilities to asecond partnership (transferee part-nership) in an exchange described insection 721, followed by a distributionof the interest in the transferee part-nership in liquidation of the transferorpartnership as part of the same plan orarrangement. A subsequent distributionof section 704(c) property by thetransferee partnership to a partner ofthe transferee partnership is subject tosection 704(c)(1)(B) to the same extentthat a distribution by the transferorpartnership would have been subject tosection 704(c)(1)(B). See §1.737–2(b)for a similar rule in the context ofsection 737.

(5) Incorporation of a partnership.Section 704(c)(1)(B) and this sectiondo not apply to an incorporation of apartnership by any method of incor-


778/20047/28MAY96/A29-003

9

poration (other than a method involvingan actual distribution of partnershipproperty to the partners followed by acontribution of that property to acorporation), provided that the part-nership is liquidated as part of theincorporation transaction. See §1.737–2(c) for a similar rule in the context ofsection 737.

(6) Undivided interests. Section704(c)(1)(B) and this section do notapply to a distribution of an undividedinterest in property to the extent thatthe undivided interest does not exceedthe undivided interest, if any, contrib-uted by the distributee partner in thesame property. See §1.737–2(d)(4) forthe application of section 737 in asimilar context. The portion of theundivided interest in property retainedby the partnership after the distribution,if any, that is treated as contributed bythe distributee partner, is reduced to theextent of the undivided interest dis-tributed to the distributee partner.

(7) Example. The following exampleillustrates the rule of paragraph (c)(2)of this section. Unless otherwise spec-ified, partnership income equals part-nership expenses (other than deprecia-tion deductions for contributedproperty) for each year of the part-nership, the fair market value ofpartnership property does not change,all distributions by the partnership aresubject to section 704(c)(1)(B), and allpartners are unrelated.

Example. (i) On January 1, 1995, A and Bform partnership AB, as equal partners. Acontributes Property A, nondepreciable realproperty with a fair market value and adjustedtax basis of $20,000. B contributes Property B,nondepreciable real property with a fair marketvalue of $20,000 and an adjusted tax basis of$10,000. Property B therefore has a built-in gainof $10,000 at the time of contribution.

(ii) On December 31, 1998, the partnershipliquidates when the fair market value of PropertyA has not changed, but the fair market value ofProperty B has increased to $40,000.

(iii) In the liquidation, A receives Property Aand a 25 percent interest in Property B. Thisinterest in Property B has a fair market value of$10,000 to A, reflecting the fact that A wasentitled to 50 percent of the $20,000 post-contribution appreciation in Property B. Thepartnership distributes to B a 75 percent interestin Property B with a fair market value of$30,000. B’s basis in this portion of Property Bis $10,000 under section 732(b). As a result, Bhas a built-in gain of $20,000 in this portion ofProperty B immediately after the distribution($30,000 fair market value less $10,000 adjustedtax basis). This built-in gain is greater than the$10,000 of built-in gain in Property B at the timeof contribution to the partnership. B thereforedoes not recognize any gain on the distributionof a portion of Property B to A under thissection.

(d) Special rules—(1) Nonrecogni-tion transactions. Property received bythe partnership in exchange for section704(c) property in a nonrecognitiontransaction is treated as the section704(c) property for purposes of section704(c)(1)(B) and this section to theextent that the property received istreated as section 704(c) property under§1.704–3(a)(8). See §1.737–2(d)(3) fora similar rule in the context of section737.

(2) Transfers of a partnership inter-est. The transferee of all or a portion ofthe partnership interest of a contribut-ing partner is treated as the contribut-ing partner for purposes of section704(c)(1)(B) and this section to theextent of the share of built-in gain orloss allocated to the transferee partner.See §1.704–3(a)(7).

(3) Distributions of like-kind prop-erty. If section 704(c) property isdistributed to a partner other than thecontributing partner and like-kind prop-erty (within the meaning of section1031) is distributed to the contributingpartner no later than the earlier of (i)180 days following the date of thedistribution to the non-contributingpartner, or (ii) the due date (determinedwith regard to extensions) of thecontributing partner’s income tax returnfor the taxable year of the distributionto the noncontributing partner, theamount of gain or loss, if any, that thecontributing partner would otherwisehave recognized under section 704(c)-(1)(B) and this section is reduced bythe amount of built-in gain or loss inthe distributed like-kind property in thehands of the contributing partner imme-diately after the distribution. The con-tributing partner’s basis in the dis-t r ibu ted l ike-k ind proper ty i sdetermined as if the like-kind propertywere distributed in an unrelated dis-tribution prior to the distribution of anyother property distributed as part of thesame distribution and is determinedwithout regard to the increase in thecontributing partner’s adjusted tax basisin the partnership interest under section704(c)(1)(B) and this section. See§1.707–3 for provisions treating thedistribution of the like-kind property tothe contributing partner as a disguisedsale in certain situations.

(4) Example. The following exampleillustrates the rules of this paragraph(d). Unless otherwise specified, part-nership income equals partnership ex-penses (other than depreciation deduc-tions for contributed property) for each

year of the partnership, the fair marketvalue of partnership property does notchange, all distributions by the part-nership are subject to section704(c)(1)(B), and all partners areunrelated.

Example. Distribution of like-kind property. (i)On January 1, 1995, A, B, and C formpartnership ABC as equal partners. A contributesProperty A, nondepreciable real property with afair market value of $20,000 and an adjusted taxbasis of $10,000. B and C each contribute$20,000 cash. The partnership subsequently buysProperty X, nondepreciable real property of alike-kind to Property A with a fair market valueand adjusted tax basis of $8,000. The fair marketvalue of Property X subsequently increases to$10,000.

(ii) On December 31, 1998, Property A isdistributed to B in a current distribution. At thesame time, Property X is distributed to A in acurrent distribution. The distribution of PropertyX does not result in the contribution of PropertyA being properly characterized as a disguisedsale to the partnership under §1.707–3. A’s basisin Property X is $8,000 under section 732(a)(1).A therefore has $2,000 of built-in gain inProperty X ($10,000 fair market value less$8,000 adjusted tax basis).

(iii) A would generally recognize $10,000 ofgain under section 704(c)(1)(B) on the distribu-tion of Property A, the difference between thefair market value ($20,000) of the property andits adjusted tax basis ($10,000). This gain isreduced, however, by the amount of the built-ingain of Property X in the hands of A. As aresult, A recognizes only $8,000 of gain on thedistribution of Property A to B under section704(c)(1)(B) and this section.

(e) Basis adjustments—(1) Contrib-uting partner’s basis in the partnershipinterest. The basis of the contributingpartner’s interest in the partnership isincreased by the amount of the gain, ordecreased by the amount of the loss,recognized by the partner under section704(c)(1)(B) and this section. Thisincrease or decrease is taken intoaccount in determining (i) the contrib-uting partner’s adjusted tax basis undersection 732 for any property distributedto the partner in a distribution that ispart of the same distribution as thedistribution of the contributed property,other than like-kind property describedin paragraph (d)(3) of this section(pertaining to the special rule fordistributions of like-kind property), and(ii) the amount of the gain recognizedby the contributing partner under sec-tion 731 or section 737, if any, on adistribution of money or property to thecontributing partner that is part of thesame distribution as the distribution ofthe contributed property. For a deter-mination of basis in a distributionsubject to section 737, see §1.737–3(a).


778/20047/28MAY96/A29-004

10

(2) Partnership’s basis in part-nership property. The partnership’sadjusted tax basis in the distributedsection 704(c) property is increased ordecreased immediately before the dis-tribution by the amount of gain or lossrecognized by the contributing partnerunder section 704(c)(1)(B) and thissection. Any increase or decrease inbasis is therefore taken into account indetermining the distributee partner’sadjusted tax basis in the distributedproperty under section 732. For adetermination of basis in a distributionsubject to section 737, see §1.737–3(b).

(3) Section 754 adjustments. Thebasis adjustments to partnership prop-erty made pursuant to paragraph (e)(2)of this section are not elective andmust be made regardless of whether thepartnership has an election in effectunder section 754. Any adjustments tothe bases of partnership property (in-cluding the distributed section 704(c)property) under section 734(b) pursuantto a section 754 election must be madeafter (and must take into account) theadjustments to basis made under para-graph (e)(2) of this section. See§1.737–3(c)(4) for a similar rule in thecontext of section 737.

(4) Example. The following exampleillustrates the rules of this paragraph(e). Unless otherwise specified, part-nership income equals partnership ex-penses (other than depreciation deduc-tions for contributed property) for eachyear of the partnership, the fair marketvalue of partnership property does notchange, all distributions by the part-nership are subject to section 704(c)-(1)(B), and all partners are unrelated.

Example. Basis adjustment. (i) On January 1,1995, A, B, and C form partnership ABC asequal partners. A contributes $10,000 cash andProperty A, nondepreciable real property with afair market value of $10,000 and an adjusted taxbasis of $4,000. B and C each contribute $20,000cash.

(ii) On December 31, 1998, Property A isdistributed to B in a current distribution.

(iii) Under paragraph (a) of this section, Arecognizes $6,000 of gain on the distribution ofProperty A because that is the amount of gainthat would have been allocated to A undersection 704(c)(1)(A) and §1.704–3 on a sale ofProperty A for its fair market value at the timeof the distribution (fair market value of PropertyA ($10,000) less its adjusted tax basis at the timeof distribution ($4,000)). The adjusted tax basisof A’s partnership interest is increased from$14,000 to $20,000 to reflect this gain. Thepartnership’s adjusted tax basis in Property A isincreased from $4,000 to $10,000 immediatelyprior to its distribution to B. B’s adjusted taxbasis in Property A is therefore $10,000 undersection 732(a)(1).

(f) Anti-abuse rule—(1) In general.The rules of section 704(c)(1)(B) andthis section must be applied in amanner consistent with the purpose ofsection 704(c)(1)(B). Accordingly, if aprincipal purpose of a transaction is toachieve a tax result that is inconsistentwith the purpose of section 704(c)(1)-(B), the Commissioner can recast thetransaction for federal tax purposes asappropriate to achieve tax results thatare consistent with the purpose ofsection 704(c)(1)(B) and this section.Whether a tax result is inconsistentwith the purpose of section 704(c)-(1)(B) and this section must be deter-mined based on all the facts andcircumstances. See §1.737–4 for ananti-abuse rule and examples in thecontext of section 737.

(2) Examples. The following exam-ples illustrate the anti-abuse rule of thisparagraph (f). The examples set forthbelow do not delineate the boundariesof either permissible or impermissibletypes of transactions. Further, the addi-tion of any facts or circumstances thatare not specifically set forth in anexample (or the deletion of any facts orcircumstances) may alter the outcomeof the transaction described in theexample. Unless otherwise specified,partnership income equals partnershipexpenses (other than depreciation de-ductions for contributed property) foreach year of the partnership, the fairmarket value of partnership propertydoes not change, all distributions bythe partnership are subject to section704(c)(1)(B), and all partners are un-related.

Example 1. Distribution in substance madewithin five-year period; results inconsistent withthe purpose of section 704(c)(1)(B). (i) OnJanuary 1, 1995, A, B, and C form partnershipABC as equal partners. A contributes PropertyA, nondepreciable real property with a fairmarket value of $10,000 and an adjusted taxbasis of $1,000. B and C each contributes$10,000 cash.

(ii) On December 31, 1998, the partners desireto distribute Property A to B in completeliquidation of B’s interest in the partnership. IfProperty A were distributed at that time,however, A would recognize $9,000 of gainunder section 704(c)(1)(B), the difference be-tween the $10,000 fair market value and the$1,000 adjusted tax basis of Property A, becauseProperty A was contributed to the partnershipless than five years before December 31, 1998.On becoming aware of this potential gainrecognition, and with a principal purpose ofavoiding such gain, the partners amend thepartnership agreement on December 31, 1998,and take any other steps necessary to providethat substantially all of the economic risks andbenefits of Property A are borne by B as of

December 31, 1998, and that substantially all ofthe economic risks and benefits of all otherpartnership property are borne by A and C. Thepartnership holds Property A until January 5,2000, at which time it is distributed to B incomplete liquidation of B’s interest in thepartnership.

(iii) The actual distribution of Property Aoccurred more than five years after the contribu-tion of the property to the partnership. The stepstaken by the partnership on December 31, 1998,however, are the functional equivalent of anactual distribution of Property A to B incomplete liquidation of B’s interest in thepartnership as of that date. Section 704(c)(1)(B)requires recognition of gain when contributedsection 704(c) property is in substance dis-tributed to another partner within five years of itscontribution to the partnership. Allowing acontributing partner to avoid section 704(c)(1)(B)through arrangements such as those in thisExample 1 that have the effect of a distributionof property within five years of the date of itscontribution to the partnership would effectivelyundermine the purpose of section 704(c)(1)(B)and this section. As a result, the steps taken bythe partnership on December 31, 1998, aretreated as causing a distribution of Property A toB for purposes of section 704(c)(1)(B) on thatdate, and A recognizes gain of $9,000 undersection 704(c)(1)(B) and this section at that time.

(iv) Alternatively, if on becoming aware ofthe potential gain recognition to A on adistribution of Property A on December 31,1998, the partners had instead agreed that Bwould continue as a partner with no changes tothe partnership agreement or to B’s economicinterest in partnership operations, the distributionof Property A to B on January 5, 2000, wouldnot have been inconsistent with the purpose ofsection 704(c)(1)(B) and this section. In thatsituation, Property A would not have been dis-tributed until after the expiration of the five-yearperiod specified in section 704(c)(1)(B) and thissection. Deferring the distribution of Property Auntil the end of the five-year period for aprincipal purpose of avoiding the recognition ofgain under section 704(c)(1)(B) and this sectionis not inconsistent with the purpose of section704(c)(1)(B). Therefore, A would not haverecognized gain on the distribution of Property Ain that case.

Example 2. Suspension of five-year period inmanner consistent with the purpose of section704(c)(1)(B). (i) A, B, and C form partnershipABC on January 1, 1995, to conduct bona fidebusiness activities. A contributes Property A,nondepreciable real property with a fair marketvalue of $10,000 and an adjusted tax basis of$1,000, in exchange for a 49.5 percent interest inpartnership capital and profits. B contributes$10,000 in cash for a 49.5 percent interest inpartnership capital and profits. C contributes cashfor a 1 percent interest in partnership capital andprofits. A and B are wholly owned subsidiariesof the same affiliated group and continue tocontrol the management of Property A by virtueof their controlling interests in the partnership.The partnership is formed pursuant to a plan aprincipal purpose of which is to minimize theperiod of time that A would have to remain apartner with a potential acquiror of Property A.

(ii) On December 31, 1997, D is admitted as apartner to the partnership in exchange for$10,000 cash.

(iii) On January 5, 2000, Property A isdistributed to D in complete liquidation of D’sinterest in the partnership.


778/20047/28MAY96/A29-004

11

(iv) The distribution of Property A to Doccurred more than five years after the contribu-tion of the property to the partnership. On thesefacts, however, a principal purpose of thetransaction was to minimize the period of timethat A would have to remain partners with apotential acquiror of Property A, and treating thefive-year period of section 704(c)(1)(B) asrunning during a time when Property A was stilleffectively owned through the partnership bymembers of the contributing affiliated group ofwhich A is a member is inconsistent with thepurpose of section 704(c)(1)(B). Prior to theadmission of D as a partner, the pooling of assetsbetween A and B, on the one hand, and C, onthe other hand, although sufficient to constituteABC as a valid partnership for federal incometax purposes, is not a sufficient pooling of assetsfor purposes of running the five-year period withrespect to the distribution of Property A to D.Allowing a contributing partner to avoid section704(c)(1)(B) through arrangements such as thosein this Example 2 would have the effect ofsubstantially nullifying the five-year requirementof section 704(c)(1)(B) and this section andelevating the form of the transaction over itssubstance. As a result, with respect to thedistribution of Property A to D, the five-yearperiod of section 704(c)(1)(B) is tolled until theadmission of D as a partner on December 31,1997. Therefore, the distribution of Property Aoccurred before the end of the five-year periodof section 704(c)(1)(B), and A recognizes gain of$9,000 under section 704(c)(1)(B) on thedistribution.

(g) Effective date. This section ap-plies to distributions by a partnership toa partner on or after January 9, 1995.

Par. 3. Sections 1.737–1, 1.737–2,1.737–3, 1.737–4, and 1.737–5 areadded to read as follows:

§1.737–1 Recognition ofprecontribution gain.

(a) Determination of gain—(1) Ingeneral. A partner that receives adistribution of property (other thanmoney) must recognize gain undersection 737 and this section in anamount equal to the lesser of theexcess distribution (as defined in para-graph (b) of this section) or thepartner’s net precontribution gain (asdefined in paragraph (c) of this sec-tion). Gain recognized under section737 and this section is in addition toany gain recognized under section 731.

(2) Transactions to which section737 applies. Section 737 and thissection apply only to the extent that adistribution by a partnership is adistribution to a partner acting in thecapacity of a partner within the mean-ing of section 731, except that section737 and this section do not apply to theextent that section 751(b) applies to thedistribution.

(b) Excess distribution—(1) Defini-tion. The excess distribution is theamount (if any) by which the fairmarket value of the distributed property(other than money) exceeds the dis-tributee partner’s adjusted tax basis inthe partner’s partnership interest.

(2) Fair market value of property.The fair market value of the distributedproperty is the price at which theproperty would change hands betweena willing buyer and a willing seller atthe time of the distribution, neitherbeing under any compulsion to buy orsell and both having reasonable knowl-edge of the relevant facts. The fairmarket value that a partnership assignsto distributed property will be regardedas correct, provided that the value isreasonably agreed to among the part-ners in an arm’s-length negotiation andthe partners have sufficiently adverseinterests.

(3) Distributee partner’s adjustedtax basis—(i) General rule. In deter-mining the amount of the excessdistribution, the distributee partner’sadjusted tax basis in the partnershipinterest includes any basis adjustmentresulting from the distribution that issubject to section 737 (for example,adjustments required under section 752)and from any other distribution ortransaction that is part of the samedistribution, except for—

(A) The increase required under sec-tion 737(c)(1) for the gain recognizedby the partner under section 737; and

(B) The decrease required under sec-tion 733(2) for any property distributedto the partner other than propertypreviously contributed to the part-nership by the distributee partner. See§1.704–4(e)(1) for a rule in the contextof section 704(c)(1)(B). See also§1.737–3(b)(2) for a special rule fordetermining a partner’s adjusted taxbasis in distributed property previouslycontributed by the partner to thepartnership.

(ii) Advances or drawings. The dis-tributee partner’s adjusted tax basis inthe partnership interest is determined asof the last day of the partnership’staxable year if the distribution to whichsection 737 applies is properly charac-terized as an advance or drawingagainst the partner’s distributive shareof income. See §1.731–1(a)(1)(ii).

(c) Net precontribution gain—(1)General rule. The distributee partner’snet precontribution gain is the net gain(if any) that would have been recog-

nized by the distributee partner undersection 704(c)(1)(B) and §1.704–4 ifall property that had been contributedto the partnership by the distributeepartner within five years of the dis-tribution and is held by the partnershipimmediately before the distribution hadbeen distributed by the partnership toanother partner other than a partnerwho owns, directly or indirectly, morethan 50 percent of the capital or profitsinterest in the partnership. See §1.704–4 for provisions determining a contrib-uting partner’s gain or loss undersection 704(c)(1)(B) on an actual dis-tribution of contributed section 704(c)property to another partner.

(2) Special rules—(i) Property con-tributed on or before October 3, 1989.Property contributed to the partnershipon or before October 3, 1989, is nottaken into account in determining apartner’s net precontribution gain. See§1.704–4(c)(1) for a similar rule in thecontext of section 704(c)(1)(B).

(ii) Section 734(b)(1)(A) adjust-ments. For distributions to a distributeepartner of money by a partnership witha section 754 election in effect that arepart of the same distribution as thedistribution of property subject to sec-tion 737, for purposes of paragraph (a)and (c)(1) of this section the distributeepartner’s net precontribution gain isreduced by the basis adjustments (ifany) made to section 704(c) propertycontributed by the distributee partnerunder section 734(b)(1)(A). See§1.737–3(c)(4) for rules regarding basisadjustments for partnerships with asection 754 election in effect.

(iii) Transfers of a partnership inter-est. The transferee of all or a portion ofa contributing partner’s partnership in-terest succeeds to the transferor’s netprecontribution gain, if any, in anamount proportionate to the interesttransferred. See §1.704–3(a)(7) and§1.704–4(d)(2) for similar provisions inthe context of section 704(c)(1)(A) andsection 704(c)(1)(B).

(iv) Section 704(c)(1)(B) gain recog-nized in related distribution. A dis-tributee partner’s net precontributiongain is determined after taking intoaccount any gain or loss recognized bythe partner under section 704(c)(1)(B)and §1.704–4 (or that would have beenrecognized by the partner except forthe like-kind exception in section704(c)(2) and §1.704–4(d)(3)) on anactual distribution to another partner ofsection 704(c) property contributed by


778/20047/28MAY96/A29-004

12

the distributee partner that is part of thesame distribution as the distribution tothe distributee partner.

(v) Section 704(c)(2) disregarded. Adistributee partner’s net precontributiongain is determined without regard tothe provisions of section 704(c)(2) and§1.704–4(d)(3) in situations in whichthe property contributed by the dis-tributee partner is not actually dis-tributed to another partner in a distribu-tion related to the section 737distribution.

(d) Character of gain. The characterof the gain recognized by the dis-tributee partner under section 737 andthis section is determined by, and isproportionate to, the character of thepartner’s net precontribution gain. Forthis purpose, all gains and losses onsection 704(c) property taken intoaccount in determining the partner’s netprecontribution gain are netted accord-ing to their character. Character isdetermined at the partnership level forthis purpose, and any character with anet negative amount is disregarded. Thecharacter of the partner’s gain undersection 737 is the same as, and inproportion to, any character with a netpositive amount. Character for thispurpose is determined as if the section704(c) property had been sold by thepartnership to an unrelated third partyat the time of the distribution andincludes any item that would have beentaken into account separately by thecontributing partner under section702(a) and §1.702–1(a).

(e) Examples. The following exam-ples illustrate the provisions of thissection. Unless otherwise specified,partnership income equals partnershipexpenses (other than depreciation de-ductions for contributed property) foreach year of the partnership, the fairmarket value of partnership propertydoes not change, all distributions bythe partnership are subject to section737, and all partners are unrelated.

Example 1. Calculation of excess distributionand net precontribution gain. (i) On January 1,1995, A, B, and C form partnership ABC asequal partners. A contributes Property A, depre-ciable real property with a fair market value of$30,000 and an adjusted tax basis of $20,000. Bcontributes Property B, nondepreciable real prop-erty with a fair market value and adjusted taxbasis of $30,000. C contributes $30,000 cash.

(ii) Property A has 10 years remaining on itscost recovery schedule and is depreciated usingthe straight-line method. The partnership uses thetraditional method for allocating items undersection 704(c) described in §1.704–3(b)(1) forProperty A. The partnership has book deprecia-

tion of $3,000 per year (10 percent of the$30,000 book basis in Property A) and eachpartner is allocated $1,000 of book depreciationper year (one-third of the total annual bookdepreciation of $3,000). The partnership also hastax depreciation of $2,000 per year (10 percentof the $20,000 adjusted tax basis in Property A).This $2,000 tax depreciation is allocated equallybetween B and C, the noncontributing partnerswith respect to Property A.

(iii) At the end of 1997, the book value ofProperty A is $21,000 ($30,000 initial bookvalue less $9,000 aggregate book depreciation)and its adjusted tax basis is $14,000 ($20,000initial tax basis less $6,000 aggregate taxdepreciation).

(iv) On December 31, 1997, Property B isdistributed to A in complete liquidation of A’spartnership interest. The adjusted tax basis ofA’s partnership interest at that time is $20,000.The amount of the excess distribution is $10,000,the difference between the fair market value ofthe distributed Property B ($30,000) and A’sadjusted tax basis in A’s partnership interest($20,000). A’s net precontribution gain is $7,000,the difference between the book value ofProperty A ($21,000) and its adjusted tax basis atthe time of the distribution ($14,000). Arecognizes gain of $7,000 on the distribution, thelesser of the excess distribution and the netprecontribution gain.

Example 2. Determination of distributee part-ner’s basis. (i) On January 1, 1995, A, B, and Cform general partnership ABC as equal partners.A contributes Property A, nondepreciable realproperty with a fair market value of $10,000 andan adjusted tax basis of $4,000. B and C eachcontributes $10,000 cash.

(ii) The partnership purchases Property B,nondepreciable real property with a fair marketvalue of $9,000, subject to a $9,000 nonrecourseliability. This nonrecourse liability is allocatedequally among the partners under section 752,increasing A’s adjusted tax basis in A’s part-nership interest from $4,000 to $7,000.

(iii) On December 31, 1998, A receives$2,000 cash and Property B, subject to the$9,000 liability, in a current distribution.

(iv) In determining the amount of the excessdistribution, the adjusted tax basis of A’spartnership interest is adjusted to take intoaccount the distribution of money and the shift inliabilities. A’s adjusted tax basis is thereforeincreased to $11,000 for this purpose ($7,000initial adjusted tax basis, less $2,000 distributionof money, less $3,000 (decrease in A’s share ofthe $9,000 partnership liability), plus $9,000(increase in A’s individual liabilities)). As aresult of this basis adjustment, the adjusted taxbasis of A’s partnership interest ($11,000) isgreater than the fair market value of thedistributed property ($9,000) and therefore, thereis no excess distribution. A recognizes no gainunder section 737.

Example 3. Net precontribution gain reducedfor gain recognized under section 704(c)(1)(B).(i) On January 1, 1995, A, B, and C formpartnership ABC as equal partners. A contributesProperties A1 and A2, nondepreciable realproperties located in the United States each witha fair market value of $10,000 and an adjustedtax basis of $6,000. B contributes Property B,nondepreciable real property located outside theUnited States, with a fair market value andadjusted tax basis of $20,000. C contributes$20,000 cash.

(ii) On December 31, 1998, Property B isdistributed to A in complete liquidation of A’sinterest and, as part of the same distribution,Property A1 is distributed to B in a currentdistribution.

(iii) A’s net precontribution gain before thedistribution is $8,000 ($20,000 fair market valueof Properties A1 and A2 less $12,000 adjustedtax basis of such properties). A recognizes$4,000 of gain under section 704(c)(1)(B) and§1.704–4 on the distribution of Property A1 to B($10,000 fair market value of Property A1 less$6,000 adjusted tax basis of Property A1). Thisgain is taken into account in determining A’sexcess distribution and net precontribution gain.As a result, A’s net precontribution gain isreduced from $8,000 to $4,000, and the adjustedtax basis in A’s partnership interest is increasedby $4,000 to $16,000.

(iv) A recognizes gain of $4,000 on thereceipt of Property B under section 737, anamount equal to the lesser of the excessdistribution of $4,000 ($20,000 fair market valueof Property B less $16,000 adjusted tax basis ofA’s interest in the partnership) and A’s remain-ing net precontribution gain of $4,000.

Example 4. Character of gain. (i) On January1, 1995, A, B, and C form partnership ABC asequal partners. A contributes the followingnondepreciable property to the partnership:

Fair MarketValue

Adjusted TaxBasis

Property A1 $30,000 $20,000Property A2 30,000 38,000Property A3 10,000 9,000

(ii) The character of gain or loss on PropertyA1 and Property A2 is long-term, U.S.-sourcecapital gain or loss. The character of gain onProperty A3 is long-term, foreign-source capitalgain. B contributes Property B, nondepreciablereal property with a fair market value andadjusted tax basis of $70,000. C contributes$70,000 cash.

(iii) On December 31, 1998, Property B isdistributed to A in complete liquidation of A’sinterest in the partnership. A recognizes $3,000of gain under section 737, an amount equal tothe excess distribution of $3,000 ($70,000 fairmarket value of Property B less $67,000 adjustedtax basis in A’s partnership interest) and A’s netprecontribution gain of $3,000 ($70,000 aggre-gate fair market value of properties contributedby A less $67,000 aggregate adjusted tax basis ofsuch properties).

(iv) In determining the character of A’s gain,all gains and losses on property taken intoaccount in determining A’s net precontributiongain are netted according to their character andallocated to A’s recognized gain under section737 based on the relative proportions of the netpositive amounts. U.S.-source and foreign-sourcegains must be netted separately because A wouldhave been required to take such gains intoaccount separately under section 702. As a result,A’s net precontribution gain of $3,000 consistsof $2,000 of net long-term, U.S.-source capitalgain ($10,000 gain on Property A1 and $8,000loss on Property A2) and $1,000 of net long-term, foreign-source capital gain ($1,000 gain onProperty A3).

(v) The character of A’s gain under paragraph(d) of this section is therefore $2,000 long-term,U.S.-source capital gain ($3,000 gain recognizedunder section 737 3 $2,000 net long-term, U.S.-


778/20047/28MAY96/A29-004

13

source capital gain/$3,000 total net precontribu-tion gain) and $1,000 long-term, foreign-sourcecapital gain ($3,000 gain recognized undersection 737 3 $1,000 net long-term, foreign-source capital gain/$3,000 total net precontribu-tion gain).

§1.737–2 Exceptions and specialrules.

(a) Section 708(b)(1)(B) termina-tions. Section 737 and this section donot apply to a deemed distribution ofproperty caused by a termination of thepartnership under section 708(b)(1)(B).See §1.704–4(c)(3) for a similar rule inthe context of section 704(c)(1)(B).

(b) Transfers to another partner-ship—(1) Complete transfer. Section737 and this section do not apply to atransfer by a partnership (transferorpartnership) of all of its assets andliabilities to a second partnership(transferee partnership) in an exchangedescribed in section 721, followed by adistribution of the interest in thetransferee partnership in liquidation ofthe transferor partnership as part of thesame plan or arrangement. See §1.704–4(c)(4) for a similar rule in the contextof section 704(c)(1)(B).

(2) Certain divisive transactions.Section 737 and this section do notapply to a transfer by a partnership(transferor partnership) of all of thesection 704(c) property contributed bya partner to a second partnership(transferee partnership) in an exchangedescribed in section 721, followed by adistribution as part of the same plan orarrangement of an interest in thetransferee partnership (and no otherproperty) in complete liquidation of theinterest of the partner that originallycontributed the section 704(c) propertyto the transferor partnership.

(3) Subsequent distributions. A sub-sequent distribution of property by thetransferee partnership to a partner ofthe transferee partnership that wasformerly a partner of the transferorpartnership is subject to section 737 tothe same extent that a distribution fromthe transferor partnership would havebeen subject to section 737.

(c) Incorporation of a partnership.Section 737 and this section do notapply to an incorporation of a part-nership by any method of incorporation(other than a method involving anactual distribution of partnership prop-erty to the partners followed by acontribution of that property to acorporation), provided that the part-

nership is liquidated as part of theincorporation transaction. See §1.704–4(c)(5) for a similar rule in the contextof section 704(c)(1)(B).

(d) Distribution of previously con-tributed property—(1) General rule.Any portion of the distributed propertythat consists of property previouslycontributed by the distributee partner(including property treated as contrib-uted by the partner in connection witha termination of the partnership undersection 708(b)(1)(B)) (previously con-tributed property) is not taken intoaccount in determining the amount ofthe excess distribution or the partner’snet precontribution gain. See §1.737–3(b)(2) for a special rule for determin-ing the basis of previously contributedproperty in the hands of a distributeepartner who contributed the property tothe partnership.

(2) Limitation for distribution ofpreviously contributed interest in anentity. An interest in an entity pre-viously contributed to the partnership isnot treated as previously contributedproperty to the extent that the value ofthe interest is attributable to propertycontributed to the entity after theinterest was contributed to the part-nership. The preceding sentence doesnot apply to the extent that the propertycontributed to the entity was contrib-uted to the partnership by the partnerthat also contributed the interest in theentity to the partnership.

(3) Nonrecognition transactions.Property received by the partnership inexchange for contributed section 704(c)property in a nonrecognition transactionis treated as the contributed propertywith regard to the contributing partnerfor purposes of section 737 to theextent that the property received istreated as section 704(c) property under§1.704–3(a)(8). See §1.704–4(d)(1) fora similar rule in the context of section704(c)(1)(B).

(4) Undivided interests. The distribu-tion of an undivided interest in prop-erty is treated as the distribution ofpreviously contributed property to theextent that the undivided interest doesnot exceed the undivided interest, ifany, contributed by the distributeepartner in the same property. See§1.704–4(c)(6) for the application ofsection 704(c)(1)(B) in a similar con-text. The portion of the undividedinterest in property retained by thepartnership after the distribution, ifany, that is treated as contributed by

the distributee partner, is reduced to theextent of the undivided interest dis-tributed to the distributee partner.

(e) Examples. The following exam-ples illustrate the rules of this section.Unless otherwise specified, partnershipincome equals partnership expenses(other than depreciation deductions forcontributed property) for each year ofthe partnership, the fair market value ofpartnership property does not change,all distributions by the partnership aresubject to section 737, and all partnersare unrelated.

Example 1. Distribution of previously contrib-uted property. (i) On January 1, 1995, A, B, andC form partnership ABC as equal partners. Acontributes the following nondepreciable realproperty to the partnership:

Fair MarketValue

Adjusted TaxBasis

Property A1 $20,000 $10,000Property A2 10,000 6,000

(ii) A’s total net precontribution gain on thecontributed property is $14,000 ($10,000 onProperty A1 plus $4,000 on Property A2). Bcontributes $10,000 cash and Property B, non-depreciable real property with a fair market valueand adjusted tax basis of $20,000. C contributes$30,000 cash.

(iii) On December 31, 1998, Property A2 andProperty B are distributed to A in completeliquidation of A’s interest in the partnership.Property A2 was previously contributed by Aand is therefore not taken into account indetermining the amount of the excess distributionor A’s net precontribution gain. The adjusted taxbasis of Property A2 in the hands of A is alsodetermined under section 732 as if that propertywere the only property distributed to A.

(iv) As a result of excluding Property A2 fromthese determinations, the amount of the excessdistribution is $10,000 ($20,000 fair marketvalue of distributed Property B less $10,000adjusted tax basis in A’s partnership interest).A’s net precontribution gain is also $10,000($14,000 total net precontribution gain less$4,000 gain with respect to previously contrib-uted Property A2). A therefore recognizes$10,000 of gain on the distribution, the lesser ofthe excess distribution and the net precontribu-tion gain.

Example 2. Distribution of a previously con-tributed interest in an entity. (i) On January 1,1995, A, B, and C form partnership ABC asequal partners. A contributes Property A, non-depreciable real property with a fair market valueof $10,000 and an adjusted tax basis of $5,000,and all of the stock of Corporation X with a fairmarket value and adjusted tax basis of $500. Bcontributes $500 cash and Property B, nondepre-ciable real property with a fair market value andadjusted tax basis of $10,000. Partner C contrib-utes $10,500 cash. On December 31, 1996, ABCcontributes Property B to Corporation X in anonrecognition transaction under section 351.

(ii) On December 31, 1998, all of the stock ofCorporation X is distributed to A in completeliquidation of A’s interest in the partnership. Thestock is treated as previously contributed prop-erty with respect to A only to the extent of the


778/20047/28MAY96/A29-004

14

$500 fair market value of the Corporation Xstock contributed by A. The fair market value ofthe distributed stock for purposes of determiningthe amount of the excess distribution is therefore$10,000 ($10,500 total fair market value ofCorporation X stock less $500 portion treated aspreviously contributed property). The $500 fairmarket value and adjusted tax basis of theCorporation X stock is also not taken intoaccount in determining the amount of the excessdistribution and the net precontribution gain.

(iii) A recognizes $5,000 of gain under section737, the amount of the excess distribution($10,000 fair market value of distributed prop-erty less $5,000 adjusted tax basis in A’spartnership interest) and A’s net precontributiongain ($10,000 fair market value of Property Aless $5,000 adjusted tax basis in Property A).

Example 3. Distribution of undivided interestin property. (i) On January 1, 1995, A and Bform partnership AB as equal partners. Acontributes $500 cash and an undivided one-halfinterest in Property X. B contributes $500 cashand an undivided one-half interest in Property X.

(ii) On December 31, 1998, an undivided one-half interest in Property X is distributed to A ina current distribution. The distribution of theundivided one-half interest in Property X istreated as a distribution of previously contributedproperty because A contributed an undividedone-half interest in Property X. As a result, Adoes not recognize any gain under section 737 onthe distribution.

§1.737–3 Basis adjustments; Recoveryrules.

(a) Distributee partner’s adjustedtax basis in the partnership interest.The distributee partner’s adjusted taxbasis in the partnership interest isincreased by the amount of gainrecognized by the distributee partnerunder section 737 and this section. Thisincrease is not taken into account indetermining the amount of gain recog-nized by the partner under section737(a)(1) and this section or in deter-mining the amount of gain recognizedby the partner under section 731(a) onthe distribution of money in the samedistribution or any related distribution.See §1.704–4(e)(1) for a determinationof the distributee partner’s adjusted taxbasis in a distribution subject to section704(c)(1)(B).

(b) Distributee partner’s adjustedtax basis in distributed property—(1)In general. The distributee partner’sadjusted tax basis in the distributedproperty is determined under section732(a) or (b) as applicable. The in-crease in the distributee partner’s ad-justed tax basis in the partnershipinterest under paragraph (a) of thissection is taken into account in deter-mining the distributee partner’s ad-justed tax basis in the distributedproperty other than property previously

contributed by the partner. See §1.704–4(e)(2) for a determination of basis in adis t r ibut ion subject to sect ion704(c)(1)(B).

(2) Previously contributed property.The distributee partner’s adjusted taxbasis in distributed property that thepartner previously contributed to thepartnership is determined as if it weredistributed in a separate and independ-ent distribution prior to the distributionthat is subject to section 737 and§1.737–1.

(c) Partnership’s adjusted tax basisin partnership property—(1) Increase inbasis. The partnership’s adjusted taxbasis in eligible property is increased bythe amount of gain recognized by thedistributee partner under section 737.

(2) Eligible property. Eligible prop-erty is property that—

(i) Entered into the calculation ofthe distributee partner’s net pre-contribution gain;

(ii) Has an adjusted tax basis to thepartnership less than the property’s fairmarket value at the time of thedistribution;

(iii) Would have the same characterof gain on a sale by the partnership toan unrelated party as the character ofany of the gain recognized by the dis-tributee partner under section 737; and

(iv) Was not distributed to anotherpartner in a distribution subject tosection 704(c)(1)(B) and §1.704–4 thatwas part of the same distribution as thedistribution subject to section 737.

(3) Method of adjustment. For thepurpose of allocating the basis increaseunder paragraph (c)(2) of this sectionamong the eligible property, all eligibleproperty of the same character istreated as a single group. Character forthis purpose is determined in the samemanner as the character of the recog-nized gain is determined under §1.737–1(d). The basis increase is allocatedamong the separate groups of eligibleproperty in proportion to the characterof the gain recognized under section737. The basis increase is then allo-cated among property within eachgroup in the order in which theproperty was contributed to the part-nership by the partner, starting with theproperty contributed first, in an amountequal to the difference between theproperty’s fair market value and itsadjusted tax basis to the partnership atthe time of the distribution. For prop-erty that has the same character and

was contributed in the same (or arelated) transaction, the basis increaseis allocated based on the respectiveamounts of unrealized appreciation insuch properties at the time of thedistribution.

(4) Section 754 adjustments. Thebasis adjustments to partnership prop-erty made pursuant to paragraph (c)(1)of this section are not elective andmust be made regardless of whether thepartnership has an election in effectunder section 754. Any adjustments tothe bases of partnership property (in-cluding eligible property as defined inparagraph (c)(2) of this section) undersection 734(b) pursuant to a section754 election (other than basis adjust-ments under section 734(b)(1)(A) de-scribed in the following sentence) mustbe made after (and must take intoaccount) the adjustments to basis madeunder paragraph (a) and paragraph(c)(1) of this section. Basis adjustmentsunder section 734(b)(1)(A) that areattributable to distributions of money tothe distributee partner that are part ofthe same distribution as the distributionof property subject to section 737 aremade before the adjustments to basisunder paragraph (a) and paragraph(c)(1) of this section. See §1.737–1(c)(2)(ii) for the effect, if any, of basisadjustments under section 734(b)(1)(A)on a partner’s net precontribution gain.See also §1.704–4(e)(3) for a similarrule regarding basis adjustments pur-suant to a section 754 election in thecontext of section 704(c)(1)(B).

(d) Recovery of increase to adjustedtax basis. Any increase to the adjustedtax basis of partnership property underparagraph (c)(1) of this section isrecovered using any applicable recov-ery period and depreciation (or othercost recovery) method (including first-year conventions) available to thepartnership for newly purchased prop-erty (of the type adjusted) placed inservice at the time of the distribution.

(e) Examples. The following exam-ples illustrate the rules of this section.Unless otherwise specified, partnershipincome equals partnership expenses(other than depreciation deductions forcontributed property) for each year ofthe partnership, the fair market value ofpartnership property does not change,all distributions by the partnership aresubject to section 737, and all partnersare unrelated.

Example 1. Partner’s basis in distributedproperty. (i) On January 1, 1995, A, B, and C


778/20047/28MAY96/A29-004

15

form partnership ABC as equal partners. Acontributes Property A, nondepreciable realproperty with a fair market value of $10,000 andan adjusted tax basis of $5,000. B contributesProperty B, nondepreciable real property with afair market value and adjusted tax basis of$10,000. C contributes $10,000 cash.

(ii) On December 31, 1998, Property B isdistributed to A in complete liquidation of A’sinterest in the partnership. A recognizes $5,000of gain under section 737, an amount equal tothe excess distribution of $5,000 ($10,000 fairmarket value of Property B less $5,000 adjustedtax basis in A’s partnership interest) and A’s netprecontribution gain of $5,000 ($10,000 fairmarket value of Property A less $5,000 adjustedtax basis of such property).

(iii) A’s adjusted tax basis in A’s partnershipinterest is increased by the $5,000 of gainrecognized under section 737. This increase istaken into account in determining A’s basis inthe distributed property. Therefore, A’s adjustedtax basis in distributed Property B is $10,000under section 732(b).

Example 2. Partner’s basis in distributedproperty in connection with gain recognizedunder section 704(c)(1)(B). (i) On January 1,1995, A, B, and C form partnership ABC asequal partners. A contributes the followingnondepreciable real property to the partnership:

Fair MarketValue

Adjusted TaxBasis

Property A1 $10,000 $5,000Property A2 10,000 2,000

(ii) B contributes $10,000 cash and PropertyB, nondepreciable real property, with a fairmarket value and adjusted tax basis of $10,000.C contributes $20,000 cash.

(iii) On December 31, 1998, Property B isdistributed to A in a current distribution andProperty A1 is distributed to B in a currentdistribution. A recognizes $5,000 of gain undersection 704(c)(1)(B) and §1.704–4 on the dis-tribution of Property A1 to B, the differencebetween the fair market value of such property($10,000) and the adjusted tax basis in dis-tributed Property A1 ($5,000). The adjusted taxbasis of A’s partnership interest is increased bythis $5,000 of gain under section 704(c)(1)(B)and §1.704–4(e)(1).

(iv) The increase in the adjusted tax basis ofA’s partnership interest is taken into account indetermining the amount of the excess distribu-tion. As a result, there is no excess distributionbecause the fair market value of Property B($10,000) is less than the adjusted tax basis ofA’s interest in the partnership at the time ofdistribution ($12,000). A therefore recognizes nogain under section 737 on the receipt of PropertyB. A’s adjusted tax basis in Property B is$10,000 under section 732(a)(1). The adjustedtax basis of A’s partnership interest is reducedfrom $12,000 to $2,000 under section 733. SeeExample 3 of §1.737–1(e).

Example 3. Partnership’s basis in partnershipproperty after a distribution with section 737gain. (i) On January 31, 1995, A, B, and C formpartnership ABC as equal partners. A contributesthe following nondepreciable property to thepartnership:

Fair MarketValue

Adjusted TaxBasis

Property A1 $1,000 $ 500Property A2 4,000 1,500 Property A3 4,000 6,000Property A4 6,000 4,000

(ii) The character of gain or loss on PropertiesA1, A2, and A3 is long-term, U.S.-source capitalgain or loss. The character of gain on PropertyA4 is long-term, foreign-source capital gain. Bcontributes Property B, nondepreciable real prop-erty with a fair market value and adjusted taxbasis of $15,000. C contributes $15,000 cash.

(iii) On December 31, 1998, Property B isdistributed to A in complete liquidation of A’sinterest in the partnership. A recognizes gain of$3,000 under section 737, an amount equal to theexcess distribution of $3,000 ($15,000 fairmarket value of Property B less $12,000 adjustedtax basis in A’s partnership interest) and A’s netprecontribution gain of $3,000 ($15,000 aggre-gate fair market value of the property contributedby A less $12,000 aggregate adjusted tax basis ofsuch property).

(iv) $2,000 of A’s gain is long-term, foreign-source capital gain ($3,000 total gain undersection 737 3 $2,000 net long-term, foreign-source capital gain/$3,000 total net precontribu-tion gain). $1,000 of A’s gain is long-term, U.S.-source capital gain ($3,000 total gain undersection 737 3 $1,000 net long-term, U.S.-sourcecapital gain/$3,000 total net precontributiongain).

(v) The partnership must increase the adjustedtax basis of the property contributed by A by$3,000. All property contributed by A is eligibleproperty. Properties A1, A2, and A3 have thesame character and are grouped into a singlegroup for purposes of allocating this basisincrease. Property A4 is in a separate charactergroup.

(vi) $2,000 of the basis increase must beallocated to long-term, foreign-source capitalassets because $2,000 of the gain recognized byA was long-term, foreign-source capital gain.The adjusted tax basis of Property A4 istherefore increased from $4,000 to $6,000.$1,000 of the increase must be allocated toProperties A1 and A2 because $1,000 of the gainrecognized by A is long-term, U.S.-source capitalgain. No basis increase is allocated to PropertyA3 because its fair market value is less than itsadjusted tax basis. The $1,000 basis increase isallocated between Properties A1 and A2 basedon the unrealized appreciation in each assetbefore such basis adjustment. As a result, theadjusted tax basis of Property A1 is increased by$167 ($1,000 3 $500/$3,000) and the adjustedtax basis of Property A2 is increased by $833($1,000 3 $2,500/3,000).

§1.737–4 Anti-abuse rule.

(a) In general. The rules of section737 and §§1.737–1, 1.737–2, and1.737–3 must be applied in a mannerconsistent with the purpose of section737. Accordingly, if a principal pur-pose of a transaction is to achieve a taxresult that is inconsistent with thepurpose of section 737, the Commis-sioner can recast the transaction forfederal tax purposes as appropriate to

achieve tax results that are consistentwith the purpose of section 737.Whether a tax result is inconsistentwith the purpose of section 737 mustbe determined based on all the factsand circumstances. See §1.704–4(f) foran anti-abuse rule and examples in thecontext of section 704(c)(1)(B). Theanti-abuse rule and examples undersection 704(c)(1)(B) and §1.704–4(f)are relevant to section 737 and§§1.737–1, 1.737–2, and 1.737–3 to theextent that the net precontribution gainfor purposes of section 737 is deter-mined by reference to section704(c)(1)(B).

(b) Examples. The following exam-ples illustrate the rules of this section.The examples set forth below do notdelineate the boundaries of either per-missible or impermissible types oftransactions. Further, the addition ofany facts or circumstances that are notspecifically set forth in an example (orthe deletion of any facts or circum-stances) may alter the outcome of thetransaction described in the example.Unless otherwise specified, partnershipincome equals partnership expenses(other than depreciation deductions forcontributed property) for each year ofthe partnership, the fair market value ofpartnership property does not change,all distributions by the partnership aresubject to section 737, and all partnersare unrelated.

Example 1. Increase in distributee partner’sbasis by temporary contribution; results incon-sistent with the purpose of section 737. (i) OnJanuary 1, 1995, A, B, and C form partnershipABC as equal partners. A contributes PropertyA1, nondepreciable real property with a fairmarket value of $10,000 and an adjusted taxbasis of $1,000. B contributes Property B,nondepreciable real property with a fair marketvalue of $10,000 and an adjusted tax basis of$10,000. C contributes $10,000 cash.

(ii) On January 1, 1999, pursuant to a plan aprincipal purpose of which is to avoid gain undersection 737, A transfers to the partnershipProperty A2, nondepreciable real property with afair market value and adjusted tax basis of$9,000. A treats the transfer as a contribution tothe partnership pursuant to section 721 andincreases the adjusted tax basis of A’s part-nership interest from $1,000 to $10,000. OnJanuary 1, 1999, the partnership agreement isamended and all other necessary steps are takenso that substantially all of the economic risks andbenefits of Property A2 are retained by A. OnFebruary 1, 1999, Property B is distributed to Ain a current distribution. If the contribution ofProperty A2 is treated as a contribution to thepartnership for purposes of section 737, there isno excess distribution because the fair marketvalue of distributed Property B ($10,000) doesnot exceed the adjusted tax basis of A’s interestin the partnership ($10,000), and therefore

SEQ 0239 JOB A29-004-007 PAGE-0016 PT 1 PGS 10- REVISED 28MAY96 AT 10:52 BY LR DEPTH: 65.01 PICAS WIDTH 46.01 PICAS COMPOSITE COLOR

778/20047/28MAY96/A29-004

16

section 737 does not apply. A’s adjusted taxbasis in distributed Property B is $10,000 undersection 732(a)(1) and the adjusted tax basis ofA’s partnership interest is reduced to zero undersection 733.

(iii) On March 1, 2000, A receives PropertyA2 from the partnership in complete liquidationof A’s interest in the partnership. A recognizesno gain on the distribution of Property A2because the property was previously contributedproperty. See §1.737–2(d).

(iv) Although A has treated the transfer ofProperty A2 as a contribution to the partnershipthat increased the adjusted tax basis of A’sinterest in the partnership, it would be inconsist-ent with the purpose of section 737 to recognizethe transfer as a contribution to the partnership.Section 737 requires recognition of gain whenthe value of distributed property exceeds thedistributee partner’s adjusted tax basis in thepartnership interest. Section 737 assumes thatany contribution or other transaction that affectsa partner’s adjusted tax basis in the partnershipinterest is a contribution or transaction insubstance and is not engaged in with a principalpurpose of avoiding recognition of gain undersection 737. Because the transfer of Property A2to the partnership was not a contribution insubstance and was made with a principal purposeof avoiding recognition of gain under section737, the Commissioner can disregard the contri-bution of Property A2 for this purpose. As aresult, A recognizes gain of $9,000 under section737 on the receipt of Property B, an amountequal to the lesser of the excess distribution of$9,000 ($10,000 fair market value of distributedProperty B less the $1,000 adjusted tax basis ofA’s partnership interest, determined withoutregard to the transitory contribution of PropertyA2) or A’s net precontribution gain of $9,000 onProperty A1.

Example 2. Increase in distributee partner’sbasis; section 752 liability shift; results consistentwith the purpose of section 737. (i) On January 1,1995, A and B form general partnership AB asequal partners. A contributes Property A, non-depreciable real property with a fair market valueof $10,000 and an adjusted tax basis of $1,000. Bcontributes Property B, nondepreciable real prop-erty with a fair market value and adjusted taxbasis of $10,000. The partnership also borrows$10,000 on a recourse basis and purchasesProperty C. The $10,000 liability is allocatedequally between A and B under section 752,thereby increasing the adjusted tax basis in A’spartnership interest to $6,000.

(ii) On December 31, 1998, the partners agreethat A is to receive Property B in a currentdistribution. If A were to receive Property B atthat time, A would recognize $4,000 of gainunder section 737, an amount equal to the lesserof the excess distribution of $4,000 ($10,000 fairmarket value of Property B less $6,000 adjustedtax basis in A’s partnership interest) or A’s netprecontribution gain of $9,000 ($10,000 fairmarket value of Property A less $1,000 adjustedtax basis of Property A).

(iii) With a principal purpose of avoiding suchgain, A and B agree that A will be solely liablefor the repayment of the $10,000 partnershipliability and take the steps necessary so that theentire amount of the liability is allocated to Aunder section 752. The adjusted tax basis in A’spartnership interest is thereby increased from$6,000 to $11,000 to reflect A’s share of the$5,000 of liability previously allocated to B. Asa result of this increase in A’s adjusted tax basis,

there is no excess distribution because the fairmarket value of distributed Property B ($10,000)is less than the adjusted tax basis of A’spartnership interest. Recognizing A’s increasedadjusted tax basis as a result of the shift inliabilities is consistent with the purpose ofsection 737 and this section. Section 737 requiresrecognition of gain only when the value of thedistributed property exceeds the distributee part-ner’s adjusted tax basis in the partnershipinterest. The $10,000 recourse liability is a bonafide liability of the partnership that was under-taken for a substantial business purpose and A’sand B’s agreement that A will assume respon-sibility for repayment of that debt has substance.Therefore, the increase in A’s adjusted tax basisin A’s interest in the partnership due to the shiftin partnership liabilities under section 752 isrespected, and A recognizes no gain undersection 737.

§1.737–5 Effective date.

Sections 1.737–1, 1.737–2, 1.737–3,and 1.737–4 apply to distributions by apartnership to a partner on or afterJanuary 9, 1995.

Dated December 13, 1995.

Margaret Milner Richardson,Commissioner of

Internal Revenue.

Approved:

Leslie Samuels,Assistant Secretary of

the Treasury.

(Filed by the Office of the Federal Register onDecember 22, 1995, 8:45 a.m., and publishedin the issue of the Federal Register forDecember 26, 1995, 60 F.R. 66727)

Section 2601.—Tax Imposed

26 CFR 26.2601–1: Effective dates.

T.D. 8644

DEPARTMENT OF THE TREASURYInternal Revenue Service 26 CFR Parts 26, 301 and 602

Generation-Skipping Transfer Tax

AGENCY: Internal Revenue Service,Treasury

ACTION: Final and temporaryregulations

SUMMARY: This document containsfinal generation-skipping transfer(GST) tax regulations under chapter 13of the Internal Revenue Code (Code),

as added by section 1431 of the TaxReform Act of 1986. Changes to theapplicable law were made by the TaxReform Act of 1986, the Technical andMiscellaneous Revenue Act of 1988,and the Revenue Reconciliation Act of1989. The regulations are necessary toprovide guidance to taxpayers so thatthey may comply with chapter 13 ofthe Code.

DATES: These regulations are effectiveDecember 27, 1995.

FOR FURTHER INFORMATIONCONTACT: James F. Hogan, (202)622-3090 (not a toll free number).


Paperwork Reduction Act

The collection of information re-quirements contained in these finalregulations have been reviewed andapproved by the Office of Managementand Budget in accordance with thePaperwork Reduction Act (44 U.S.C.3507) under control numbers 1545–0985 (relating to §§26.2601–1 and26.2662–2) and 1545–1358 (relating to§§26.2632–1, 26.2642–1, 26.2642–2,26.2642–3, 26.2642–4 and 26.2652–2).All of these paperwork requirementswill be consolidated under controlnumber 1545–0985. Responses to thiscollection of information are requiredto ensure the proper collection of thegeneration-skipping transfer tax.

An agency may not conduct orsponsor, and a person is not required torespond to, a collection unless thecollection of information displays avalid control number.

The estimated burden per respondent is1 hour under control number 1545–0985.The time estimates for the reporting andrecordkeeping requirements under controlnumber 1545–1358 are included in theestimates of burden applicable to Forms706, 706NA, 706GS(T), 706GS(D),706GS(D–1), and 709.

Comments concerning the accuracyof this burden estimate and suggestionsfor reducing this burden should bedirected to the Internal Revenue Serv-ice, Attn: IRS Reports Clearance Of-ficer T:FP, Washington, DC 20224, andto the Office of Management andBudget, Attn: Desk Officer for theDepartment of Treasury, Office ofInformation and Regulatory Affairs,Washington, DC 20503.


778/20047/28MAY96/A29-004

17

Books or records relating to thiscollection of information must be re-tained as long as their contents maybecome material in the administrationof any internal revenue law. Generally,tax returns and tax return informationare confidential, as required by 26U.S.C. 6103.

Background

On March 15, 1988, the IRS pub-lished in the Federal Register a noticeof proposed rulemaking (53 FR 8469)by cross reference to Temporary Reg-ulations published on the same date inthe Federal Register (53 FR 8441)under §§2601 and 2662. Subsequently,on December 24, 1992, the IRS pub-lished a second notice of proposedrulemaking (57 FR 61353) amendingthe prior notice. Also, on December 24,1992, the IRS published a notice ofproposed rulemaking in the FederalRegister (57 FR 61356) containingproposed regulations under §§2611,2612, 2613, 2632, 2641, 2642, 2652,2653, 2654, and 2663. The IRS re-ceived written and oral comments onthe proposed regulations and, on April21, 1993, a public hearing was held.These documents adopt final regula-tions with respect to these notices ofproposed rulemaking.

The following is a discussion of themore significant revisions that weremade.

Section 2601—Transitional Rules

Transfers after September 25, 1985and before October 23, 1986

Section 26.2601–1(a)(2)(i), relatingto inter vivos transfers made afterSeptember 25, 1985, and before Octo-ber 23, 1986, clarifies that chapter 13applies to inter vivos transfers that aresubject to chapter 12 even though a gifttax is not actually paid because of, forexample, the marital deduction or theunified credit.

Section 26.2601–1(a)(2)(ii) (whichtreats inter vivos transfers made afterSeptember 25, 1985, and before Octo-ber 23, 1986, as if made on October23, 1986) clarifies that the value of thetransferred property for purposes ofchapter 13 is determined as of theactual transfer date rather than as of thedeemed transfer date of October 23,1986.

Section 26.2601–1(a)(4) adds an ex-ample illustrating that §26.2601–1(a)(2)

does not apply to transfers made undera revocable trust that becomes irrevoca-ble by reason of the grantor’s deathafter September 25, 1985, but beforeOctober 23, 1986. Those transfers arenot subject to chapter 13 because theyare in the nature of testamentarytransfers that occurred prior to October23, 1986.

Section 26.2601–1(b)(1)(ii)(C) clar-ifies that incidents of ownership in aninsurance policy that are relinquishedbefore September 25, 1985, are not tobe taken into account in determiningwhether a trust is irrevocable forpurposes of §26.2601–1(b)(1), whichexempts trusts that were irrevocable onSeptember 25, 1985, from the provi-sions of chapter 13.

Under §26.2601–1(b)(1)(iii)(A), aqualified terminable interest property(QTIP) trust that is grandfathered under§26.2601–1(b)(1) is treated as if thereverse QTIP election had been madeunder section 2652(a)(3). Example 1 in§26.2601–1(b)(1)(iii)(B) has been re-vised to illustrate that the initial QTIPelection under section 2523(f) need notbe made before September 25, 1985,provided that the trust was irrevocableon that date. Further, §26.2601–1(b)(1)-(v)(C) has been revised to provide thatin the case of a trust with respect towhich a reverse QTIP election isdeemed to have been made, the failureto exercise the right of reimbursementunder section 2207A will not be treatedas a constructive addition to the trust.This conforms the treatment of truststhat are irrevocable on September 25,1985, with the rule provided in§26.2652–1(a)(3) which applies totrusts created after September 25, 1985.

In §26.2601–1(b)(2)(iv)(B), thephrase ‘‘or to a generation-skippingtrust’’ has been added to eliminate anyimplication that the provision is limitedto situations involving direct skips. Theprovision applies to all generation-skipping transfers.

Section 26.2601–1(b)(3)(iii) appliesthe transitional rules where the dece-dent was under a mental disability buthad not been adjudged a mental incom-petent. This section has been clarifiedto provide that any evidence submittedto establish the decedent’s state ofincompetency is not conclusive and issubject to examination. In addition, anexample has been added to illustratethe transitional rules applicable in thecase of mental incompetency.

Uniform statutory rule againstperpetuities

The notice of proposed rulemakingpublished on December 24, 1992, (57FR 61353) contained a proposed modi-fication to §26.2601–1(b)(1)(v)(B)(2).Section 26.2601–1(b)(1)(v)(B)(2)provided that the exercise of a non-general power of appointment will notbe treated as an addition to a grand-fathered GST trust if the power isexercised in a manner that may notpostpone or suspend the vesting, abso-lute ownership, or power of alienationof a interest in property for a period,measured from the date of creation ofthe trust, extending beyond any life inbeing at the date of creation of the trustplus a period of 21 years (perpetuitiesperiod).

The proposed modification to§26.2601–1(b)(1)(v)(B)(2), which is fi-nalized in this document, provides thatthe exercise of a nongeneral power ofappointment that validly postpones orsuspends the vesting, absolute owner-ship, or power of alienation of aninterest in property for a term of yearsthat will not exceed 90 years (measuredfrom the date of creation of the trust)will not be considered an exercise thatpostpones vesting, etc., beyond theperpetuities period. The modificationtakes into account the fact that manystates have adopted the Uniform Statu-tory Rule Against Perpetuities(USRAP) which allows either a 90 yearperpetuities period or the common lawperpetuities period. Under §26.2601–1(b)(1)(v)(B)(2), as modified, the non-general power may not be exercised ina manner that postpones vesting, etc.,for the longer of 90 years or thecommon law period (lives in being plus21 years).

The discussion in the preamble pub-lished on December 24, 1992, indicatesthat USRAP has a ‘‘wait and see’’aspect that is not appropriate for GSTpurposes because it will be necessaryto determine the GST tax consequencesof distributions and terminations at thetime they occur. Thus, the preamblestated that, in order to comply with theregulation and avoid a constructiveaddition, it must be clear at the timethe nongeneral power is exercised thatthe exercise may not postpone orsuspend vesting, etc., beyond eitherlives in being plus 21 years or 90 years(but not the longer of the two periods).A commentator has pointed out that theUSRAP invalidates any attempt to


778/20047/28MAY96/A29-004

18

exercise a power for the longer of thetwo periods. Under the USRAP, it willbe clear at the time the nongeneralpower is exercised that the exercisemay not postpone or suspend vesting,etc., beyond one of the two periods(but not both). Under the USRAP, thecommon law period (lives in being plus21 years) is imposed in the event thatthe power holder exercises the powerin a manner that attempts to suspend orpostpone vesting, etc., for the longer ofthe two periods. Although the preamblepublished on December 24, 1992, mayhave been misleading in referring to a‘‘wait and see’’ aspect of USRAP, themodification to §26.2601–1(b)(1)(v)-(B)(2) is not affected.

Section 2611 et. seq.—GSTsubstantive rules

Definition of generation-skippingtransfers

Section 26.2611–1 has been revisedto clarify that, in determining whetheran event is subject to the GST tax,reference must be made to the mostrecent transfer that was subject toFederal estate or gift tax. This isbecause the most recent transfer thatwas subject to estate or gift taxestablishes the identity of the trans-feror, which in turn determines theidentity of the skip persons and non-skip persons.

Definitions

Section 26.2612–1(a)(2)(i) of theproposed regulations provides generallythat, for purposes of determiningwhether a transfer constitutes a directskip, the generation assignment of aperson who would otherwise be a skipperson is redetermined by disregardingthe intervening generation, if certainindividuals have died prior to thetransfer (e.g., a predeceased child ofthe transferor). The section has beenmodified to provide that, if an individ-ual who is a member of the interveninggeneration dies no later than 90 daysafter the transfer, the deceased individ-ual is treated as having predeceased thetransferor, if the governing instrumentor applicable state law provides forsuch treatment.

Section 26.2612–1(a)(2)(ii) has beenadded to provide that, if a transferormakes an addition to an existing trustafter the death of an individual de-

scribed in paragraph (a)(2)(i) of thatsection (i.e., an individual in theintervening generation), the additionalproperty is treated as being held in aseparate trust for purposes of chapter13.

Section 2612(a)(1) defines the termtaxable termination to mean the termi-nation of an interest in property held intrust unless, among other things, at notime after such termination may a dis-tribution (including distributions ontermination) be made from the trust toa skip person. Section 26.2612–1(b)(1)-(iii), as proposed, has been revised toprovide that, for purposes of applyingthis rule, potential distributions to skippersons are to be disregarded if theprobability of occurrence is so remoteas to be negligible. A similar rule hasbeen applied to §26.2612–1(d)(2), re-garding when a trust is considered askip person. The probability that adistribution will occur is so remote asto be negligible only if it can beascertained by actuarial standards thatthere is less than a 5 percent proba-bility that the distribution will occur.

Section 26.2612–1(c)(2) has beenadded to clarify that the look-throughrule in section 2651(e)(2) does notapply for purposes of determiningwhether a transfer from one trust toanother trust is a taxable distribution.Thus, the transfer is treated as havingbeen made to the recipient trust ratherthan to the beneficiaries of that trust.Accordingly, a transfer is a taxabledistribution only if the recipient trustitself is a skip person.

Section 26.2612–1(e)(3) has beenadded to provide that, in determiningwhether a trust is a skip person, trustinterests disclaimed pursuant to aqualified disclaimer described in sec-tion 2518 are not taken into account.

Example 3 has been added to§26.2612–1(f) to illustrate that a trans-fer to a trust pursuant to which abeneficiary who is a skip person has awithdrawal power is not a direct skipunless the trust is a skip person.

Example 9 has been added to§26.2612–1(f) to illustrate that a tax-able termination may occur upon thedistribution of the entire trust property(less amounts retained to pay a result-ing GST tax and administrationexpenses).

Example 14 contained in §26.2612–1(f) of the proposed regulations illus-trates that an individual is not treatedas having an interest in a trust for

purposes of Chapter 13, if the individ-ual’s support obligation could be satis-fied at the discretion of the trustee.This example has been renumbered asExample 15 and has been clarified toprovide that an individual will have aninterest in the trust if the trustee isrequired to make distributions for thebeneficiary’s support, in satisfaction ofthe individual’s support obligation.

Allocation of GST exemption

Under §26.2632–1(b)(2)(ii)(A) of theproposed regulations, a late allocationof GST exemption is effective on thedate the Form 709 reporting the alloca-tion is filed, and is deemed to precedein point of time any taxable eventoccurring on that date. This section hasbeen revised to specify that the Form709 is treated as filed on the date it ismailed to the appropriate IRS ServiceCenter. Further, the late allocation maybe made on a timely filed Form 709reporting another transfer.

Section 26.2632–1(b)(2)(ii)(B) hasbeen added to clarify how the GSTexemption allocated on a Federal gifttax return (Form 709) is to be appor-tioned in the event that the amountallocated on the return exceeds thevalue of the transfers reported on thereturn.

Example 4 of §26.2632–1(b)(2)(iii)of the proposed regulations has beenrevised to better illustrate the effectivedate of a late allocation of GSTexemption.

Example 5 of §26.2632–1(b)(2)(iii)has been added to illustrate the auto-matic allocation of GST exemption tointer vivos direct skips in situationswhere split gift treatment is elected onan initial gift tax return filed after itsdue date.

Section 26.2632–1(d)(1) has been re-vised to provide that a late allocationof GST exemption made by an execu-tor with respect to an inter vivostransfer not included in the grossestate, is effective as of the date theallocation is filed. This rule does notapply to any automatic allocation undersection 2632(b)(1). This revision con-forms the regulation to section2642(b)(3).

Estate tax inclusion period

As proposed, §26.2632–1(c)(2)(ii)provided that an estate tax inclusionperiod (ETIP) exists during the period


778/20047/28MAY96/A29-005

19

in which the transferred property wouldhave been includible in the transferor’sgross estate had the transferor retainedan interest held by the transferor’sspouse, but only to the extent thespouse acquired the interest from thetransferor in an inter vivos transfer thatwas not included in the transferor’staxable gifts or for which a deductionwas allowed under section 2523. Com-mentators stated that there was nosupport in the statute for this spousalrule, and any such rule would require alegislative change. The final regulationseliminate this spousal rule and Example5 of §26.2632–1(c)(5).

Section 26.2632–1(c)(2)(ii)(A) hasbeen added to provide that the ETIPrules do not apply when the possibilitythat the property will be included in thegross estate of the transferor (or thetransferor’s spouse) is so remote as tobe negligible. Further, §26.2632–1(c)-(2)(ii)(B) has been added to providethat transferred property will not betreated as being subject to inclusion inthe transferor’s spouse’s gross estate,and thus, subject to an ETIP, where theonly power possessed by the spouse isa right to withdraw no more than thegreater of 5 percent or $5,000 of thetrust’s corpus and the withdrawal rightterminates within 60 days of thetransfer to the trust.

Section 26.2632–1(c)(5) Example 3,of the proposed regulations illustratesthat if a transferor’s spouse elects gift-splitting treatment with respect to thetransferor’s gift that is subject to anETIP, the spouse is treated as thetransferor of one-half of the gift. Theexample has been expanded to illustratethat, since the spouse’s deemed transferis subject to an ETIP, if the spouse diesprior to the termination of the trust, thespouse’s executor may allocate GSTexemption to the trust. However, theallocation will not be effective until theETIP terminates on the transferor’sdeath.

Erroneous allocations

Under the proposed regulations, al-locations in excess of the amount ofthe property transferred are void. Thistreatment has been expanded under thefinal regulations. Thus, any allocationto a trust that has no GST potential atthe time of the allocation, with respectto the transferor for whom the alloca-tion is made, is also void. This pro-vision is intended to prevent the

wasting of GST exemption because ofan erroneous allocation with respect toa testamentary or inter vivos transfer.A trust will have no GST potential onlyif there is no possibility that a GSTwill be made from the trust withrespect to the transferor.

Determination of applicable fraction

Section 26.2642–1(b)(2) of the pro-posed regulations provided rules fordetermining the inclusion ratio withrespect to a trust subject to an ETIPwhere GSTs are made from the trustduring the ETIP. Comments were re-ceived that the rules were unclearregarding whether an ineffective alloca-tion, i.e., an allocation made prior toany distributions or terminations, wouldapply in determining the amount of thetransferor’s unused GST exemption, orwhether such an allocation could bemodified prior to an ETIP termination.In response to the comments,§26.2632–1(c)(1) (providing rules forthe allocation of exemption with re-spect to a trust subject to an ETIP) and§26.2642–1(b)(2) clarify that an alloca-tion made to a trust subject to an ETIPprior to any distribution or terminationis not subject to modification orrevocation. However, the allocationwill not be effective, i.e., the allocationdoes not operate to fix the inclusionratio of the trust, at the time it is made.Rather, the allocation becomes effec-tive as of the date of a subsequentdistribution or termination. Section26.2632–1(c)(5) Example 2, illustratesthis point.

Section 26.2642–2 of the proposedregulations provides valuation rules fordetermining the denominator of theapplicable fraction under section 2642.Section 26.2642–2(a)(1) of the finalregulations specifies that, in the case ofa timely allocation of GST exemptionwith respect to an inter vivos transfer,the denominator of the applicable frac-tion is the fair market value of thetransferred property, as finally deter-mined for gift tax purposes.

Section 26.2642–2(b)(1) of the pro-posed regulations provides special rulesfor determining the denominator of theapplicable fraction in situations involv-ing property subject to the specialvaluation rules contained in section2032A. Under the proposed regulations,the special use value of the propertycould only be used in determining theapplicable fraction if the property was

transferred in a direct skip. Thus, ageneration-skipping trust to which sec-tion 2032A property was transferred ina transfer that was not a direct skipwould not receive the benefit of thefavorable valuation rules of section2032A in determining the applicablefraction with respect to the trust.

Comments stated that the proposedregulation was inconsistent with section2642(b), which provides that the chap-ter 11 value must be used to determinethe applicable fraction in the case of atestamentary transfer. Under the finalregulations, the section 2032A value ofproperty is to be used to determine theapplicable fraction for a direct skiptransfer and for a generation-skippingtrust created in a transfer other than adirect skip.

In the event that additional estate taxis imposed under section 2032A(c)with respect to the property, then theapplicable fraction is redetermined asof the transferor’s date of death. Thus,the GST tax liability with respect toany direct skip, taxable termination, ortaxable distribution occurring prior tothe recapture event would be recom-puted based on the redetermined appli-cable fraction, and an additional GSTtax would be due. The taxation of anyfuture GST transfers would also bebased on the redetermined applicablefraction.

Sections 26.2642–2(b)(2) and (3) ofthe proposed regulations contain specialrules for determining the denominatorof the applicable fraction in situationsinvolving residuary and pecuniary pay-ments. Generally, in the case of aresidual GST after the payment of apecuniary amount, the denominator ofthe applicable fraction will be theestate tax value of the total assetsavailable to satisfy the pecuniary pay-ment less the amount of the pecuniarypayment, provided the pecuniary pay-ment carries ‘‘appropriate interest’’ asdefined in §26.2642–2(b)(4). Under§26.2642–2(b)(4)(ii), the payment neednot carry appropriate interest if, interalia, the payment is irrevocably ‘‘setaside’’ within 15 months of the trans-feror’s death. The final regulationsclarify that this exception to the appro-priate interest requirement applies onlyif the entire payment is set aside.Further, the payment is treated as setaside if the amount is segregated andheld in a separate account pendingdistribution. Finally, under the pro-posed regulation, the appropriate inter-


778/20047/28MAY96/A29-005

20

est requirement can be satisfied if a prorata share of estate income is allocatedto the pecuniary bequest. The finalregulations clarify that the payment ofincome may be allocated pursuant tothe terms of the governing instrumentor applicable local law.

Section 26.2642–4(a)(3) of the pro-posed regulations addresses a situationwhere a lifetime allocation is madewith respect to a trust when the trustwas not subject to an ETIP, and thetrust is subsequently included in thetransferor’s gross estate. The regulationhas been revised to provide that, ifadditional GST exemption is allocatedto the trust, the nontax portion of thetrust is determined immediately afterthe date of the transferor’s death. Also,if additional GST exemption is notallocated to the trust by the transferor’sexecutor, the applicable fraction doesnot change, if the trust was nototherwise subject to an ETIP at thetime the previous allocation of GSTexemption was made. Further, wheresuch property is included in the grossestate, the denominator of the applica-ble fraction is reduced to reflect anyfederal or state estate or inheritance taxpaid by the trust.

Definition of transferor

Section 26.2652–1(a)(1) of the pro-posed regulations, defining transferor,has been revised to specify that asurviving spouse is treated as thetransferor of a qualified domestic trust(QDOT) described in section 2056Athat is included in the survivingspouse’s gross estate for federal estatetax purposes, assuming the trust is notsubject to a reverse QTIP electionunder section 2652(a)(3). The survivingspouse is also the transferor of anyQDOT created by the surviving spouseunder section 2056(d)(2)(B).

Section 26.2652–1(a)(4), as pro-posed, provided that the creator of aspecial power of appointment will betreated as making a transfer subject toestate or gift tax (and thus be consid-ered a transferor) if the holder of thepower exercised the power in a mannerthat may postpone vesting, etc., of theproperty subject to the power beyondthe permissible perpetuities period.This result is inconsistent with section2041(a)(3), which treats the holder ofthe power as making a transfer underthese circumstances. Accordingly, theregulation has been revised to provide

that the holder of the power will betreated as making a taxable transfer, ifthe holder exercises the power in themanner prescribed.

Section 26.2652–1(a)(5) has beenadded to specify that where a donor’sspouse consents to have the donor’sgift treated as made one-half by thespouse, then for purposes of chapter13, the spouse is treated as thetransferor of one-half of the propertytransferred by the donor. Thus, if adonor transfers property to a trust andretains a qualified interest as defined insection 2702(b), with the remainder toa grandchild, a consenting spousewould be treated as the transferor ofone-half the entire property. It wassuggested that the spouse should onlybe treated as the transferor of thatportion of the trust corresponding toone-half of the actuarial value of theinterest passing to the grandchild, sinceunder section 2513, only one-half thegift to the grandchild may be treated asmade by the consenting spouse. How-ever, treating the consenting spouse asthe transferor of one-half of the entiretrust is consistent with the generaltreatment accorded other split-interesttransfers. For example, if a transferortransferred property in trust retainingan interest that qualified under section2702(b), with the remainder to thetransferor’s grandchild, the transferorwould be considered the transferor ofthe entire trust for purposes of chapter13, notwithstanding that, from a techni-cal standpoint, only the actuarial valueof the gift to the grandchild is subjectto gift tax at the time of the transfer.

Example 8 in §26.2652–1(a)(6) hasbeen added illustrating that a survivingspouse will not be treated as making acontribution to a QTIP trust that isincluded in the spouse’s gross estateand is subject to a reverse QTIPelection, where the spouse directs inthe will that the estate tax generated bythe inclusion of the trust is to be paidfrom the spouse’s probate estate.

Separate shares treated as separatetrusts

Section 26.2654–1 of the proposedregulations provides rules under which‘‘separate shares’’ of a single trust thatsatisfy the requirements of the regula-tions will be recognized as separatetrusts for GST purposes.

Under the proposed regulations, amandatory payment of a pecuniary

amount is treated as a separate share ofa trust (and thus, a separate trust forGST purposes) if certain conditions aresatisfied. The section is clarified tospecify that a mandatory payment is apayment that is nondiscretionary andnoncontingent; i.e., the payment mustbe made in all events.

A sentence was added to Example 3,now contained in §26.2654–1(a)(5), toclarify that, where a decedent’s probateestate pours over to a revocable trust,and then amounts are distributed pur-suant to the terms of the trust, thedistributions will be treated as separateshares for purposes of chapter 13.

Example 4, now contained in§26.2654–1(a)(5), has been revised tospecify that the bequest of a pecuniaryamount payable in kind is not treatedas a separate share of the trust, since,under the facts presented, neither thetrust nor local law requires that theassets distributed in satisfaction of thebequest fairly reflect net appreciationand depreciation. This is the resultregardless of whether the assets aredistributed within 15 months of thetransferor’s death.

Comments received suggested thatthe regulations should allow separatetrust treatment whenever a single intervivos trust was recognized as separatetrusts under local law. For example, aninter vivos trust provides income tochild for life, but when each grandchildreaches age 35, a separate trust is to beestablished for the child, the grand-child, and the grandchild’s issue. Com-ments suggested that the Service shouldrecognize each trust established when agrandchild reaches age 35 as a separatetrust, and allow a late allocation ofGST exemption specifically to thattrust when severance occurs.

This suggestion was rejected. Gener-ally, the adoption of this approachwould effectively allow the allocationof GST exemption to specific distribu-tions from a GST trust, rather than tothe entire trust. This result would becontrary to the clear language of thestatute. See, e.g., sections 2642(a)(1)-(A) and (a)(2).

Division of a single trust intoseparate trusts

Under §26.2654–1(c) of the proposedregulations, a testamentary trust couldbe severed into several parts, providedthe severance was commenced prior tothe filing of the estate tax return.


778/20047/28MAY96/A29-005

21

Further, the new trusts created pursuantto the severance had to be identical tothe old trusts. For example, a testamen-tary trust providing for income tospouse, remainder to be divided equallybetween child and grandchild couldonly be severed into two trusts bothproviding income to spouse with theremainder to be divided between childand grandchild. Finally, an inter vivostrust could not be severed unless itconsisted of separate shares, or dif-ferent transferors had contributed to thetrust.

The regulation has been clarified tospecify that the division of a singletrust that is included in the transferor’sgross estate will be recognized ifeither: (1) the single trust consists ofseparate shares and is thus, treated asseparate trusts; or (2) the single trust,although not consisting of separateshares, is severed into separate trustspursuant to a direction in the governinginstrument providing that the trust is tobe divided into separate trusts on thetransferor’s death; or (3) the governinginstrument does not require or directseverance but the trust is severedpursuant to the discretionary authorityof the trustee granted under the govern-ing instrument or local law.

The final regulations provide that thetrusts resulting from the severance of asingle testamentary trust need not beidentical. Thus, if the trust providesincome to spouse, remainder to childand grandchild, the trust may besevered to create two trusts, one withincome to spouse, remainder to childand a second with income to spouseremainder to grandchild. This resultcould be achieved through proper estateplanning in any event. However, theregulations make it clear that theresulting trusts must provide for thesame succession of interests asprovided for under the original trusts.Thus, a trust providing for an incomeinterest to a child, with remainder to agrandchild, could not be divided intoone trust for the child (equal in valueto the child’s income interest) andanother for the grandchild.

The proposed regulations providedthat the new trusts must be funded witha fractional share of each and everyasset held by the original single trust.The provision has been revised toprovide that the new trusts may also befunded on a nonpro rata basis, based onthe fair market value of the assetsselected on the date of severance. Thus,the executor or trustee may select the

assets with which to fund each trust,and need not fractionalize each asset.

An example has been added to illu-strate that, if a revocable trust includedin the transferor’s gross estate is, underthe terms of the trust, divided intomultiple trusts on the transferor’sdeath, then each trust established willbe treated as a separate trust for GSTpurposes.

Due date of return

New §26.2662–1(d)(2) has beenadded to provide that the due date ofthe return with respect to a taxabletermination subject to an election undersection 2624(c) (relating to alternatevaluation in accordance with section2032) is April 15th of the followingyear in which the taxable terminationoccurred or on or before the 15th dayof the tenth month following the monthin which the death that resulted in thetaxable termination occurred, which-ever is later.

Application of chapter 13 tononresident aliens

Section 2663(2) requires that theCommissioner prescribe regulations,consistent with the provisions of chap-ters 11 and 12, providing for theapplication of the GST tax to anonresident alien (NRA). In general,under §26.2663–2(b) as proposed, theGST tax applied to inter vivos andtestamentary direct skip transfers by aNRA, to the extent that the transferredproperty was U.S. situs property suchthat the transfer was subject to a gifttax (in the case of inter vivos transfers)or an estate tax (in the case of testa-mentary transfers). Similarly, in thecase of transfers in trust, chapter 13applied to taxable terminations anddistributions to the extent the initialtransfer to the trust (whether inter vivosor testamentary) consisted of U.S. situsproperty, such that the initial transferwas subject to the gift or estate tax.This was the case regardless of thesitus of the property at the time of theactual distribution or termination andregardless of the residency or citizen-ship of the skip person receiving thebeneficial interest or property.

Under §26.2663–2(c) as proposed, ifthe property involved in a generation-skipping transfer was not situated inthe U.S. at the time of the initialtransfer, the generation-skipping trans-

fer was still subject to the GST tax if:(1) at the time of the direct skip,taxable termination or distribution, theproperty passes to a skip person who isa U.S. resident or citizen; and (2) at thetime of the initial transfer to the skipperson or trust, a lineal descendant ofthe transferor, who is a lineal ancestorof the skip person, was a resident orcitizen of the U.S. This rule appliedregardless of the situs of the propertyat the time of the actual distribution ortermination. Section 26.2663–2(f) ofthe proposed regulations provided forthe automatic allocation of a NRA’s$1,000,000 GST exemption regardlessof whether the transfer was a directskip.

Thus, the proposed regulations sub-jected non-U.S. situs property to theGST tax based on the status of the skipperson/recipient of the property at thetime the property was received, and thestatus of the generation that wasskipped at the time of the initialtransfer to the trust or skip person.

Many comments were critical of thisapproach. In general, these commentsemphasized that the estate and gift taxprovisions subject transfers by NRAs totransfer tax based on the situs of theproperty, not the status of the recipient.Therefore, the proposed regulationsconflict with section 2663, whichprovides that the regulations should beconsistent with the principles of chap-ters 11 and 12 of the Internal RevenueCode (Code). Further, the commenta-tors argued that treating a NRA whotransfers non-U.S. situs property as atransferor for GST tax purposes wouldconflict with the definition of trans-feror under section 2652, since thetransfer would not be subject to estateor gift tax. Under section 2652, anindividual is a transferor only to theextent the transfer is subject to U.S.gift tax or estate tax.

The proposed regulations have beenrevised to address these concerns.Thus, the rules in the proposed regula-tions applying chapter 13 to transfersof property that were not subject toestate or gift tax have been eliminated.Under the final regulations, the applica-tion of the GST tax will be limited tosituations where an estate or gift tax isimposed on the property. Thus, theGST tax will apply to inter vivos andtestamentary direct skip transfers by aNRA transferor to the extent a gift taxis imposed on the transfer (in the caseof an inter vivos transfer) or thetransferred property is included in the


778/20047/28MAY96/A29-005

22

transferor’s gross estate (in the case ofa testamentary direct skip). In the caseof taxable terminations and taxabledistributions, chapter 13 will apply tothe extent a gift tax was imposed onthe initial transfer to the trust, or theproperty was included in the trans-feror’s gross estate. Accordingly, underthe final regulations (in the absence ofa situation involving an ETIP), theapplication of Chapter 13 is generallydependent on the situs of the propertyat the time of the initial transfer. Theregulations contain special rules fordetermining the applicable fraction andinclusion ratio where a trust is fundedwith both U.S. and foreign situsproperty.

In general, the rules of §26.2632–1apply with respect to the allocation ofthe exemption. However, the ETIP ruleprovided in §26.2632–1(c) applies onlyif the property transferred by the NRAis subsequently included in the trans-feror’s gross estate. The final regula-tions provide transitional relief withrespect to NRA’s who made GSTtransfers and relied on the automaticallocation rules in the proposedregulations.

Special Analyses

It has been determined that thisTreasury decision is not a significantregulatory action as defined in EO12866. Therefore, a regulatory assess-ment is not required. It has also beendetermined that section 553(b) of theAdministrative Procedure Act (5 U.S.C.chapter 5) and the Regulatory Flex-ibility Act (5 U.S.C. chapter 6) do notapply to these regulations, and there-fore, a Regulatory Flexibility Analysisis not required. Pursuant to section7805(f) of the Internal Revenue Code,the notice of proposed rulemakingpreceding these regulations was submit-ted to the Small Business Administra-tion for comment on its impact onsmall business.


The principal author of these regula-tions is James F. Hogan, Office of theChief Counsel, IRS. Other personnelfrom the IRS and Treasury Departmentparticipated in their development.

* * * * * *

Adoption of Amendments to theRegulations

Accordingly, 26 CFR parts 26, 301,and 602 are amended as follows:

Paragraph 1. Part 26 is revised toread as follows:

PART 26—GENERATION-SKIPPINGTRANSFER TAX REGULATIONSUNDER THE TAX REFORM ACTOF 1986

26.2600–1 Table of contents.26.2601–1 Effective dates.26.2611–1 Generation-skipping transferdefined.26.2612–1 Definitions.26.2613–1 Skip person.26 .2632–1 Al loca t ion of GSTexemption.26.2641–1 Applicable rate of tax.

26.2642–1 Inclusion ratio.26.2642–2 Valuation.26.2642–3 Special rule for charitablelead annuity trusts.26.2642–4 Redetermination of applica-ble fraction.26.2642–5 Finality of inclusion ratio.26.2652–1 Transferor defined; otherdefinitions.26.2652–2 Special election forqualified terminable interest property.

26.2653–1 Taxation of multiple skips.26.2654–1 Certain trusts treated asseparate trusts.26.2662–1 Generation-skipping transfertax return requirements.26.2663–1 Recapture tax under section2032A.26.2663–2 Application of chapter 13 totransfers by nonresidents not citizens ofthe United States.

Authority: 26 U.S.C. 7805 and 26U.S.C. 2663. Section 26.2632–1 also issued under 26U.S.C. 2632 and 2663.Section 26.2642–4 also issued under 26U.S.C. 2632 and 2663.Section 26.2662–1 also issued under 26U.S.C. 2662.Section 26.2663–2 also issued under 26U.S.C. 2632 and 2663.§26.2600–1 Table of contents.

§26.2601–1 Effective dates.

(a) Transfers subject to thegeneration-skipping transfertax.(1) In general.(2) Certain transfers treated as

if made after October 22,1986.

(3) Certain trust events treatedas if occurring after Octo-ber 22, 1986.

(4) Example. (b) Exceptions.

(1) Irrevocable trusts.(2) Transition rule for wills or

revocable trusts executedbefore October 22, 1986.

(3) Transition rule in the caseof mental incompetency.

(4) Exceptions to additionsrule.

(c) Additional effective dates.

§26.2611–1 Generation-skippingtransfer defined.

§26.2612–1 Definitions.

(a) Direct skip.(1) In general.(2) Special rule for certain lin-

eal descendants.(b) Taxable termination.

(1) In general.(2) Partial termination.

(c) Taxable distribution.(1) In general.(2) Look-through rule not to

apply.(d) Skip person.(e) Interest in trust.

(1) In general.(2) Exceptions.

(f) Examples.

§26.2613–1 Skip person.

§26.2632–1 Allocation of GSTexemption.

(a) General rule.(b) Lifetime allocations.

(1) Automatic allocation to di-rect skips.

(2) A l l o c a t i o n t o o t h e rtransfers.

(c) Special rules during an estatetax inclusion period.(1) In general.(2) Estate tax inclusion period

defined.(3) Termination of an ETIP.(4) Treatment of direct skips.


778/20047/28MAY96/A29-005

23

(5) Examples.(d) Allocations after the trans-

feror’s death.(1) Allocation by executor.(2) Automatic allocation after

death.

§26.2641–1 Applicable rate of tax.

§26.2642–1 Inclusion ratio.

(a) In general.(b) Numerator of applicable

fraction.(1) In general.(2) GSTs occurring during an

ETIP.(c) Denominator of applicable

fraction.(1) In general.(2) Zero denominator.(3) Nontaxable gifts.

(d) Examples.

§26.2642–2 Valuation.

(a) Lifetime transfers.(1) In general.(2) Special rule for late alloca-

tions during life.(b) Transfers at death.

(1) In general.(2) Special rule for pecuniary

payments.(3) Special rule for residual

transfers after payment of apecuniary payment.

(4) Appropriate interest.(c) Examples.

§26.2642–3 Special rule forcharitable lead annuity trusts.

(a) In general.(b) Adjusted GST exemption

defined.(c) Example.

§26.2642–4 Redetermination ofapplicable fraction.

(a) In general.(1) Multiple transfers to a sin-

gle trust.(2) Consolidation of separate

trusts.(3) Property included in trans-

feror’s gross estate.(4) Imposition of recapture tax

under section 2032A.(b) Examples.

§26.2642–5 Finality of inclusionratio.

(a) Direct skips.(b) Other GSTs.

§26.2652–1 Transferor defined; otherdefinitions.

(a) Transferor defined.(1) In general.(2) Transfers subject to Federal

estate or gift tax.(3) Special rule for certain

QTIP trusts.(4) Exercise of certain non-

general powers of appoint-ment.

(5) Split-gift transfers.(6) Examples.

(b) Trust defined.(1) In general.(2) Examples.

(c) Trustee defined.(d) Executor defined.(e) Interest in trust.

§26.2652–2 Special election forqualified terminable interest property.

(a) In general.(b) Time and manner of making

election.(c) Transitional rule.(d) Examples.

§26.2653–1 Taxation of multipleskips.

(a) General rule.(b) Examples.

§26.2654–1 Certain trusts treated asseparate trusts.

(a) Single trust treated as separatetrusts.(1) Substantially separate and

independent shares. (2) Multiple transferors with

respect to a single trust.(3) Severance of a single trust.(4) Allocation of exemption.(5) Examples.

(b) Division of a trust included inthe gross estate.(1) In general.(2) Special rule.(3) Allocation of exemption.(4) Example.

§26.2662–1 Generation-skippingtransfer tax return requirements.

(a) In general.(b) Form of return.

(1) Taxable distributions.(2) Taxable terminations.(3) Direct skip.

(c) Person liable for tax and re-quired to make return.(1) In general.(2) Special rule for direct skips

occurring at death with re-spect to property held intrust arrangements.

(3) Limitation on personal lia-bility of trustee.

(4) Exceptions.(d) Time and manner of filing

return.(1) In general.(2) Exceptions.

(e) Place for filing returns.(f) Lien on property.

§26.2663–1 Recapture tax undersection 2032A.

§26.2663–2 Application of chapter 13to transfers by nonresidents notcitizens of the United States.

(a) In general.(b) Transfers subject to Chapter

13.(1) Direct skips.(2) Taxable distributions and

taxable terminations.(c) Trusts funded in part with

property subject to Chapter 13and in part with property notsubject to Chapter 13.(1) In general.(2) Nontax portion of the trust.(3) Special rule with respect to

estate tax inclusion period.(d) Examples.(e) Transitional rule for allocations

for transfers made before De-cember 27, 1995.

26.2601–1 Effective dates.

(a) Transfers subject to thegeneration-skipping transfer tax—(1)In general. Except as otherwise pro-vided in this section, the provisions ofchapter 13 of the Internal RevenueCode of 1986 (Code) apply to anygeneration-skipping transfer (as definedin section 2611) made after October 22,1986.

(2) Certain transfers treated as ifmade after October 22, 1986. Solely


778/20047/28MAY96/A29-006

24

for purposes of chapter 13, an intervivos transfer is treated as if it weremade on October 23, 1986, if it was—

(i) Subject to chapter 12 (regardlessof whether a tax was actually incurredor paid); and

(ii) Made after September 25, 1985,but before October 23, 1986. Forpurposes of this paragraph, the value ofthe property transferred shall be thevalue of the property on the date theproperty was transferred.

(3) Certain trust events treated as ifoccurring after October 22, 1986. Forpurposes of chapter 13, if an intervivos transfer is made to a trust afterSeptember 25, 1985, but before Octo-ber 23, 1986, any subsequent distribu-tion from the trust or termination of aninterest in the trust that occurred beforeOctober 23, 1986, is treated as occur-ring immediately after the deemedtransfer on October 23, 1986. If morethan one distribution or terminationoccurs with respect to a trust, theevents are treated as if they occurredon October 23, 1986, in the same orderas they occurred. See paragraph (b)(1)-(iv)(B) of this section for rules deter-mining the portion of distributions andterminations subject to tax under chap-ter 13. This paragraph (a)(3) does notapply to transfers to trusts not subjectto chapter 13 by reason of the transi-tion rules in paragraphs (b)(2) and (3)of this section. The provisions of thisparagraph (a)(3) do not apply indetermining the value of the propertyunder chapter 13.

(4) Example. The following exampleillustrates the principle that paragraph(a)(2) of this section is not applicableto transfers under a revocable trust thatbecame irrevocable by reason of thetransferor’s death after September 25,1985, but before October 23, 1986:

Example. T created a revocable trust onSeptember 30, 1985, that became irrevocablewhen T died on October 10, 1986. Although thetrust terminated in favor of a grandchild of T, thetransfer to the grandchild is not treated asoccurring on October 23, 1986, pursuant toparagraph (a)(2) of this section because it is notan inter vivos transfer subject to chapter 12. Thetransfer is not subject to chapter 13 because it isin the nature of a testamentary transfer thatoccurred prior to October 23, 1986.

(b) Exceptions—(1) Irrevocabletrusts—(i) In general. The provisionsof chapter 13 do not apply to anygeneration-skipping transfer under atrust (as defined in section 2652(b))that was irrevocable on September 25,

1985. The rule of the preceding sen-tence does not apply to a pro rataportion of any generation-skippingtransfer under an irrevocable trust ifadditions are made to the trust afterSeptember 25, 1985. See paragraph (b)-(1)(iv) of this section for rules fordetermining the portion of the trust thatis subject to the provisions of chapter13.

(ii) Irrevocable trust defined—(A) Ingeneral. Unless otherwise provided ineither paragraph (b)(1)(ii)(B) or (C) ofthis section, any trust (as defined insection 2652(b)) in existence on Sep-tember 25, 1985, is considered anirrevocable trust.

(B) Property includible in the grossestate under section 2038. For purposesof this chapter a trust is not an ir-revocable trust to the extent that, onSeptember 25, 1985, the settlor held apower with respect to such trust thatwould have caused the value of thetrust to be included in the settlor’sgross estate for Federal estate taxpurposes by reason of section 2038(without regard to powers relinquishedbefore September 25, 1985) if thesettlor had died on September 25,1985. A trust is considered subject to apower on September 25, 1985, eventhough the exercise of the power wassubject to the precedent giving ofnotice, or even though the exercisecould take effect only on the expirationof a stated period, whether or not on orbefore September 25, 1985, notice hadbeen given or the power had beenexercised. A trust is not consideredsubject to a power if the power is, byits terms, exercisable only on theoccurrence of an event or contingencynot subject to the settlor’s control(other than the death of the settlor) andif the event or contingency had not infact taken place on September 25,1985.

(C) Property includible in the grossestate under section 2042. A policy ofinsurance on an individual’s life that istreated as a trust under section 2652(b)is not considered an irrevocable trust tothe extent that, on September 25, 1985,the insured possessed any incident ofownership (as defined in §20.2042–1(c)of this chapter, and without regard toany incidents of ownership relinquishedbefore September 25, 1985), that wouldhave caused the value of the trust, (i.e.,the insurance proceeds) to be includedin the insured’s gross estate for Federalestate tax purposes by reason of section2042, if the insured had died onSeptember 25, 1985.

(D) Examples. The following exam-ples illustrate the application of thisparagraph (b)(1):

Example 1. Section 2038 applicable. OnSeptember 25, 1985, T, the settlor of a trust thatwas created before September 25, 1985, held atestamentary power to add new beneficiaries tothe trust. T held no other powers over anyportion of the trust. The testamentary power heldby T would have caused the trust to be includedin T’s gross estate under section 2038 if T haddied on September 25, 1985. Therefore, the trustis not an irrevocable trust for purposes of thissection.

Example 2. Section 2038 not applicable whenpower held by a person other than settlor. OnSeptember 25, 1985, S, the spouse of the settlorof a trust in existence on that date, had an annualright to withdraw a portion of the principal ofthe trust. The trust was otherwise irrevocable onthat date. Because the power was not held by thesettlor of the trust, it is not a power described insection 2038. Thus, the trust is considered anirrevocable trust for purposes of this section.

Example 3. Section 2038 not applicable. In1984, T created a trust and retained the right toexpand the class of remaindermen to include anyof T’s afterborn grandchildren. As of September25, 1985, all of T’s grandchildren were namedremaindermen of the trust. Since the exercise ofT’s power was dependent on there beingafterborn grandchildren who were not membersof the class of remaindermen, a contingency thatdid not exist on September 25, 1985, the trust isnot considered subject to the power on Septem-ber 25, 1985, and is an irrevocable trust forpurposes of this section. The result is notchanged even if grandchildren are born afterSeptember 25, 1985, whether or not T exercisesthe power to expand the class of remaindermen.

Example 4. Section 2042 applicable. OnSeptember 25, 1985, T purchased an insurancepolicy on T’s own life and designated child, C,and grandchild, GC, as the beneficiaries. Tretained the power to obtain from the insurer aloan against the surrender value of the policy.T’s insurance policy is a trust (as defined insection 2652(b)) for chapter 13 purposes. Thetrust is not considered an irrevocable trustbecause, on September 25, 1985, T possessed anincident of ownership that would have caused thevalue of the policy to be included in T’s grossestate under section 2042 if T had died on thatdate.

Example 5. Trust partially irrevocable. In1984, T created a trust naming T’s grandchildrenas the income and remainder beneficiaries. Tretained the power to revoke the trust as to one-half of the principal at any time prior to T’sdeath. T retained no other powers over the trustprincipal. T did not die before September 25,1985, and did not exercise or release the powerbefore that date. The half of the trust not subjectto T’s power to revoke is an irrevocable trust forpurposes of this section.

(iii) Trust containing qualified termi-nable interest property—(A) In gen-eral. For purposes of chapter 13, a trustdescribed in paragraph (b)(1)(ii) of thissection that holds qualified terminableinterest property by reason of anelection under section 2056(b)(7) or


778/20047/28MAY96/A29-006

25

section 2523(f) (made either on, beforeor after September 25, 1985) is treatedin the same manner as if the decedentspouse or the donor spouse (as the casemay be) had made an election undersection 2652(a)(3). Thus, transfers fromsuch trusts are not subject to chapter13, and the decedent spouse or thedonor spouse (as the case may be) istreated as the transferor of such prop-erty. The rule of this paragraph(b)(1)(iii) does not apply to that portionof the trust that is subject to chapter 13by reason of an addition to the trustoccurring after September 25, 1985.See §26.2652–2(a) for rules where anelection under section 2652(a)(3) ismade. See §26.2652–2(c) for ruleswhere a portion of a trust is subject toan election under section 2652(a)(3).

(B) Examples. The following exam-ples illustrate the application of thisparagraph (b)(1)(iii):

Example 1. QTIP election made after Septem-ber 25, 1985. On March 28, 1985, T establisheda trust. The trust instrument provided that thetrustee must distribute all income annually to T’sspouse, S, during S’s life. Upon S’s death, theremainder is to be distributed to GC, thegrandchild of T and S. On April 15, 1986, Telected under section 2523(f) to treat theproperty in the trust as qualified terminableinterest property. On December 1, 1987, S diedand soon thereafter the trust assets were dis-tributed to GC. Because the trust was irrevocableon September 25, 1985, the transfer to GC is notsubject to tax under chapter 13. T is treated asthe transferor with respect to the transfer of thetrust assets to GC in the same manner as if Thad made an election under section 2652(a)(3) toreverse the effect of the section 2523(f) electionfor chapter 13 purposes.

Example 2. Section 2652(a)(3) election deemedto have been made. Assume the same facts as inExample 1, except the trust instrument providesthat after S’s death all income is to be paidannually to C, the child of T and S. Upon C’sdeath, the remainder is to be distributed to GC.C died on October 1, 1992, and soon thereafterthe trust assets are distributed to GC. Becausethe trust was irrevocable on September 25, 1985,the termination of C’s interest is not subject tochapter 13.

(iv) Additions to irrevocable trusts—(A) In general. If an addition is madeafter September 25, 1985, to an irrevo-cable trust which is excluded fromchapter 13 by reason of paragraph(b)(1) of this section, a pro rata portionof subsequent distributions from (andterminations of interests in propertyheld in) the trust is subject to theprovisions of chapter 13. If an additionis made, the trust is thereafter deemedto consist of two portions, a portion notsubject to chapter 13 (the non-chapter13 portion) and a portion subject to

chapter 13 (the chapter 13 portion),each with a separate inclusion ratio (asdefined in section 2642(a)). The non-chapter 13 portion represents the valueof the assets of the trust as it existedon September 25, 1985. The applicablefraction (as defined in section2642(a)(2)) for the non-chapter 13portion is deemed to be 1 and theinclusion ratio for such portion is 0.The chapter 13 portion of the trustrepresents the value of all additionsmade to the trust after September 25,1985. The inclusion ratio for thechapter 13 portion is determined undersection 2642. This paragraph (b)(1)(iv)-(A) requires separate portions of onetrust only for purposes of determininginclusion ratios. For purposes of chap-ter 13, a constructive addition underparagraph (b)(1)(v) of this section istreated as an addition. See paragraph(b)(4) of this section for exceptions tothe additions rule of this paragraph(b)(1)(iv). See §26.2654–1(a)(2) forrules treating additions to a trust by anindividual other than the initial trans-feror as a separate trust for purposes ofchapter 13.

(B) Terminations of interests in anddistributions from trusts. Where atermination or distribution described insection 2612 occurs with respect to atrust to which an addition has beenmade, the portion of such terminationor distribution allocable to the chapter13 portion is determined by referenceto the allocation fraction, as defined inparagraph (b)(1)(iv)(C) of this section.In the case of a termination describedin section 2612(a) with respect to atrust, the portion of such terminationthat is subject to chapter 13 is theproduct of the allocation fraction andthe value of the trust (to the extent ofthe terminated interest therein). In thecase of a distribution described insection 2612(b) from a trust, theportion of such distribution that issubject to chapter 13 is the product ofthe allocation fraction and the value ofthe property distributed.

(C) Allocation fraction—(1) In gen-eral. The allocation fraction allocatesappreciation and accumulated incomebetween the chapter 13 and non-chapter13 portions of a trust. The numerator ofthe allocation fraction is the amount ofthe addition (valued as of the date theaddition is made), determined withoutregard to whether any part of thetransfer is subject to tax under chapter11 or chapter 12, but reduced by the

amount of any Federal or state estate orgift tax imposed and subsequently paidby the recipient trust with respect tothe addition. The denominator of theallocation fraction is the total value ofthe entire trust immediately after theaddition. For purposes of this para-graph (b)(1)(iv)(C), the total value ofthe entire trust is the fair market valueof the property held in trust (deter-mined under the rules of section 2031),reduced by any amount attributable toor paid by the trust and attributable tothe transfer to the trust that is similarto an amount that would be allowableas a deduction under section 2053 ifthe addition had occurred at the deathof the transferor, and further reducedby the same amount that the numeratorwas reduced to reflect Federal or stateestate or gift tax incurred by andsubsequently paid by the recipient trustwith respect to the addition. Wherethere is more than one addition toprincipal after September 25, 1985, theportion of the trust subject to chapter13 after each such addition is deter-mined pursuant to a revised fraction. Ineach case, the numerator of the revisedfraction is the sum of the value of thechapter 13 portion of the trust imme-diately before the latest addition, andthe amount of the latest addition. Thedenominator of the revised fraction isthe total value of the entire trustimmediately after the addition. If thetransfer to the trust is a generation-skipping transfer, the numerator anddenominator are reduced by the amountof the generation-skipping transfer tax,if any, that is imposed by chapter 13on the transfer and actually recoveredfrom the trust. The allocation fractionis rounded off to five decimal places(.00001).

(2) Examples. The following exam-ples illustrate the application of para-graph (b)(1)(iv) of this section. In eachof the examples, assume that therecipient trust does not pay any Federalor state transfer tax by reason of theaddition.

Example 1. Post September 25, 1985, additionto trust. (i) On August 16, 1980, T established anirrevocable trust. Under the trust instrument, thetrustee is required to distribute the entire incomeannually to T’s child, C, for life, then to T’sgrandchild, GC, for life. Upon GC’s death, theremainder is to be paid to GC’s issue. OnOctober 1, 1986, when the total value of theentire trust is $400,000, T transfers $100,000 tothe trust. The allocation fraction is computed asfollows:


778/20047/28MAY96/A29-006

26

Value of addition= $100,000

= .2Total value of trust $400,000 + $100,000

(ii) Thus, immediately after the transfer, 20percent of the value of future generation-skippingtransfers under the trust will be subject tochapter 13.

Example 2. Effect of expenses. Assume thesame facts as in Example 1, except immediatelyprior to the transfer on October 1, 1986, the fairmarket value of the individual assets in the trusttotaled $400,000. Also, assume that the trust hadaccrued and unpaid debts, expenses, and taxestotaling $300,000. Assume further that the entire$300,000 represented amounts that would bedeductible under section 2053 if the trust wereincludible in the transferor’s gross estate. Thenumerator of the allocation fraction is $100,000and the denominator of the allocation fraction is$200,000 (($400,000 – $300,000) + $100,000).Thus , t he a l l oca t i on f r ac t i on i s . 5($100,000/$200,000) and 50 percent of the valueof future generation-skipping transfers will besubject to chapter 13.

Example 3. Multiple additions. (i) Assume thesame facts as in Example 1, except on January30, 1988, when the total value of the entire trustis $600,000, T transfers an additional $40,000 tothe trust. Before the transfer, the value of theportion of the trust that was attributable to theprior addition was $120,000 ($600,000 3 .2).The new allocation fraction is computed asfollows:

Total value of additions=

Total value of trust

$120,000 + $40,000=

$160,000= .25

$600,000 + $40,000 $640,000

(ii) Thus, immediately after the transfer, 25percent of the value of future generation-skippingtransfers under the trust will be subject tochapter 13.

Example 4. Allocation fraction at time ofgeneration-skipping transfer. Assume the samefacts as in Example 3, except on March 1, 1989,when the value of the trust is $800,000, C dies.A generation-skipping transfer occurs at C’sdeath because of the termination of C’s lifeestate. Therefore, $200,000 ($800,000 3 .25) issubject to tax under chapter 13.

(v) Constructive additions—(A)Powers of Appointment. Except asprovided in paragraph (b)(1)(v)(B) ofthis section, where any portion of atrust remains in the trust after the post-September 25, 1985, release, exercise,or lapse of a power of appointmentover that portion of the trust, and therelease, exercise, or lapse is treated toany extent as a taxable transfer underchapter 11 or chapter 12, the value ofthe entire portion of the trust subject tothe power that was released, exercised,or lapsed is treated as if that portion

had been withdrawn and immediatelyretransferred to the trust at the time ofthe release, exercise, or lapse. Thecreator of the power will be consideredthe transferor of the addition except tothe extent that the release, exercise, orlapse of the power is treated as ataxable transfer under chapter 11 orchapter 12. See §26.2652–1 for rulesfor determining the identity of thetransferor of property for purposes ofchapter 13.

(B) Special rule for certain powersof appointment. The release, exercise,or lapse of a power of appointment(other than a general power of appoint-ment as defined in §2041(b)) is nottreated as an addition to a trust if—

(1) Such power of appointment wascreated in an irrevocable trust that isnot subject to chapter 13 under para-graph (b)(1) of this section; and

(2) In the case of an exercise, thepower of appointment is not exercisedin a manner that may postpone orsuspend the vesting, absolute owner-ship or power of alienation of aninterest in property for a period,measured from the date of creation ofthe trust, extending beyond any life inbeing at the date of creation of the trustplus a period of 21 years plus, ifnecessary, a reasonable period of gesta-tion (the perpetuities period). For pur-poses of this paragraph (b)(1)(v)(B)(2),the exercise of a power of appointmentthat validly postpones or suspends thevesting, absolute ownership or powerof alienation of an interest in propertyfor a term of years that will not exceed90 years (measured from the date ofcreation of the trust) will not beconsidered an exercise that postponesor suspends vesting, absolute owner-ship or the power of alienation beyondthe perpetuities period. If a power isexercised by creating another power, itis deemed to be exercised to whateverextent the second power may beexercised.

(C) Constructive addition if liabilityis not paid out of trust principal.Where a trust described in paragraph(b)(1) of this section is relieved of anyliability properly payable out of theassets of such trust, the person or entitywho actually satisfies the liability is

considered to have made a constructiveaddition to the trust in an amount equalto the liability. The constructive addi-tion occurs when the trust is relieved ofliability (e.g., when the right of recov-ery is no longer enforceable). But see§26.2652–1(a)(3) for rules involvingthe application of section 2207A in thecase of an election under section2652(a)(3).

(D) Examples. The following exam-ples illustrate the application of thisparagraph (b)(1)(v):

Example 1. Lapse of a power of appointment.On June 19, 1980, T established an irrevocabletrust with a corpus of $500,000. The trustinstrument provides that the trustee shall dis-tribute the entire income from the trust annuallyto T’s spouse, S, during S’s life. At S’s death,the remainder is to be distributed to T and S’sgrandchild, GC. T also gave S a general powerof appointment over one-half of the trust assets.On December 21, 1989, when the value of thetrust corpus is $1,500,000, S died without havingexercised the general power of appointment. Thevalue of one-half of the trust corpus, $750,000($1,500,000 3 .5) is included in S’s gross estateunder section 2041(a) and is subject to tax underChapter 11. Because the value of one-half of thetrust corpus is subject to tax under Chapter 11with respect to S’s estate, S is treated as thetransferor of that property for purposes ofChapter 13 (see section 2652(a)(1)(A)). Forpurposes of the generation-skipping transfer tax,the lapse of S’s power of appointment is treatedas if $750,000 ($1,500,000 3 .5) had beendistributed to S and then transferred back to thetrust. Thus, S is considered to have added$750,000 ($1,500,000 3 .5) to the trust at thedate of S’s death. Because this constructiveaddition occurred after September 25, 1985, 50percent of the corpus of the trust became subjectto Chapter 13 at S’s death.

Example 2. Multiple actual additions. On June19, 1980, T established an irrevocable trust witha principal of $500,000. The trust instrumentprovides that the trustee shall distribute the entireincome from the trust annually to T’s spouse, S,during S’s life. At S’s death, the remainder is tobe distributed to GC, the grandchild of T and S.On October 1, 1985, when the trust assets werevalued at $800,000, T added $200,000 to thetrust. After the transfer on October 1, 1985, theallocation fraction was .2 ($200,000/$1,000,000).On December 21, 1989, when the value of thetrust principal is $1,000,000, T adds $1,000,000to the trust. After this addition, the new alloca-tion fraction is 0.6 ($1,200,000/$2,000,000). Thenumerator of the fraction is the value of thatportion of trust assets that were subject tochapter 13 immediately prior to the addition (byreason of the first addition), $200,000 (.2 3$1,000,000), plus the value of the secondtransfer, $1,000,000, which equals $1,200,000.The denominator of the fraction, $2,000,000, isthe total value of the trust assets immediatelyafter the second transfer. Thus, 60 percent of theprincipal of the trust becomes subject to chapter13.


778/20047/28MAY96/A29-006

27

Example 3. Entire portion of trust subject tolapsed power is treated as an addition. OnSeptember 25, 1985, B possessed a generalpower of appointment over the assets of anirrevocable trust that had been created by T in1980. Under the terms of the trust, B’s powerlapsed on July 20, 1987. For Federal gift taxpurposes, B is treated as making a gift of ninety-five percent (100% – 5%) of the value of theprincipal (see section 2514). However, becausethe entire trust was subject to the power ofappointment, 100 percent (that portion of thetrust subject to the power) of the assets of thetrust are treated as a constructive addition. Thus,the entire amount of all generation-skippingtransfers occurring pursuant to the trust instru-ment after July 20, 1987, are subject to chapter13.

Example 4. Exercise of power of appointmentin favor of another trust. On March 1, 1985, Testablished an irrevocable trust as defined inparagraph (b)(1)(ii) of this section. Under theterms of the trust instrument, the trustee isrequired to distribute the entire income annuallyto T’s child, C, for life, then to T’s grandchild,GC, for life. GC has the power to appoint any orall of the trust assets to Trust 2 which is anirrevocable trust (as defined in paragraph (b)(1)-(ii) of this section) that was established onAugust 1, 1985. The terms of Trust 2’s govern-ing instrument provide that the trustee shall payincome to T’s great grandchild, GGC, for life.Upon GGC’s death the remainder is to be paid toGGC’s issue. GGC was alive on March 1, 1985,when Trust 1 was created. C died on April 1,1986. On July 1, 1987, GC exercised the powerof appointment. The exercise of GC’s powerdoes not subject future transfers from Trust 2 totax under chapter 13 because the exercise of thepower in favor of Trust 2 does not suspend thevesting, absolute ownership, or power of aliena-tion of an interest in property for a period,measured from the date of creation of Trust 1,extending beyond the life of GGC (a beneficiaryunder Trust 2 who was in being at the date ofcreation of Trust 1) plus a period of 21 years.The result would be the same if Trust 2 had beencreated after the effective date of chapter 13.

Example 5. Exercise of power of appointmentin favor of another trust. Assume the same factsas in Example 3, except that GGC was born onMarch 28, 1986. The valid exercise of GC’spower in favor of Trust 2 causes the principal ofTrust 1 to be subject to chapter 13, because GGCwas not born until after the creation of Trust 1.Thus, such exercise may suspend the vesting,absolute ownership, or power of alienation of aninterest in the trust principal for a period,measured from the date of creation of Trust 1,extending beyond the life of GGC (a beneficiaryunder Trust 2 who was not a life in being at thedate of creation of Trust 1).

Example 6. Extension for the longer of twoperiods. Prior to the effective date of chapter 13,GP established an irrevocable trust under whichthe trust income was to be paid to GP’s child, C,for life. C was given a testamentary power toappoint the remainder in further trust for thebenefit of C’s issue. In default of C’s exercise ofthe power, the remainder was to pass to charity.C died on February 3, 1995, survived by a childwho was alive when GP established the trust. Cexercised the power in a manner that validlyextends the trust in favor of C’s issue until thelater of May 15, 2064 (80 years from the datethe trust was created), or the death of C’s childplus 21 years. C’s exercise of the power is aconstructive addition to the trust because the

exercise may extend the trust for a period longerthan the permissible periods of either the life ofC’s child (a life in being at the creation of thetrust) plus 21 years or a term not more than 90years measured from the creation of the trust. Onthe other hand, if C’s exercise of the powercould extend the trust based only on the life ofC’s child plus 21 years or only for a term of 80years from the creation of the trust (but not thelater of the two periods) then the exercise of thepower would not have been a constructiveaddition to the trust.

Example 7. Extension for the longer of twoperiods. The facts are the same as in Example 6except local law provides that the effect of C’sexercise is to extend the term of the trust untilMay 15, 2064, whether or not C’s child pre-deceases that date by more than 21 years. C’sexercise is not a constructive addition to the trustbecause C exercised the power in a manner thatcannot postpone or suspend vesting, absoluteownership, or power of alienation for a term ofyears that will exceed 90 years. The result wouldbe the same if the effect of C’s exercise is eitherto extend the term of the trust until 21 yearsafter the death of C’s child or to extend the termof the trust until the first to occur of May 15,2064 or 21 years after the death of C’s child.

(vi) Appreciation and income. Ex-cept to the extent that the provisions ofparagraphs (b)(1)(iv) and (v) of thissection allocate subsequent appreciationand accumulated income between theoriginal trust and additions thereto,appreciation in the value of the trustand undistributed income added theretoare not considered an addition to theprincipal of a trust.

(2) Transition rule for wills or revo-cable trusts executed before October22, 1986—(i) In general. The provi-sions of chapter 13 do not apply to anygeneration-skipping transfer under awill or revocable trust executed beforeOctober 22, 1986, provided that—

(A) The document in existence onOctober 21, 1986, is not amended atany time after October 21, 1986, in anyrespect which results in the creation of,or an increase in the amount of, ageneration-skipping transfer;

(B) In the case of a revocable trust,no addition is made to the revocabletrust after October 21, 1986, thatresults in the creation of, or an increasein the amount of, a generation-skippingtransfer; and

(C) The decedent dies before Janu-ary 1, 1987.

(ii) Revocable trust defined. For pur-poses of this section, the term revoca-ble trust means any trust (as defined insection 2652(b)) except to the extentthat, on October 22, 1986, the trust—

(A) Was an irrevocable trust de-scribed in paragraph (b)(1) of thissection; or

(B) Would have been an irrevocabletrust described in paragraph (b)(1) ofthis section had it not been created orbecome irrevocable after September 25,1985, and before October 22, 1986.

(iii) Will or revocable trust contain-ing qualified terminable interest prop-erty. The rules contained in paragraph(b)(1)(iii) of this section apply to anywill or revocable trust within the scopeof the transition rule of this paragraph(b)(2).

(iv) Amendments to will or revoca-ble trust. For purposes of this para-graph (b)(2), an amendment to a will ora revocable trust in existence onOctober 21, 1986, is not considered toresult in the creation of, or an increasein the amount of, a generation-skippingtransfer where the amendment is—

(A) Basically administrative or clar-ifying in nature and only incidentallyincreases the amount transferred; or

(B) Designed to ensure that an exist-ing bequest or transfer qualifies for theapplicable marital or charitable deduc-tion for estate, gift, or generation-skipping transfer tax purposes and onlyincidentally increases the amount trans-ferred to a skip person or to ageneration-skipping trust.

(v) Creation of, or increase in theamount of, a GST. In determiningwhether a particular amendment to awill or revocable trust creates, orincreases the amount of, a generation-skipping transfer for purposes of thisparagraph (b)(2), the effect of theinstrument(s) in existence on October21, 1986, is measured against the effectof the instrument(s) in existence on thedate of death of the decedent or on thedate of any prior generation-skippingtransfer. If the effect of an amendmentcannot be immediately determined, it isdeemed to create, or increase theamount of, a generation-skipping trans-fer until a determination can be made.

(vi) Additions to revocable trusts.Any addition made after October 21,1986, but before the death of thesettlor, to a revocable trust subjects allsubsequent generation-skipping trans-fers under the trust to the provisions ofchapter 13. Any addition made to arevocable trust after the death of thesettlor (if the settlor dies before Janu-ary 1, 1987) is treated as an addition toan irrevocable trust. See paragraph(b)(1)(v) of this section for rulesinvolving constructive additions totrusts. See paragraph (b)(1)(v)(B) ofthis section for rules providing that


778/20047/28MAY96/A29-006

28

certain transfers to trusts are not treatedas additions for purposes of thissection.

(vii) Examples. The following exam-ples illustrate the application of para-graph (b)(2)(iv) of this section:

(A) Facts applicable to Examples 1 through 5.In each of Examples 1 through 5 assume that Texecuted a will prior to October 22, 1986, andthat T dies on December 31, 1986.

Example 1. Administrative change. On Novem-ber 1, 1986, T executes a codicil to T’s willremoving one of the co-executors named in thewill. Although the codicil may have the effect oflowering administrative costs and thus increasingthe amount transferred, it is considered admin-istrative in nature and thus does not causegeneration-skipping transfers under the will to besubject to chapter 13.

Example 2. Effect of amendment not imme-diately determinable. On November 1, 1986, Texecutes a codicil to T’s will revoking a bequestof $100,000 to C, a non-skip person (as definedunder section 2613(b)) and causing that amountto be added to a residuary trust held for a skipperson. The amendment is deemed to increasethe amount of a generation-skipping transfer andprevents any transfers under the will fromqualifying under paragraph (b)(2)(i) of thissection. If, however, C dies before T and underlocal law the property would have been added tothe residue in any event because the bequestwould have lapsed, the codicil is not consideredan amendment that increases the amount of ageneration-skipping transfer.

Example 3. Refund of tax paid because ofamendment. T’s will provided that an amountequal to the maximum allowable marital deduc-tion would pass to T’s spouse with the residue ofthe estate passing to a trust established for thebenefit of skip persons. On October 23, 1986, thewill is amended to provide that the marital sharepassing to T’s spouse shall be the lesser of themaximum allowable marital deduction or theminimum amount that will result in no estate taxliability for T’s estate. The amendment mayincrease the amount of a generation-skippingtransfer. Therefore, any generation-skippingtransfers under the will are subject to tax underchapter 13. If it becomes apparent that theamendment does not increase the amount of ageneration-skipping transfer, a claim for refundmay be filed with respect to any generation-skipping transfer tax that was paid within theperiod set forth in section 6511. For example, itwould become apparent that the amendment didnot result in an increase in the residue if it issubsequently determined that the maximummarital deduction and the minimum amount thatwill result in no estate tax liability are equal inamount.

Example 4. An amendment that increases ageneration-skipping transfer causes completeloss of exempt status. T’s will provided for thecreation of two trusts for the benefit of skippersons. On November 1, 1986, T executed acodicil to the will specifically increasing theamount of a generation-skipping transfer underthe will. All transfers made pursuant to the willor either of the trusts created thereunder areprecluded from qualifying under the transitionrule of paragraph (b)(2)(i) of this section and aresubject to tax under chapter 13.

Example 5. Corrective action effective. As-sume that T in Example 4 later executes a second

codicil deleting the increase to the generation-skipping transfer. Because the provision increas-ing a generation-skipping transfer does notbecome effective, it is not considered anamendment to a will in existence on October 22,1986.

(B) Facts applicable to Examples 6 through 9.T created a trust on September 30, 1985, inwhich T retained the power to revoke thetransfer at any time prior to T’s death. The trustprovided that, upon the death of T, the incomewas to be paid to T’s spouse, W, for life andthen to A, B, and C, the children of T’s sibling,S, in equal shares for life, with one-third of theprincipal to be distributed per stirpes to eachchild’s surviving issue upon the death of thechild. The trustee has the power to makediscretionary distributions of trust principal toT’s sibling, S.

Example 6. Amendment that affects only aperson who is not a skip person. A becamedisabled, and T modified the trust on December1, 1986, to increase A’s share of the income.Since the amendment does not result in thecreation of, or increase in the amount of, ageneration-skipping transfer, transfers pursuant tothe trust are not subject to chapter 13.

Example 7. Amendment increasing skip per-son’s share. Assume that A, B, and C are thegrandchildren of S rather than the children (andthus are skip persons as defined in section 2613).T’s amendment of the trust increasing A’s shareof the income subjects the trust to the provisionsof chapter 13 because the amendment increasesthe amount of the generation-skipping transfersto be made to A.

Example 8. Amendment that adds a skipperson. Assume that T amends the trust to addT’s grandchild, D, as an income beneficiary. Thetrust will be subject to the provisions of chapter13 because the amendment creates a generation-skipping transfer.

Example 9. Refund of tax paid during interimperiod when effect of amendment is not deter-minable. Assume that T amends the trust toprovide that the issue of S are to take a one-fourth share of the principal per stirpes upon S’sdeath. Because the distribution to be made uponS’s death may involve skip persons, the amend-ment is considered an amendment that creates orincreases the amount of a generation-skippingtransfer until a determination can be made.Accordingly, any distributions from (or termina-tions of interests in) such trust are subject tochapter 13 until it is determined that no skipperson has been added to the trust. At that time,a claim for refund may be filed within the periodset forth in section 6511 with respect to anygeneration-skipping transfer tax that was paid.

(3) Transition rule in the case ofmental incompetency—(i) In general. Ifan individual was under a mentaldisability to change the disposition ofhis or her property continuously fromOctober 22, 1986, until the date of hisor her death, the provisions of chapter13 do not apply to any generation-skipping transfer—

(A) Under a trust (as defined insection 2652(b)) to the extent such trustconsists of property, or the proceeds ofproperty, the value of which wasincluded in the gross estate of the

individual (other than property trans-ferred by or on behalf of the individualduring the individual’s life after Octo-ber 22, 1986); or

(B) Which is a direct skip (otherthan a direct skip from a trust) thatoccurs by reason of the death of theindividual.

(ii) Mental disability defined. Forpurposes of this paragraph (b)(2), theterm mental disability means mentalincompetence to execute an instrumentgoverning the disposition of the indi-vidual’s property, whether or not therewas an adjudication of incompetenceand regardless of whether there hasbeen an appointment of a guardian,fiduciary, or other person charged witheither the care of the individual or thecare of the individual’s property.

(iii) Decedent who has not beenadjudged mentally incompetent. If therehas not been a court adjudication thatthe decedent was mentally incompetenton or before October 22, 1986, theexecutor must file, with Form 706,either—

(A) A certification from a qualifiedphysician stating that the decedentwas—

(1) mentally incompetent at all timeson and after October 22, 1986; and

(2) did not regain competence tomodify or revoke the terms of the trustor will prior to his or her death; or

(B) Sufficient other evidence demon-strating that the decedent was mentallyincompetent at all times on and afterOctober 22, 1986, as well as astatement explaining why no certifica-tion is available from a physician; and

(C) Any judgement or decree relat-ing to the decedent’s incompetency thatwas made after October 22, 1986. Such items will be considered relevant,but not determinative, in establishingthe decedent’s state of competency.

(iv) Decedent who has been ad-judged mentally incompetent. If thedecedent has been adjudged mentallyincompetent on or before October 22,1986, a copy of the judgment ordecree, and any modification thereof,must be filed with the Form 706.

(v) Rule applies even if anotherperson has power to change trustterms. In the case of a transfer from atrust, this paragraph (b)(3) applies eventhough a person charged with the careof the decedent or the decedent’sproperty has the power to revoke ormodify the terms of the trust, provided


778/20047/28MAY96/A29-006

29

that the power is not exercised afterOctober 22, 1986, in a manner thatcreates, or increases the amount of, ageneration-skipping transfer. See para-graph (b)(2)(iv) of this section for rulesconcerning amendments that create orincrease the amount of a generation-skipping transfer.

(vi) Example. The following exam-ple illustrates the application of para-graph (b)(3)(v) of this section:

Example. T was mentally incompetent onOctober 22, 1986, and remained so until death in1993. Prior to becoming incompetent, T createda revocable generation-skipping trust that wasincludible in T’s gross estate. Prior to October22, 1986, the appropriate court issued an orderunder which P, who was thereby charged withthe care of T’s property, had the power tomodify or revoke the revocable trust. Although Pexercised the power after October 22, 1986, andwhile T was incompetent, the power was notexercised in a manner that created, or increasedthe amount of, a generation-skipping transfer.Thus, the existence and exercise of P’s powerdid not cause the trust to lose its exempt statusunder paragraph (b)(3) of this section. The resultwould be the same if the court order was issuedafter October 22, 1986.

(4) Exceptions to additions rule—(i)In general. Any addition to a trustmade pursuant to an instrument orarrangement covered by the transitionrules in paragraph (b)(2) or (3) of thissection is not treated as an addition forpurposes of this section. Moreover, anyproperty transferred inter vivos to atrust is not treated as an addition if thesame property would have been addedto the trust pursuant to an instrumentcovered by the transition rules inparagraph (b)(2) or (3) of this section.

(ii) Examples. The following exam-ples illustrate the application of para-graph (b)(4)(i) of this section:

Example 1. Addition pursuant to terms ofexempt instrument. On December 31, 1980, Tcreated an irrevocable trust having a principal of$100,000. Under the terms of the trust, theprincipal was to be held for the benefit of T’sgrandchild, GC. Pursuant to the terms of T’swill, a document entitled to relief under thetransition rule of paragraph (b)(2) of this section,the residue of the estate was paid to the trust.Because the addition to the trust was paidpursuant to the terms of an instrument (T’s will)that is not subject to the provisions of chapter 13because of paragraph (b)(2) of this section, thepayment to the trust is not considered an additionto the principal of the trust. Thus, distributions toor for the benefit of GC, are not subject to theprovisions of chapter 13.

Example 2. Property transferred inter vivosthat would have been transferred to the sametrust by the transferor’s will. T is the grantor ofa trust that was irrevocable on September 25,1985. T’s will, which was executed beforeOctober 22, 1986, and not amended thereafter,

provides that, upon T’s death, the entire estatewill pour over into T’s trust. On October 1,1985, T transfers $100,000 to the trust. WhileT’s will otherwise qualifies for relief under thetransition rule in paragraph (b)(2) of this section,the transition rule is not applicable unless T diesprior to January 1, 1987. Thus, if T dies afterDecember 31, 1986, the transfer is treated as anaddition to the trust for purposes of anydistribution made from the trust after the transferto the trust on October 1, 1985. If T dies beforeJanuary 1, 1987, the entire trust (as well as anydistributions from or terminations of interests inthe trust prior to T’s death) is exempt, underparagraph (b)(2) of this section, from chapter 13because the $100,000 would have been added tothe trust under a will that would have qualifiedunder paragraph (b)(2) of this section. In eithercase, for any generation-skipping transfers madeafter the transfer to the trust on October 1, 1985,but before T’s death, the $100,000 is treated asan addition to the trust and a proportionateamount of the trust is subject to chapter 13.

Example 3. Pour over to a revocable trust. Tand S are the settlors of separate revocable trustswith equal values. Both trusts were establishedfor the benefit of skip persons (as defined insection 2613). S dies on December 1, 1985, andunder the provisions of S’s trust, the principalpours over into T’s trust. If T dies beforeJanuary 1, 1987, the entire trust is excludedunder paragraph (b)(2) of this section from theoperation of chapter 13. If T dies after December31, 1986, the entire trust is subject to thegeneration-skipping transfer tax provisions be-cause T’s trust is not a trust described inparagraph (b)(1) or (2) of this section. In thelatter case, the fact that S died before January 1,1987, is irrelevant because the principal of S’strust was added to a trust that never qualifiedunder the transition rules of paragraph (b)(1) or(2) of this section.

Example 4. Pour over to exempt trust. Assumethe same facts as in Example 3, except upon thedeath of S on December 1, 1985, S’s trustcontinues as an irrevocable trust and that theprincipal of T’s trust is to be paid over upon T’sdeath to S’s trust. Again, if T dies beforeJanuary 1, 1987, S’s entire trust falls within theprovisions of paragraph (b)(2) of this section.However, if T dies after December 31, 1986, thepour-over is considered an addition to the trust.Therefore, S’s trust is not a trust excluded underparagraph (b)(2) of this section because anaddition is made to the trust.

Example 5. Lapse of a general power ofappointment. S, the spouse of the settlor of anirrevocable trust that was created in 1980, had,on September 25, 1985, a general power ofappointment over the trust assets. The trustprovides that should S fail to exercise the powerof appointment the property is to remain in thetrust. On October 21, 1986, S executed a willunder which S failed to exercise the power ofappointment. If S dies before January 1, 1987,without having exercised the power in a mannerwhich results in the creation of, or increase inthe amount of, a generation-skipping transfer (oramended the will in a manner that results in thecreation of, or increase in the amount of, ageneration-skipping transfer), transfers pursuantto the trust or the will are not subject to chapter13 because the trust is an irrevocable trust andthe will qualifies under paragraph (b)(2) of thissection.

Example 6. Lapse of general power ofappointment held by intestate decedent. Assume

the same facts as in Example 5, except onOctober 22, 1986, S did not have a will and thatS dies after that date. Upon S’s death, or uponthe prior exercise or release of the power, thevalue of the entire trust is treated as having beendistributed to S, and S is treated as having madean addition to the trust in the amount of theentire principal. Any distribution or terminationpursuant to the trust occurring after S’s death issubject to chapter 13. It is immaterial whetherS’s death occurs before January 1, 1987, sinceparagraph (b)(2) of this section is only applicablewhere a will or revocable trust was executedbefore October 22, 1986.

(c) Additional effective dates. Exceptas otherwise provided, the regulationsunder §§26.2611–1, 26.2612–1,26.2613–1, 26.2632–1, 26.2641–1,26.2642–1, 26.2642–2, 26.2642–3,26.2642–4, 26.2642–5, 26.2652–1,26.2652–2, 26.2653–1, 26.2654–1,26.2663–1, and 26.2663–2 are effectivewith respect to generation-skippingtransfers as defined in §26.2611–1made on or after December 27, 1995.However, taxpayers may, at their op-tion, rely on these regulations in thecase of generation-skipping transfersmade, and trusts that became irrevoca-ble, after December 23, 1992, andbefore December 27, 1995.

§26.2611–1 Generation-skippingtransfer defined.

A generation-skipping transfer (GST)is an event that is either a direct skip, ataxable distribution, or a taxable termi-nation. See §26.2612–1 for the defini-tion of these terms. The determinationas to whether an event is a GST ismade by reference to the most recenttransfer subject to the estate or gift tax.See §26.2652–1(a)(2) for determiningwhether a transfer is subject to Federalestate or gift tax.

§26.2612–1 Definitions.

(a) Direct skip—(1) In general. Adirect skip is a transfer to a skip personthat is subject to Federal estate or gifttax. If property is transferred to a trust,the transfer is a direct skip only if thetrust is a skip person. Only one directskip occurs when a single transfer ofproperty skips two or more generations.See paragraph (d) of this section forthe definition of skip person. See§26.2652–1(b) for the definition oftrust. See §26.2632–1(c)(4) for the timethat a direct skip occurs if the trans-ferred property is subject to an estatetax inclusion period.


778/20047/28MAY96/A29-006

30

(2) Special rule for certain linealdescendants—(i) In general. Solely forthe purpose of determining whether atransfer to or for the benefit of a linealdescendant of the transferor, the trans-feror’s spouse, or a former spouse ofthe transferor is a direct skip, thegeneration assignment of the descend-ant is determined by disregarding thegeneration of a predeceased individualwho was both an ancestor of thedescendant and a lineal descendant ofthe transferor, the transferor’s spouse,or a former spouse of the transferor (apredeceased child). If a transfer to atrust would be a direct skip but for thisparagraph, any generation assignmentdetermined under this paragraph con-tinues to apply in determining whetherany subsequent distribution from (ortermination of an interest in) theportion of the trust attributable to thattransfer is a GST. A living descendantwho dies no later than 90 days after thesubject transfer is treated as havingpredeceased the transferor to the extentthat either the governing instrument orapplicable local law provides that suchindividual shall be treated as predeceas-ing the transferor. Except as providedin this paragraph (a)(2), a livingdescendant is not treated as a pre-deceased child solely by reason ofapplicable local law; e.g., an individualis not treated as a predeceased childsolely because state law treats anindividual executing a disclaimer ashaving predeceased the transferor ofthe disclaimed property. See §26.2652–1(a)(1) for the definition of transferor.See paragraph (e) of this section for thedefinition of interest in trust.

(ii) Special rule. If a transferormakes an addition to an existing trustafter the death of an individual de-scribed in paragraph (a)(2)(i) of thissection (so that the transferor would beassigned to a lower generation byreason of that death), the additionalproperty is treated as being held in aseparate trust for purposes of chapter13 and the provisions of §26.2654–1(a)(2) apply as if the portions of thesingle trust had separate transferors.Subsequent additions are treated asadditions to the appropriate portion ofthe single trust.

(b) Taxable termination—(1) In gen-eral. Except as otherwise provided inthis paragraph (b), a taxable termina-tion is a termination (occurring for anyreason) of an interest in trust unless—

(i) A transfer subject to Federalestate or gift tax occurs with respect to

the property held in the trust at thetime of the termination (i.e., a newtransferor is determined with respect tothe property);

(ii) Immediately after the termina-tion, a person who is not a skip personhas an interest in the trust; or

(iii) At no time after the terminationmay a distribution, other than a dis-tribution the probability of which oc-curring is so remote as to be negligible(including a distribution at the termina-tion of the trust) be made from thetrust to a skip person. For this purpose,the probability that a distribution willoccur is so remote as to be negligibleonly if it can be ascertained byactuarial standards that there is lessthan a 5 percent probability that thedistribution will occur.

(2) Partial termination. If a distribu-tion of a portion of trust property ismade to a skip person by reason of atermination occurring on the death of alineal descendant of the transferor, thetermination is a taxable terminationwith respect to the distributed property.

(3) Simultaneous terminations. A si-multaneous termination of two or moreinterests creates only one taxabletermination.

(c) Taxable distribution—(1) In gen-eral. A taxable distribution is a dis-tribution of income or principal from atrust to a skip person unless the distri-bution is a taxable termination or adirect skip. If any portion of GST tax(including penalties and interestthereon) imposed on a distributee ispaid from the distributing trust, thepayment is an additional taxable dis-tribution to the distributee. For pur-poses of chapter 13, the additionaldistribution is treated as having beenmade on the last day of the calendaryear in which the original taxabledistribution is made. If Federal estateor gift tax is imposed on any individualwith respect to an interest in propertyheld by a trust, the interest in propertyis treated as having been distributed tothe individual to the extent that thevalue of the interest is subject toFederal estate or gift tax. See§26.2652–1(a)(6) Example 5, regardingthe treatment of the lapse of a power ofappointment as a transfer to a trust.

(2) Look-through rule not to apply.Solely for purposes of determiningwhether any transfer from a trust toanother trust is a taxable distribution,the rules of section 2651(e)(2) do notapply. If the transferring trust and the

recipient trust have the same transferor,see §26.2642–4(a)(1) and (2) for rulesfor recomputing the applicable fractionof the recipient trust.

(d) Skip person. A skip person is—(1) An individual assigned to a

generation more than one generationbelow that of the transferor (determinedunder the rules of section 2651); or

(2) A trust if—(i) All interests in the trust are held

by skip persons; or(ii) No person holds an interest in

the trust and no distributions, otherthan a distribution the probability ofwhich occurring is so remote as to benegligible (including distributions atthe termination of the trust), may bemade after the transfer to a personother than a skip person. For thispurpose, the probability that a distribu-tion will occur is so remote as to benegligible only if it can be ascertainedby actuarial standards that there is lessthan a 5 percent probability that thedistribution will occur.

(e) Interest in trust—(1) In general.An interest in trust is an interest inproperty held in trust as defined insection 2652(c) and these regulations.An interest in trust exists if a person—

(i) Has a present right to receivetrust principal or income;

(ii) Is a permissible current recipientof trust principal or income and is notdescribed in section 2055(a); or

(iii) Is described in section 2055(a)and the trust is a charitable remainderannuity trust or unitrust (as defined insection 664(d)) or a pooled incomefund (as defined in section 642(c)(5)).

(2) Exceptions—(i) Support obliga-tions. In general, an individual has apresent right to receive trust income orprincipal if trust income or principalmay be used to satisfy the individual’ssupport obligations. However, an indi-vidual does not have an interest in atrust merely because a support obliga-tion of that individual may be satisfiedby a distribution that is either withinthe discretion of a fiduciary or pursuantto provisions of local law substantiallyequivalent to the Uniform Gifts (Trans-fers) to Minors Act.

(ii) Certain interests disregarded.An interest which is used primarily topostpone or avoid the GST tax is dis-regarded for purposes of chapter 13.An interest is considered as usedprimarily to postpone or avoid the GSTtax if a significant purpose for the


778/20047/28MAY96/A29-006

31

creation of the interest is to postponeor avoid the tax.

(3) Disclaimers. An interest does notexist to the extent it is disclaimedpursuant to a disclaimer that constitutesa qualified disclaimer under section2518.

(f) Examples. The following exam-ples illustrate the provisions of thissection. Unless stated otherwise, para-graph (a)(2) of this section, whichassigns descendants to a higher genera-tion when there is a predeceasedancestor, does not apply.

Example 1. Direct skip. T gratuitously conveysBlackacre to T’s grandchild. Because the transferis a transfer to a skip person of property subjectto Federal gift tax, it is a direct skip.

Example 2. Direct skip of more than onegeneration. T gratuitously conveys Blackacre toT’s great-grandchild. The transfer is a directskip. Only one GST tax is imposed on the directskip although two generations are skipped by thetransfer.

Example 3. Withdrawal power in trust. Ttransfers $50,000 to a new trust providing thattrust income is to be paid to T’s child, C, for lifeand, on C’s death, the trust principal is to bepaid to T’s descendants. Under the terms of thetrust, T grants four grandchildren the right towithdraw $10,000 from the trust for a 60 dayperiod following the transfer. Since C, who isnot a skip person, has an interest in the trust, thetrust is not a skip person. T’s transfer to the trustis not a direct skip.

Example 4. Taxable termination. T establishesan irrevocable trust under which the income is tobe paid to T’s child, C, for life. On the death ofC, the trust principal is to be paid to T’sgrandchild, GC. Since C has an interest in thetrust, the trust is not a skip person and thetransfer to the trust is not a direct skip. If C diessurvived by GC, a taxable termination occurs atC’s death because C’s interest in the trustterminates and thereafter the trust property isheld by a skip person who occupies a lowergeneration than C.

Example 5. Direct skip of property held intrust. T establishes a testamentary trust underwhich the income is to be paid to T’s survivingspouse, S, for life and the remainder is to bepaid to a grandchild of T and S. T’s executorelects to treat the trust as qualified terminableinterest property under section 2056(b)(7). Thetransfer to the trust is not a direct skip becauseS, a person who is not a skip person, holds apresent right to receive income from the trust.Upon S’s death, the trust property is included inS’s gross estate under section 2044 and passesdirectly to a skip person. The GST occurring atthat time is a direct skip because it is a transfersubject to chapter 11. The fact that the interestcreated by T is terminated at S’s death isimmaterial because S becomes the transferor atthe time of the transfer subject to chapter 11.

Example 6. Predeceased ancestor exception. Testablishes an irrevocable trust providing thattrust income is to be paid to T’s grandchild, GC,for 5 years. At the end of the 5-year period, thetrust is to terminate and the principal is to bedistributed to GC. T’s child, C, a parent of GC,is deceased at the time T establishes the trust.

Therefore, GC is treated as a child of T ratherthan as a grandchild. As a result, GC is not askip person, and the initial transfer to the trust isnot a direct skip. Similarly, distributions to GCduring the term of the trust and at thetermination of the trust will not be GSTs.

Example 7. Predeceased ancestor exceptionnot applicable. The facts are the same as inExample 6, except the trust income is to be paidto T’s spouse, S, during the first two years of thetrust. Since S has an interest in the trust, the trustis not a skip person and the transfer by T is not adirect skip. Since the transfer is not a direct skip,the predeceased ancestor rule does not apply andGC is not treated as the child of T. A taxabletermination occurs at the expiration of S’sinterest.

Example 8. Taxable termination. T establishesan irrevocable trust for the benefit of T’s child,C, T’s grandchild, GC, and T’s great-grandchild,GGC. Under the terms of the trust, income andprincipal may be distributed to any or all of theliving beneficiaries at the discretion of thetrustee. Upon the death of the second beneficiaryto die, the trust principal is to be paid to thesurvivor. C dies first. A taxable terminationoccurs at that time because, immediately afterC’s interest terminates, all interests in the trustare held by skip persons (GC and GGC).

Example 9. Taxable termination resulting fromdistribution. The facts are the same as inExample 8, except twenty years after C’s deaththe trustee exercises its discretionary power anddistributes the entire principal to GGC. Thedistribution results in a taxable terminationbecause GC’s interest in the trust terminates as aresult of the distribution of the entire trustproperty to GGC, a skip person. The resultwould be the same if the trustee retainedsufficient funds to pay the GST tax due byreason of the taxable termination, as well as anyexpenses of winding up the trust.

Example 10. Simultaneous termination ofinterests of more than one beneficiary. Testablishes an irrevocable trust for the benefit ofT’s child, C, T’s grandchild, GC, and T’s great-grandchild, GGC. Under the terms of the trust,income and principal may be distributed to anyor all of the living beneficiaries at the discretionof the trustee. Upon the death of C, the trustproperty is to be distributed to GGC if thenliving. If C is survived by both GC and GGC,both C’s and GC’s interests in the trust willterminate on C’s death. However, because bothinterests will terminate at the same time and as aresult of one event, only one taxable terminationoccurs.

Example 11. Partial taxable termination. Tcreates an irrevocable trust providing that trustincome is to be paid to T’s children, A and B, insuch proportions as the trustee determines fortheir joint lives. On the death of the first child todie, one-half of the trust principal is to be paidto T’s then living grandchildren. The balance ofthe trust principal is to be paid to T’sgrandchildren on the death of the survivor of Aand B. If A predeceases B, the distributionoccurring on the termination of A’s interest inthe trust is a taxable termination and not ataxable distribution. It is a taxable terminationbecause the distribution is a distribution of aportion of the trust that occurs as a result of thedeath of A, a lineal descendant of T. It isimmaterial that a portion of the trust continuesand that B, a person other than a skip person,thereafter holds an interest in the trust.

Example 12 . Taxable distribution . Testablishes an irrevocable trust under which the

trust income is payable to T’s child, C, for life.When T’s grandchild, GC, attains 35 years ofage, GC is to receive one-half of the principal.The remaining one-half of the principal is to bedistributed to GC on C’s death. Assume that Csurvives until GC attains age 35. When thetrustee distributes one-half of the principal to GCon GC’s 35th birthday, the distribution is ataxable distribution because it is a distribution toa skip person and is neither a taxable terminationnor a direct skip.

Example 13. Exercise of withdrawal right astaxable distribution. The facts are the same as inExample 12, except GC holds a continuing rightto withdraw trust principal and after one year GCwithdraws $10,000. The withdrawal by GC is nota taxable termination because the withdrawaldoes not terminate C’s interest in the trust. Thewithdrawal by GC is a taxable distribution toGC.

Example 14. Interest in trust. T establishes anirrevocable trust under which the income is to bepaid to T’s child, C, for life. On the death of C,the trust principal is to be paid to T’s grandchild,GC. Because C has a present right to receiveincome from the trust, C has an interest in thetrust. Because GC cannot currently receivedistributions from the trust, GC does not have aninterest in the trust.

Example 15. Support obligation. T establishesan irrevocable trust for the benefit of T’sgrandchild, GC. The trustee has discretion todistribute property for GC’s support withoutregard to the duty or ability of GC’s parent, C,to support GC. Because GC is a permissiblecurrent recipient of trust property, GC has aninterest in the trust. C does not have an interestin the trust because the potential use of the trustproperty to satisfy C’s support obligation iswithin the discretion of a fiduciary. C would betreated as having an interest in the trust if thetrustee was required to distribute trust propertyfor GC’s support.

§26.2613–1 Skip person.

For the definition of skip person see§26.2612–1(d).

§26.2632–1 Allocation of GSTexemption.

(a) General rule. Except as other-wise provided in this section, anindividual or the individual’s executormay allocate the individual’s $1 millionGST exemption at any time from thedate of the transfer through the date forfiling the individual’s Federal estate taxreturn (including any extensions forfiling that have been actually granted).If no estate tax return is required to befiled, the GST exemption may be al-located at any time through the date aFederal estate tax return would be dueif a return were required to be filed


778/20047/28MAY96/A29-007

32

(including any extensions actuallygranted). If property is held in trust, theallocation of GST exemption is madeto the entire trust rather than to specifictrust assets. If a transfer is a direct skipto a trust, the allocation of GSTexemption to the transferred property isalso treated as an allocation of GSTexemption to the trust for purposes offuture GSTs with respect to the trust bythe same transferor.

(b) Lifetime allocations—(1) Auto-matic allocation to direct skips—(i) Ingeneral. If a direct skip occurs duringthe transferor’s lifetime, the transferor’sGST exemption not previously allo-cated (unused GST exemption) is auto-matically allocated to the transferredproperty (but not in excess of the fairmarket value of the property on thedate of the transfer). The transferormay prevent the automatic allocation ofGST exemption by describing on atimely-filed United States Gift (andGeneration-Skipping Transfer) Tax Re-turn (Form 709) the transfer and theextent to which the automatic alloca-tion is not to apply. In addition, atimely-filed Form 709 accompanied bypayment of the GST tax (as shown onthe return with respect to the directskip) is sufficient to prevent an auto-matic allocation of GST exemptionwith respect to the transferred property.See paragraph (c)(4) of this section forspecial rules in the case of direct skipstreated as occurring at the terminationof an estate tax inclusion period.

(ii) Time for filing Form 709. AForm 709 is timely filed if it is filed onor before the date required for report-ing the transfer if it were a taxable gift(i.e., the date prescribed by section6075(b), including any extensions tofile actually granted (the due date)).Except as provided in paragraph (b)(1)-(iii) of this section, the automaticallocation of GST exemption (or theelection to prevent the allocation, ifmade) is irrevocable after the due date.An automatic allocation of GST ex-emption is effective as of the date ofthe transfer to which it relates. Exceptas provided above, a Form 709 neednot be filed to report an automaticallocation.

(iii) Transitional rule. An election toprevent an automatic allocation of GSTexemption filed on or before January26, 1996, becomes irrevocable on July24, 1996.

(2) Allocation to other transfers—(i)In general. An allocation of GST

exemption to property transferred dur-ing the transferor’s lifetime, other thanin a direct skip, is made on Form 709.The allocation must clearly identify thetrust to which the allocation is beingmade, the amount of GST exemptionallocated to it, and if the allocation islate or if an inclusion ratio greater thanzero is claimed, the value of the trustassets at the effective date of theallocation. See paragraph (b)(2)(ii) ofthis section. The allocation should alsostate the inclusion ratio of the trustafter the allocation. Except as other-wise provided in this paragraph, anallocation of GST exemption may bemade by a formula; e.g., the allocationmay be expressed in terms of theamount necessary to produce an inclu-sion ratio of zero. However, formulaallocations made with respect to chari-table lead annuity trusts are not validexcept to the extent they are dependenton values as finally determined forFederal estate or gift tax purposes.With respect to a timely allocation, anallocation of GST exemption becomesirrevocable after the due date of thereturn. Except as provided in§26.2642–3 (relating to charitable leadannuity trusts), an allocation of GSTexemption to a trust is void to theextent the amount allocated exceeds theamount necessary to obtain an inclu-sion ratio of zero with respect to thetrust. See §26.2642–1 for the definitionof inclusion ratio. An allocation is alsovoid if the allocation is made withrespect to a trust that has no GSTpotential with respect to the transferormaking the allocation, at the time ofthe allocation. For this purpose, a trusthas GST potential even if the pos-sibility of a GST is so remote as to benegligible.

(ii) Effective date of allocation—(A)In general. (1) Except as otherwiseprovided, an allocation of GST exemp-tion is effective as of the date of anytransfer as to which the Form 709 onwhich it is made is a timely filed return(a timely allocation). If more than onetimely allocation is made, the earlierallocation is modified only if the laterallocation clearly identifies the transferand the nature and extent of themodification. Except as provided inparagraph (d)(1) of this section, anallocation to a trust made on a Form709 filed after the due date for re-porting a transfer to the trust (a lateallocation) is effective on the date theForm 709 is filed and is deemed toprecede in point of time any taxable

event occurring on such date. Forpurposes of this paragraph (b)(2)(ii),the Form 709 is deemed filed on thedate it is postmarked to the InternalRevenue Se rv i ce Cen te r . See§26.2642–2 regarding the effect of alate allocation in determining the inclu-sion ratio, etc. See paragraph (c)(1) ofthis section regarding allocation ofGST exemption to property subject toan estate tax inclusion period. If it isunclear whether an allocation of GSTexemption on a Form 709 is a late or atimely allocation to a trust, the alloca-tion is effective in the followingorder—

(i) To any transfer to the trustdisclosed on the return as to which thereturn is a timely return;

(ii) As a late allocation; and(iii) To any transfer to the trust not

disclosed on the return as to which thereturn would be a timely return.

(2) A late allocation to a trust maybe made on a Form 709 that is timelyfiled with respect to another transfer. Alate allocation is irrevocable whenmade.

(B) Amount of allocation. If othertransfers exist with respect to whichGST exemption could be allocatedunder paragraphs (b)(2)(ii)(A)(1)(ii)and (iii), any GST exemption allocatedunder paragraph (b)(2)(ii)(A)(1)(i) ofthis section is allocated in an amountequal to the value of the transferredproperty as reported on the Form 709.Thus, if the GST exemption allocatedon the Form 709 exceeds the value ofthe transfers reported on that return thathave generation-skipping potential, theinitial allocation under paragraph(b)(2)(ii)(A)(1)(i) of this section is inthe amount of the value of those trans-fers as reported on that return. Anyremaining amount of GST exemptionallocated on that return is then allo-cated pursuant to paragraphs (b)(2)-(ii)(A)(1)(ii) and (iii) of this section,notwithstanding any subsequent upwardadjustment in value of the transfersreported on the return.

(iii) Examples. The following exam-ples illustrate the provisions of thisparagraph (b):

Example 1. Modification of allocation of GSTexemption. T transfers $100,000 to an irrevocablegeneration-skipping trust on December 1, 1996.The transfer to the trust is not a direct skip. Thedate prescribed for filing the gift tax returnreporting the taxable gift is April 15, 1997. OnFebruary 10, 1997, T files a Form 709 allocating$50,000 of GST exemption to the trust. On April


778/20047/28MAY96/A29-007

33

10 of the same year, T files an amended Form709 allocating $100,000 of GST exemption tothe trust in a manner that clearly indicates theintention to modify and supersede the priorallocation with respect to the 1996 transfer. Theallocation made on the April 10 return super-sedes the prior allocation because it is made on atimely-filed Form 709 that clearly identifies thetrust and the nature and extent of the modifica-tion of GST exemption allocation. The allocationof $100,000 of GST exemption to the trust iseffective as of December 1, 1996. The resultwould be the same if the amended Form 709decreased the amount of the GST exemptionallocated to the trust.

Example 2. Modification of allocation of GSTexemption. The facts are the same as in Example1, except on July 10, 1997, T files a Form 709attempting to reduce the earlier allocation. Thereturn is not a timely-filed return. The $100,000GST exemption allocated to the trust, asamended on April 10, 1997, remains in effectbecause an allocation, once made, is irrevocableand may not be modified after the last date onwhich a timely-filed Form 709 can be filed.

Example 3. Effective date of late allocation ofGST exemption. T transfers $100,000 to anirrevocable generation-skipping trust on Decem-ber 1, 1996. The transfer to the trust is not adirect skip. The date prescribed for filing the gifttax return reporting the taxable gift is April 15,1997. On December 1, 1997, T files a Form 709and allocates $50,000 to the trust. The allocationis effective as of December 1, 1997.

Example 4. Effective date of late allocation ofGST exemption. T transfers $100,000 to ageneration-skipping trust on December 1, 1996,in a transfer that is not a direct skip. T does notmake an allocation of GST exemption on atimely-filed Form 709. On July 1, 1997, thetrustee makes a taxable distribution from thetrust to T’s grandchild in the amount of $30,000.Immediately prior to the distribution, the valueof the trust assets was $150,000. On the samedate, T allocates GST exemption to the trust inthe amount of $50,000. The allocation of GSTexemption on the date of the transfer is treatedas preceding in point of time the taxable distri-bution. At the time of the GST, the trust has aninclusion ratio of .6667 (1 – (50,000/150,000)).

Example 5. Automatic allocation to split-giftdirect skip. On May 15, 1996, T transfers$50,000 to a trust in a direct skip. T does not filea timely gift tax return electing out of theautomatic allocation. On April 30, 1998, T andT’s spouse, S, file an initial gift tax return for1996 on which they consent, pursuant to section2513, to have the gift treated as if one-half hadbeen made by each. As a result of the electionunder section 2513, which is retroactive to thedate of T’s transfer, T and S are each treated asthe transferor of one-half of the propertytransferred in the direct skip. Thus, $25,000 ofT’s unused GST exemption and $25,000 of S’sunused GST exemption is automatically allocatedto the trust. Both allocations are effective on andafter the date that T made the transfer.

(c) Special rules during an estate taxinclusion period—(1) In general. Anallocation of GST exemption (includingan automatic allocation) to propertysubject to an estate tax inclusion period(ETIP) that is made prior to termina-tion of the ETIP cannot be revoked, but

becomes effective no earlier than thedate of any termination of the ETIPwith respect to the trust. Where anallocation has not been made prior tothe termination of the ETIP, an alloca-tion is effective at the termination ofthe ETIP during the transferor’s life-time if made by the due date for filinga Form 709 that would apply to ataxable gift occurring at the time theETIP terminates (timely ETIP return).An allocation is effective in the case ofthe termination of the ETIP on thedeath of the transferor as provided inparagraph (d) of this section. If anypart of a trust is subject to an ETIP, theentire trust is subject to the ETIP. See§26.2642–1(b)(2) for rules determiningthe inclusion ratio applicable in thecase of GSTs during an ETIP.

(2) Estate tax inclusion perioddefined—(i) In general. An ETIP is theperiod during which, should deathoccur, the value of transferred propertywould be includible (other than byreason of section 2035) in the grossestate of—

(A) The transferor; or(B) The spouse of the transferor.(ii) Exceptions—(A) For purposes of

paragraph (c)(2) of this section, thevalue of transferred property is notconsidered as being subject to inclusionin the gross estate of the transferor orthe spouse of the transferor if thepossibility that the property will beincluded is so remote as to be neglig-ible. A possibility is so remote as to benegligible if it can be ascertained byactuarial standards that there is lessthan a 5 percent probability that theproperty will be included in the grossestate.

(B) For purposes of paragraph (c)(2)of this section, the value of transferredproperty is not considered as beingsubject to inclusion in the gross estateof the spouse of the transferor, if thespouse possesses with respect to anytransfer to the trust, a right to withdrawno more than the greater of $5,000 or 5percent of the trust corpus, and suchwithdrawal right terminates no laterthan 60 days after the transfer to thetrust.

(C) The rules of this paragraph(c)(2) do not apply to qualified termin-able interest property with respect towhich the special election under§26.2652–2 has been made.

(3) Termination of an ETIP. AnETIP terminates on the first to occurof—

(i) The death of the transferor;(ii) The time at which no portion of

the property is includible in the trans-feror’s gross estate (other than byreason of section 2035) or, in the caseof an individual who is a transferorsolely by reason of an election undersection 2513, the time at which noportion would be includible in thegross estate of the individual’s spouse(other than by reason of section 2035);

(iii) The time of a GST, but onlywith respect to the property involved inthe GST; or

(iv) In the case of an ETIP arisingby reason of an interest or power heldby the transferor’s spouse under sub-section (c)(2)(i)(B) of this section, atthe first to occur of—

(A) The death of the spouse; or(B) The time at which no portion of

the property would be includible in thespouse’s gross estate (other than byreason of section 2035).

(4) Treatment of direct skips. Ifproperty transferred to a skip person issubject to an ETIP, the direct skip istreated as occurring on the terminationof the ETIP.

(5) Examples. The following exam-ples illustrate the rules of this sectionas they apply to the termination of anETIP during the lifetime of the trans-feror. In each example assume that Ttransfers $100,000 to an irrevocabletrust:

Example 1. Allocation of GST exemptionduring ETIP. The trust instrument provides thattrust income is to be paid to T for 9 years oruntil T’s prior death. The trust principal is to bepaid to T’s grandchild on the termination of T’sincome interest. If T dies within the 9-yearperiod, the value of the trust principal isincludible in T’s gross estate under section2036(a). Thus, the trust is subject to an ETIP. Tfiles a timely Form 709 reporting the transferand allocating $100,000 of GST exemption to thetrust. The allocation of GST exemption to thetrust is not effective until the termination of theETIP.

Example 2. Effect of prior allocation ontermination of ETIP. The facts are the same as inExample 1, except the trustee has the power toinvade trust principal on behalf of T’s grand-child, GC, during the term of T’s incomeinterest. In year 4, when the value of the trust is$200,000, the trustee distributes $15,000 to GC.The distribution is a taxable distribution. TheETIP with respect to the property distributed toGC terminates at the time of the taxable dis-tribution. See paragraph (c)(3)(iii) of this section.Solely for purposes of determining the trust’sinclusion ratio with respect to the taxabledistribution, the prior $100,000 allocation ofGST exemption (as well as any additional allo-cation made on a timely ETIP return) is effectiveimmediately prior to the taxable distribution. See


778/20047/28MAY96/A29-007

34

§26.2642–1(b)(2). The trust’s inclusion ratio withrespect to the taxable distribution is therefore .50(1–(100,000/200,000)).

Example 3. Split-gift transfers subject to ETIP.The trust instrument provides that trust income isto be paid to T for 9 years or until T’s priordeath. The trust principal is to be paid to T’sgrandchild on the termination of T’s incomeinterest. T files a timely Form 709 reporting thetransfer. T’s spouse, S, consents to have the gifttreated as made one-half by S under section2513. Because S is treated as transferring one-half of the property to T’s grandchild, S becomesthe transferor of one-half of the trust forpurposes of chapter 13. Because the value of thetrust would be includible in T’s gross estate if Tdied immediately after the transfer, S’s transferis subject to an ETIP. If S should die prior to thetermination of the trust, S’s executor mayallocate S’s GST exemption to the trust, but onlyto the portion of the trust for which S is treatedas the transferor. However, the allocation doesnot become effective until the earlier of theexpiration of T’s income interest or T’s death.

Example 4. Transfer of retained interest asETIP termination. The trust instrument providesthat trust income is to be paid to T for 9 years oruntil T’s prior death. The trust principal is to bepaid to T’s grandchild on the termination of T’sincome interest. Four years after the initialtransfer, T transfers the income interest to T’ssibling. The ETIP with respect to the trustterminates on T’s transfer of the income interestbecause, after the transfer, the trust propertywould not be includible in T’s gross estate (otherthan by reason of section 2035) if T died at thattime.

(d) Allocations after the transferor’sdeath—(1) Allocation by executor. Ex-cept as otherwise provided in thisparagraph (d), an allocation of adecedent’s unused GST exemption bythe executor of the decedent’s estate ismade on the appropriate United StatesEstate (and Generation-Skipping Trans-fer) Tax Return (Form 706 or Form706NA) filed on or before the date pre-scribed for filing the return by section6075(a) (including any extensions actu-ally granted (the due date)). An alloca-tion of GST exemption with respect toproperty included in the gross estate ofa decedent is effective as of the date ofdeath. A timely allocation of GSTexemption by an executor with respectto a lifetime transfer of property that isnot included in the transferor’s grossestate is made on a Form 709. A lateallocation of GST exemption by anexecutor, other than an allocation thatis deemed to be made under section2632(b)(1), with respect to a lifetimetransfer of property is made on Form706 or Form 706NA and is effective asof the date the allocation is filed. Anallocation of GST exemption to a trust(whether or not funded at the time theForm 706 or Form 706NA is filed) iseffective if the notice of allocation

clearly identifies the trust and theamount of the decedent’s GST exemp-tion allocated to the trust. An executormay allocate the decedent’s GST ex-emption by use of a formula. Forpurposes of this section, an allocationis void if the allocation is made for atrust that has no GST potential withrespect to the transferor for whom theallocation is being made, as of the dateof the transferor’s death. For thispurpose, a trust has GST potential evenif the possibility of a GST is so remoteas to be negligible.

(2) Automatic allocation after death.A decedent’s unused GST exemption isautomatically allocated on the due datefor filing Form 706 or Form 706NA tothe extent not otherwise allocated bythe decedent’s executor on or beforethat date. The automatic allocationoccurs whether or not a return isactually required to be filed. UnusedGST exemption is allocated pro rata(subject to the rules of §26.2642–2(b)),on the basis of the value of theproperty as finally determined forpurposes of chapter 11 (chapter 11value), first to direct skips treated asoccurring at the transferor’s death. Thebalance, if any, of unused GST exemp-tion is allocated pro rata (subject to therules of §26.2642–2(b)) on the basis ofthe chapter 11 value of the nonexemptportion of the trust property (or in thecase of trusts that are not included inthe gross estate, on the basis of thedate of death value of the trust) totrusts with respect to which a taxabletermination may occur or from which ataxable distribution may be made. Theautomatic allocation of GST exemptionis irrevocable, and an allocation madeby the executor after the automaticallocation is made is ineffective. Noautomatic allocation of GST exemptionis made to a trust that will have a newtransferor with respect to the entiretrust prior to the occurrence of anyGST with respect to the trust. Inaddition, no automatic allocation ofGST exemption is made to a trust if,during the nine month period endingimmediately after the death of thetransferor—

(i) No GST has occurred with re-spect to the trust; and

(ii) At the end of such period nofuture GST can occur with respect tothe trust.

§26.2641–1 Applicable rate of tax.

The rate of tax applicable to anyGST (applicable rate) is determined by

multiplying the maximum Federalestate tax rate in effect at the time ofthe GST by the inclusion ratio (asdefined in §26.2642–1). For this pur-pose, the maximum Federal estate taxrate is the maximum rate set forthunder section 2001(c) (without regardto section 2001(c)(2)).

§26.2642–1 Inclusion ratio.

(a) In general. Except as otherwiseprovided in this section, the inclusionratio is determined by subtracting theapplicable fraction (rounded to thenearest one-thousandth (.001)) from 1.In rounding the applicable fraction tothe nearest one-thousandth, any amountthat is midway between one one-thousandth and another one-thousandthis rounded up to the higher of thosetwo amounts.

(b) Numerator o f appl icablefraction—(1) In general. Except asotherwise provided in this paragraph(b), and in §§26.2642–3 (providing aspecial rule for charitable lead annuitytrusts) and 26.2642–4 (providing rulesfor the redetermination of the applica-ble fraction), the numerator of theapplicable fraction is the amount ofGST exemption allocated to the trust(or to the transferred property in thecase of a direct skip not in trust).

(2) GSTs occurring during anETIP—(i) In general. For purposes ofdetermining the inclusion ratio withrespect to a taxable termination or ataxable distribution that occurs duringan ETIP, the numerator of the applica-ble fraction is the sum of—

(A) The GST exemption previouslyallocated to the trust (including anyallocation made to the trust prior to anytaxable termination or distribution) re-duced (but not below zero) by thenontax amount of any prior GSTs withrespect to the trust; and

(B) Any GST exemption allocated tothe trust on a timely ETIP return filedafter the termination of the ETIP. See§26.2632–1(c)(5) Example 2.

(ii) Nontax amount of a prior GST.(1) The nontax amount of a prior GSTwith respect to the trust is the amountof the GST multiplied by the applicablefraction attributable to the trust at thetime of the prior GST.

(2) For rules regarding the allocationof GST exemption to property duringan ETIP, see §26.2632–1(c).

(c) Denominator of applicablefraction—(1) In general. Except as


778/20047/28MAY96/A29-007

35

otherwise provided in this paragraph(c) and in §§26.2642–3 and 26.2642–4,the denominator of the applicable frac-tion is the value of the propertytransferred to the trust (or transferred ina direct skip not in trust) (as deter-mined under §26.2642–2) reduced bythe sum of—

(i) Any Federal estate tax and anyState death tax incurred by reason ofthe transfer that is chargeable to thetrust and is actually recovered from thetrust;

(ii) The amount of any charitablededuction allowed under section 2055,2106, or 2522 with respect to thetransfer; and

(iii) In the case of a direct skip, thevalue of the portion of the transfer thatis a nontaxable gift. See paragraph(c)(3) of this section for the definitionof nontaxable gift.

(2) Zero denominator. If the de-nominator of the applicable fraction iszero, the inclusion ratio is zero.

(3) Nontaxable gifts. Generally, forpurposes of chapter 13, a transfer is anontaxable gift to the extent the trans-fer is excluded from taxable gifts byreason of section 2503(b) (after ap-plication of section 2513) or section2503(e). However, a transfer to a trustfor the benefit of an individual is not anontaxable gift for purposes of thissection unless—

(i) Trust principal or income may,during the individual’s lifetime, bedistributed only to or for the benefit ofthe individual; and

(ii) The assets of the trust will beincludible in the gross estate of theindividual if the individual dies beforethe trust terminates.

(d) Examples. The following exam-ples illustrate the provisions of thissection. See §26.2652–2(d) Examples 2and 3 for illustrations of the computa-tion of the inclusion ratio where thespecial (reverse QTIP) election may beapplicable.

Example 1. Computation of the inclusion ratio.T transfers $100,000 to a newly-created irrevoca-ble trust providing that income is to be ac-cumulated for 10 years. At the end of 10 years,the accumulated income is to be distributed toT’s child, C, and the trust principal is to be paidto T’s grandchild. T allocates $40,000 of T’sGST exemption to the trust on a timely-filed gifttax return. The applicable fraction with respect tothe trust is .40 ($40,000 (the amount of GSTexemption allocated to the trust) over $100,000(the value of the property transferred to thetrust)). The inclusion ratio is .60 (1 – .40). If themaximum Federal estate tax rate is 55 percent at

the time of a GST, the rate of tax applicable tothe transfer (applicable rate) will be .333 (55percent (the maximum estate tax rate) 3 .60 (theinclusion ratio)).

Example 2. Gift entirely nontaxable. OnDecember 1, 1996, T transfers $10,000 to anirrevocable trust for the benefit of T’s grand-child, GC. GC possesses a right to withdraw anycontributions to the trust such that the entiretransfer qualifies for the annual exclusion undersection 2503(b). Under the terms of the trust, theincome is to be paid to GC for 10 years or untilGC’s prior death. Upon the expiration of GC’sincome interest, the trust principal is payable toGC or GC’s estate. The transfer to the trust is adirect skip. T made no prior gifts to or for thebenefit of GC during 1996. The entire $10,000transfer is a nontaxable transfer. For purposes ofcomputing the tax on the direct skip, thedenominator of the applicable fraction is zero,and thus, the inclusion ratio is zero.

Example 3. Gift nontaxable in part. T transfers$12,000 to an irrevocable trust for the benefit ofT’s grandchild, GC. Under the terms of the trust,the income is to be paid to GC for 10 years oruntil GC’s prior death. Upon the expiration ofGC’s income interest, the trust principal ispayable to GC or GC’s estate. Further, GC hasthe right to withdraw $10,000 of any contributionto the trust such that $10,000 of the transferqualifies for the annual exclusion under section2503(b). The amount of the nontaxable transferis $10,000. Solely for purposes of computing thetax on the direct skip, T’s transfer is divided intotwo portions. One portion is equal to the amountof the nontaxable transfer ($10,000) and has azero inclusion ratio; the other portion is $2,000($12,000 – $10,000). With respect to the $2,000portion, the denominator of the applicable frac-tion is $2,000. Assuming that T has sufficientGST exemption available, the numerator of theapplicable fraction is $2,000 (unless T elects tohave the automatic allocation provisions notapply). Thus, assuming T does not elect to havethe automatic allocation not apply, the applicablefraction is one ($2,000/$2,000 = 1) and theinclusion ratio is zero (1 – 1 = 0).

Example 4. Gift nontaxable in part. Assumethe same facts as in Example 3, except T files atimely Form 709 electing that the automaticallocation of GST exemption not apply to the$12,000 transferred in the direct skip. T’stransfer is divided into two portions, a $10,000portion with a zero inclusion ratio and a $2,000portion with an applicable fraction of zero(0/$2,000 = 0) and an inclusion ratio of one (1 –0 = 1).

§26.2642–2 Valuation.

(a) Lifetime transfers—(1) In gen-eral. For purposes of determining thedenominator of the applicable fraction,the value of property transferred duringlife is its fair market value on theeffective date of the allocation of GSTexemption. In the case of a timely al-location under §26.2632–1(b)(2)(ii), thedenominator of the applicable fractionis the fair market value of the propertyas finally determined for purposes ofchapter 12.

(2) Special rule for late allocationsduring life. If a transferor makes a late

allocation of GST exemption to a trust,the value of the property transferred tothe trust is the fair market value of thetrust assets determined on the effectivedate of the allocation of GST exemp-tion. Except as otherwise provided inthis paragraph (a)(2), if a transferormakes a late allocation of GST exemp-tion to a trust, the transferor may,solely for purposes of determining thefair market value of the trust assets,elect to treat the allocation as havingbeen made on the first day of themonth during which the late allocationis made (valuation date). An electionunder this paragraph (a)(2) is noteffective with respect to a life insur-ance policy or a trust holding a lifeinsurance policy, if the insured individ-ual has died. An allocation subject tothe election contained in this paragraph(a)(2) is not effective until it is actuallyfiled with the Internal Revenue Service.The election is made by stating on theForm 709 on which the allocation ismade—

(i) That the election is being made;(ii) The applicable valuation date;

and(iii) The fair market value of the

trust assets on the valuation date.(b) Transfers at death—(1) In gen-

eral. Except as provided in paragraphs(b)(2) and (3) of this section, indetermining the denominator of theapplicable fraction, the value of prop-erty included in the decedent’s grossestate is its value for purposes ofchapter 11. In the case of qualified realproperty with respect to which theelection under section 2032A is made,the value of the property is the valuedetermined under section 2032A pro-vided the recapture agreement de-scribed in section 2032A(d)(2) filedwith the Internal Revenue Servicespecifically provides for the signato-ries’ consent to the imposition of, andpersonal liability for, additional GSTtax in the event an additional estate taxis imposed under section 2032A(c). See§26.2642–4(a)(4). If the recaptureagreement does not contain these provi-sions, the value of qualified realproperty as to which the election undersection 2032A is made is the fairmarket value of the property deter-mined without regard to the provisionsof section 2032A.

(2) Special rule for pecuniarypayments—(i) In general. If a pecuni-ary payment is satisfied with cash, thedenominator of the applicable fraction


778/20047/28MAY96/A29-007

36

is the pecuniary amount. If propertyother than cash is used to satisfy apecuniary payment, the denominator ofthe applicable fraction is the pecuniaryamount only if payment must be madewith property on the basis of the valueof the property on—

(A) The date of distribution; or(B) A date other than the date of

distribution, but only if the pecuniarypayment must be satisfied on a basisthat fairly reflects net appreciation anddepreciation (occurring between thevaluation date and the date of distribu-tion) in all of the assets from which thedistribution could have been made.

(ii) Other pecuniary amounts pay-able in kind. The denominator of theapplicable fraction with respect to anyproperty used to satisfy any otherpecuniary payment payable in kind isthe date of distribution value of theproperty.

(3) Special rule for residual trans-fers after payment of a pecuniary pay-ment—(i) In general. Except as other-wise provided in this paragraph (b)(3),the denominator of the applicable frac-tion with respect to a residual transferof property after the satisfaction of apecuniary payment is the estate taxvalue of the assets available to satisfythe pecuniary payment reduced, if thepecuniary payment carries appropriateinterest (as defined in paragraph (b)(4)of this section), by the pecuniaryamount. The denominator of the appli-cable fraction with respect to a residualtransfer of property after the satisfac-tion of a pecuniary payment that doesnot carry appropriate interest is theestate tax value of the assets availableto satisfy the pecuniary payment re-duced by the present value of thepecuniary payment. For purposes ofthis paragraph (b)(3)(i), the presentvalue of the pecuniary payment isdetermined by using—

(A) The interest rate applicable un-der section 7520 at the death of thetransferor; and

(B) The period between the date ofthe transferor’s death and the date thepecuniary amount is paid.

(ii) Special rule for residual trans-fers after pecuniary payments payablein kind. The denominator of the appli-cable fraction with respect to anyresidual transfer after satisfaction of apecuniary payment payable in kind isthe date of distribution value of theproperty distributed in satisfaction ofthe residual transfer, unless the pecuni-

ary payment must be satisfied on thebasis of the value of the property on—

(A) The date of distribution; or(B) A date other than the date of

distribution, but only if the pecuniarypayment must be satisfied on a basisthat fairly reflects net appreciation anddepreciation (occurring between thedate of death and the date of distribu-tion) in all of the assets from which thedistribution could have been made.

(4) Appropriate interest—(i) In gen-eral. For purposes of this section and§26.2654–1 (relating to certain truststreated as separate trusts), appropriateinterest means that interest must bepayable from the date of death of thetransferor (or from the date specifiedunder applicable State law requiring thepayment of interest) to the date ofpayment at a rate—

(A) At least equal to—(1) The statutory rate of interest, if

any, applicable to pecuniary bequestsunder the law of the State whose lawgoverns the administration of the estateor trust; or

(2) If no such rate is indicated underapplicable State law, 80 percent of therate that is applicable under section7520 at the death of the transferor; and

(B) Not in excess of the greater of—(1) The statutory rate of interest, if

any, applicable to pecuniary bequestsunder the law of the State whose lawgoverns the administration of the trust;or

(2) 120 percent of the rate that isapplicable under section 7520 at thedeath of the transferor.

(ii) Pecuniary payments deemed tocarry appropriate interest. For pur-poses of this paragraph (b)(4), if apecuniary payment does not carryappropriate interest, the pecuniary pay-ment is considered to carry appropriateinterest to the extent—

(A) The entire payment is made orproperty is irrevocably set aside tosatisfy the entire pecuniary paymentwithin 15 months of the transferor’sdeath; or

(B) The governing instrument orapplicable local law specifically re-quires the executor or trustee to allo-cate to the pecuniary payment a prorata share of the income earned by thefund from which the pecuniary pay-ment is to be made between the date ofdeath of the transferor and the date ofpayment. For purposes of paragraph(b)(4)(ii)(A) of this section, property is

irrevocably set aside if it is segregatedand held in a separate account pendingdistribution.

(c) Examples. The following exam-ples illustrate the provisions of thissection:

Example 1. T transfers $100,000 to a newly-created irrevocable trust on December 15, 1996.The trust provides that income is to be paid toT’s child for 10 years. At the end of the 10-yearperiod, the trust principal is to be paid to T’sgrandchild. T does not allocate any GSTexemption to the trust on the gift tax returnreporting the transfer. On November 15, 1997, Tfiles a Form 709 allocating $50,000 of GSTexemption to the trust. Because the allocationwas made on a late filed return, the value of theproperty transferred to the trust is determined onthe date the allocation is filed (unless an electionis made pursuant to paragraph (a)(2) of thissection to value the trust property as of the firstday of the month in which the allocationdocument is filed with the Internal RevenueService). On November 15, 1997, the value ofthe trust property is $150,000. Effective as ofNovember 15, 1997, the applicable fraction withrespect to the trust is .333 ($50,000 (the amountof GST exemption allocated to the trust) over$150,000 (the value of the trust principal on theeffective date of the GST exemption allocation)),and the inclusion ratio is .667 (1.0 – .333).

Example 2. The facts are the same as inExample 1, except the value of the trust propertyis $80,000 on November 15, 1997. The applica-ble fraction is .625 ($50,000 over $80,000) andthe inclusion ratio is .375 (1.0 – .625).

Example 3. T transfers $100,000 to a newly-created irrevocable trust on December 15, 1996.The trust provides that income is to be paid toT’s child for 10 years. At the end of the 10-yearperiod, the trust principal is to be paid to T’sgrandchild. T does not allocate any GSTexemption to the trust on the gift tax returnreporting the transfer. On November 15, 1997, Tfiles a Form 709 allocating $50,000 of GSTexemption to the trust. T elects to value the trustprincipal on the first day of the month in whichthe allocation is made pursuant to the electionprovided in paragraph (a)(2) of this section.Because the late allocation is made in November,the value of the trust is determined as ofNovember 1, 1997.

§26.2642–3 Special rule forcharitable lead annuity trusts.

(a) In general. In determining theapplicable fraction with respect to acharitable lead annuity trust—

(1) The numerator is the adjustedgeneration-skipping transfer tax exemp-tion (adjusted GST exemption); and

(2) The denominator is the value ofall property in the trust immediatelyafter the termination of the charitablelead annuity.

(b) Adjusted GST exemption defined.The adjusted GST exemption is theamount of GST exemption allocated tothe trust increased by an amount equal


778/20047/28MAY96/A29-007

37

to the interest that would accrue if anamount equal to the allocated GSTexemption were invested at the rateused to determine the amount of theestate or gift tax charitable deduction,compounded annually, for the actualperiod of the charitable lead annuity. Ifa late allocation is made to a charitablelead annuity trust, the adjusted GSTexemption is the amount of GSTexemption allocated to the trust in-creased by the interest that wouldaccrue if invested at such rate for theperiod beginning on the date of the lateallocation and extending for the bal-ance of the actual period of thecharitable lead annuity. The amount ofGST exemption allocated to a chari-table lead annuity trust is not reducedeven though it is ultimately determinedthat the allocation of a lesser amount ofGST exemption would have resulted inan inclusion ratio of zero. For purposesof chapter 13, a charitable lead annuitytrust is any trust providing an interestin the form of a guaranteed annuitydescribed in §25.2522(c)–3(c)(2)(vi) ofthis chapter for which the transferor isallowed a charitable deduction forFederal estate or gift tax purposes.

(c) Example. The following exampleillustrates the provisions of this section:

Example. T creates a charitable lead annuitytrust for a 10-year term with the remainderpayable to T’s grandchild. T timely allocates anamount of GST exemption to the trust which Texpects will ultimately result in a zero inclusionratio. However, at the end of the charitable leadinterest, because the property has not appreciatedto the extent T anticipated, the numerator of theapplicable fraction is greater than the denomina-tor. The inclusion ratio for the trust is zero. Noportion of the GST exemption allocated to thetrust is restored to T or to T’s estate.

§26.2642–4 Redetermination ofapplicable fraction.

(a) In general. The applicable frac-tion for a trust is redetermined when-ever additional exemption is allocatedto the trust or when certain changesoccur with respect to the principal ofthe trust. Except as otherwise providedin this paragraph (a), the numerator ofthe redetermined applicable fraction isthe sum of the amount of GSTexemption currently being allocated tothe trust (if any) plus the value of thenontax portion of the trust, and thedenominator of the redetermined appli-cable fraction is the value of the trustprincipal immediately after the eventoccurs. The nontax portion of a trust isdetermined by multiplying the value of

the trust assets, determined imme-diately prior to the event, by the thenapplicable fraction.

(1) Multiple transfers to a singletrust. If property is added to anexisting trust, the denominator of theredetermined applicable fraction is thevalue of the trust immediately after theaddition reduced as provided in§26.2642–1(c).

(2) Consolidation of separate trusts.If separate trusts created by one trans-feror are consolidated, a single applica-ble fraction for the consolidated trust isdetermined. The numerator of the re-determined applicable fraction is thesum of the nontax portions of eachtrust immediately prior to theconsolidation.

(3) Property included in transferor’sgross estate. If the value of propertyheld in a trust created by the transferor,with respect to which an allocation wasmade at a time that the trust was notsubject to an ETIP, is included in thetransferor’s gross estate, the applicablefraction is redetermined if additionalGST exemption is allocated to theproperty. The numerator of the redeter-mined applicable fraction is an amountequal to the nontax portion of theproperty immediately after the death ofthe transferor increased by the amountof GST exemption allocated by theexecutor of the transferor’s estate to thetrust. If additional GST exemption isnot allocated to the trust, the applicablefraction immediately before death isnot changed, if the trust was notsubject to an ETIP at the time GSTexemption was allocated to the trust.The denominator of the applicablefraction is reduced to reflect anyfederal or state, estate or inheritancetaxes paid from the trust.

(4) Imposition of recapture tax un-der section 2032A—(i) If an additionalestate tax is imposed under section2032A and if the section 2032Aelec t ion was e f fec t ive (under§26.2642–2(b)) for purposes of theGST tax, the applicable fraction withrespect to the property is redeterminedas of the date of death of the transferor.In making the redetermination, anyavailable GST exemption not allocatedat the death of the transferor (or at aprior recapture event) is automaticallyallocated to the property. The de-nominator of the applicable fraction isthe fair market value of the property atthe date of the transferor’s deathreduced as provided in §26.2642–1(c)

and further reduced by the amount ofthe additional GST tax actually re-covered from the trust.

(ii) The GST tax imposed withrespect to any taxable termination,taxable distribution, or direct skipoccurring prior to the recapture event isrecomputed based on the applicablefraction as redetermined. Any addi-tional GST tax as recomputed is dueand payable on the date that is sixmonths after the event that causes theimposition of the additional estate taxunder section 2032A. The additionalGST tax is remitted with Form 706-Aand is reported by attaching a statementto Form 706–A showing the computa-tion of the additional GST tax.

(iii) The applicable fraction, as re-determined under this section, is alsoused in determining any GST taximposed with respect to GSTs occur-ring after the date of the recaptureevent.

(b) Examples. The following exam-ples illustrate the principles of thissection:

Example 1. Allocation of additional exemption.T transfers $200,000 to an irrevocable trustunder which the income is payable to T’s child,C, for life. Upon the termination of the trust, theremainder is payable to T’s grandchild, GC. At atime when no ETIP exists with respect to thetrust property, T makes a timely allocation of$100,000 of GST exemption, resulting in aninclusion ratio of .50. Subsequently, when theentire trust property is valued at $500,000, Tallocates an additional $100,000 of T’s unusedGST exemption to the trust. The inclusion ratioof the trust is recomputed at that time. Thenumerator of the applicable fraction is $350,000($250,000 (the nontax portion as of the date ofthe allocation) plus $100,000 (the GST exemp-tion currently being allocated)). The denominatoris $500,000 (the date of allocation fair marketvalue of the trust). The inclusion ratio is .30 (1 –.70).

Example 2. Multiple transfers to a trust,allocation both timely and late. On December10, 1993, T transfers $10,000 to an irrevocabletrust that does not satisfy the requirements ofsection 2642(c)(2). T makes identical transfers tothe trust on December 10, 1994, 1995, 1996, andon January 15, 1997. Immediately after thetransfer on January 15, 1997, the value of thetrust principal is $40,000. On January 14, 1998,when the value of the trust principal is $50,000,T allocates $30,000 of GST exemption to thetrust. T discloses the 1997 transfer on the Form709 filed on January 14, 1998. Thus, T’sallocation is a timely allocation with respect tothe transfer in 1997, $10,000 of the allocation iseffective as of the date of that transfer, and, onand after January 15, 1997, the inclusion ratio ofthe trust is .75 (1 – ($10,000/$40,000)). Thebalance of the allocation is a late allocation withrespect to prior transfers to the trust and iseffective as of January 14, 1998. In redetermin-ing the inclusion ratio as of that date, thenumerator of the redetermined applicable fraction


778/20047/28MAY96/A29-008

38

is $32,500 ($12,500 (.25 3 $50,000), the nontaxportion of the trust on January 14, 1998) plus$20,000 (the amount of GST exemption allocatedlate to the trust). The denominator of the newapplicable fraction is $50,000 (the value of thetrust principal at the time of the late allocation).

Example 3. Excess allocation. (i) T creates anirrevocable trust for the benefit of T’s child andgrandchild in 1996 transferring $50,000 to thetrust on the date of creation. T allocates no GSTexemption to the trust on the Form 709 reportingthe transfer. On July 1, 1997 (when the value ofthe trust property is $60,000), T transfers anadditional $40,000 to the trust.

(ii) On April 15, 1998, when the value of thetrust is $150,000, T files a Form 709 reportingthe 1997 transfer and allocating $150,000 ofGST exemption to the trust. The allocation is atimely allocation of $40,000 with respect to the1997 transfer and is effective as of that date.Thus, the applicable fraction for the trust as ofJuly 1, 1997 is .40 ($40,000/$100,000 ($40,000 +$60,000)).

(iii) The allocation is also a late allocation of$90,000, the amount necessary to attain a zeroinclusion ratio on April 15, 1998, computed asfollows: $60,000 (the nontax portion immediatelyprior to the allocation (.40 3 $150,000)) plus$90,000 (the additional allocation necessary toproduce a zero inclusion ratio based on adenominator of $150,000)/$150,000 equals oneand, thus, an inclusion ratio of zero. The balanceof the allocation, $20,000 ($150,000 less thetimely allocation of $40,000 less the lateallocation of $90,000) is void.

Example 4. Undisclosed transfer. (i) The factsare the same as in Example 3, except that onFebruary 1, 1998 (when the value of the trust is$150,000), T transfers an additional $50,000 tothe trust and the value of the entire trust corpuson April 15, 1998 is $220,000. The Form 709filed on April 15, 1998 does not disclose the1998 transfer. Under the rule in §26.2632–1(b)-(2)(ii), the allocation is effective first as a timelyallocation to the 1997 transfer; second, as a lateallocation to the trust as of April 15, 1998; and,finally as a timely allocation to the February 1,1998 transfer. As of April 15, 1998, $55,000, apro rata portion of the trust assets, is consideredto be the property transferred to the trust onFebruary 1, 1998 (($50,000/$200,000) 3$220,000). The balance of the trust, $165,000,represents prior transfers to the trust.

(ii) As in Example 3, the allocation is a timelyallocation as to the 1997 transfer (and theapplicable fraction as of July 1, 1997 is .40) anda late allocation as of 1998. The amount of thelate allocation is $99,000, computed as follows:(.40 3 $165,000 plus $99,000)/$165,000 = one.

(iii) The balance of the allocation, $11,000($150,000 less the timely allocation of $40,000less the late allocation of $99,000) is a timelyallocation as of February 1, 1998. The applicablefraction with respect to the trust, as of February1, 1998, is .355, computed as follows: $60,000(the nontax portion of the trust immediately priorto the February 1, 1998 transfer (.40 3$150,000)) plus $11,000 (the amount of thetimely allocation to the 1998 transfer)/$200,000(the value of the trust on February 1, 1998, afterthe transfer on that date) = $71,000/$200,000 =.355.

(iv) The applicable fraction with respect to thetrust, as of April 15, 1998, is .805 computed asfollows: $78,100 (the nontax portion immediatelyprior to the allocation (.355 3 $220,000)) plus$99,000 (the amount of the late allocation)/$220,000 = $177,100/$220,000 = .805.

Example 5. Redetermination of inclusion ratioon ETIP termination. (i) T transfers $100,000 toan irrevocable trust. The trust instrument pro-vides that trust income is to be paid to T for 9years or until T’s prior death. The trust principalis to be paid to T’s grandchild, GC, on thetermination of T’s income interest. The trusteehas the power to invade trust principal for thebenefit of GC during the term of T’s incomeinterest. The trust is subject to an ETIP while Tholds the retained income interest. T files atimely Form 709 reporting the transfer andallocates $100,000 of GST exemption to thetrust. In year 4, when the value of the trust is$200,000, the trustee distributes $15,000 to GC.The distribution is a taxable distribution. Becauseof the existence of the ETIP, the inclusion ratiowith respect to the taxable distribution is deter-mined immediately prior to the occurrence of theGST. Thus, the inclusion ratio applicable to theyear 4 GST is .50 (1 – ($100,000/$200,000 =.50).

(ii) In year 5, when the value of the trust isagain $200,000, the trustee distributes another$15,000 to GC. Because the trust is still subjectto the ETIP in year 5, the inclusion ratio withrespect to the year 5 GST is again computedimmediately prior to the GST. In computing thenew inclusion ratio, the numerator of theapplicable fraction is reduced by the nontaxportion of prior GSTs occurring during the ETIP.Thus, the numerator of the applicable fractionwith respect to the GST in year 5 is $92,500($100,000 – (.50 3 $15,000)) and the inclusionratio applicable with respect to the GST in year5 is .537 (1 – ($92,500/$200,000) = .463). Anyadditional GST exemption allocated on a timelyETIP return with respect to the GST in year 5 iseffective immediately prior to the transfer.

§26.2642–5 Finality of inclusionratio.

(a) Direct skips. The inclusion ratioapplicable to a direct skip becomesfinal when no additional GST tax(including additional GST tax payableas a result of a cessation, etc. ofqualified use under section 2032A(c))may be assessed with respect to thedirect skip.

(b) Other GSTs. With respect totaxable distributions and taxable termi-nations, the inclusion ratio for a trustbecomes final, on the later of—

(1) The expiration of the period forassessment with respect to the firstGST tax return filed using that inclu-sion ratio; (unless the trust is subject toan election under section 2032A inwhich case the applicable date underthis subsection is the expiration of theperiod of assessment of any additionalGST tax due as a result of a cessation,etc. of qualified use under section2032A); or

(2) The expiration of the period forassessment of Federal estate tax withrespect to the estate of the transferor.For purposes of this paragraph (b)(2),if an estate tax return is not required to

be filed, the period for assessment isdetermined as if a return were requiredto be filed and as if the return weretimely filed within the period pre-scribed by section 6075(a).

§26.2652–1 Transferor defined; otherdefinitions.

(a) Transferor defined—(1) In gen-eral. Except as otherwise provided inparagraph (a)(3) of this section, theindividual with respect to whom prop-erty was most recently subject toFederal estate or gift tax is thetransferor of that property for purposesof chapter 13. An individual is treatedas transferring any property with re-spect to which the individual is thetransferor. Thus, an individual may bea transferor even though there is notransfer of property under local law atthe time the Federal estate or gift taxapplies. For purposes of this paragraph,a surviving spouse is the transferor of aqualified domestic trust created by thedeceased spouse that is included in thesurviving spouse’s gross estate, pro-vided the trust is not subject to theelection described in §26.2652–2 (re-verse QTIP election). A survivingspouse is also the transferor of aqualified domestic trust created by thesurviving spouse pursuant to section2056(d)(2)(B).

(2) Transfers subject to Federalestate or gift tax. For purposes of thissection, a transfer is subject to Federalgift tax if a gift tax is imposed undersection 2501(a). A transfer is subject toFederal estate tax if the value of theproperty is includible in the decedent’sgross estate as determined under sec-tion 2031 or section 2103.

(3) Special rule for certain QTIPtrusts. Solely for purposes of chapter13, if a transferor of qualified termin-able interest property (QTIP) electsunder §26.2652–2(a) to treat the prop-erty as if the QTIP election had notbeen made (reverse QTIP election), theidentity of the transferor of the prop-erty is determined without regard to theapplication of sections 2044, 2207A,and 2519.

(4) Exercise of certain nongeneralpowers of appointment. The exercise ofa power of appointment that is not ageneral power of appointment (as de-fined in section 2041(b)) is treated as atransfer subject to Federal estate or gifttax by the holder of the power if thepower is exercised in a manner that


778/20047/28MAY96/A29-008

39

may postpone or suspend the vesting,absolute ownership, or power of aliena-tion of an interest in property for aperiod, measured from the date ofcreation of the trust, extending beyondany specified life in being at the dateof creation of the trust plus a period of21 years plus, if necessary, a reason-able period of gestation (perpetuitiesperiod). For purposes of this paragraph(a)(4), the exercise of a power ofappointment that validly postpones orsuspends the vesting, absolute owner-ship, or power of alienation of aninterest in property for a term of yearsthat will not exceed 90 years (measuredfrom the date of creation of the trust) isnot an exercise that may extend beyondthe perpetuities period.

(5) Split-gift transfers. In the case ofa transfer with respect to which thedonor’s spouse makes an election undersection 2513 to treat the gift as madeone-half by the spouse, the electingspouse is treated as the transferor ofone-half of the entire value of theproperty transferred by the donor,regardless of the interest the electingspouse is actually deemed to havetransferred under section 2513. Thedonor is treated as the transferor ofone-half of the value of the entireproperty. See §26.2632–1(c)(5) Exam-ple 3, regarding allocation of GSTexemption with respect to split-gifttransfers subject to an ETIP.

(6) Examples. The following exam-ples illustrate the principles of thisparagraph (a):

Example 1. Identity of transferor. T transfers$100,000 to a trust for the sole benefit of T’sgrandchild. The transfer is a completed giftunder §25.2511–2 of this chapter. Thus, forpurposes of chapter 13, T is the transferor of the$100,000. It is immaterial that a portion of thetransfer is excluded from the total amount of T’staxable gift by reason of section 2503(b).

Example 2. Gift splitting and identity oftransferor. The facts are the same as in Example1, except T’s spouse, S, consents under section2513 to split the gift with T. For purposes ofchapter 13, S and T are each treated as atransferor of $50,000 to the trust.

Example 3. Change of transferor on subse-quent transfer tax event. T transfers $100,000 toa trust providing that all the net trust income isto be paid to T’s spouse, S, for S’s lifetime. Telects under section 2523(f) to treat the transferas a transfer of qualified terminable interestproperty, and T does not make the reverse QTIPelection under section 2652(a)(3). On S’s death,the trust property is included in S’s gross estateunder section 2044. Thus, S becomes thetransferor at the time of S’s death.

Example 4. Effect of transfer of an interest intrust on identity of the transferor. T transfers$100,000 to a trust providing that all of the net

income is to be paid to T’s child, C, for C’slifetime. At C’s death, the trust property is to bepaid to T’s grandchild. C transfers the incomeinterest to X, an unrelated party, in a transferthat is a completed transfer for Federal gift taxpurposes. Because C’s transfer is a transfer of aterm interest in the trust that does not affect therights of other parties with respect to the trustproperty, T remains the transferor with respect tothe trust.

Example 5. Effect of lapse of withdrawal righton identity of transferor. T transfers $10,000 to anew trust providing that the trust income is to bepaid to T’s child, C, for C’s life and, on thedeath of C, the trust principal is to be paid to T’sgrandchild, GC. The trustee has discretion todistribute principal for GC’s benefit during C’slifetime. C has a right to withdraw $10,000 fromthe trust for a 60-day period following thetransfer. Thereafter, the power lapses. C does notexercise the withdrawal right. The transfer by Tis a completed transfer within the meaning of§25.2511–2 of this chapter and, thus, T is treatedas having transferred the entire $10,000 to thetrust. On the lapse of the withdrawal right, Cbecomes a transferor to the extent C is treated ashaving made a completed transfer for purposesof chapter 12. Therefore, except to the extentthat the amount with respect to which the powerof withdrawal lapses exceeds the greater of$5,000 or 5% of the value of the trust property,T remains the transferor of the trust property forpurposes of chapter 13.

Example 6. Effect of reverse QTIP election onidentity of the transferor. T establishes atestamentary trust having a principal of$500,000. Under the terms of the trust, all trustincome is payable to T’s surviving spouse, S,during S’s lifetime. T’s executor makes anelection to treat the trust property as qualifiedterminable interest property and also makes thereverse QTIP election. For purposes of chapter13, T is the transferor with respect to the trust.On S’s death, the then full fair market value ofthe trust is includible in S’s gross estate undersection 2044. However, because of the reverseQTIP election, S does not become the transferorwith respect to the trust; T continues to be thetransferor.

Example 7. Effect of reverse QTIP election onconstructive additions. The facts are the same asin Example 6, except the inclusion of the QTIPtrust in S’s gross estate increased the Federalestate tax liability of S’s estate by $200,000. Theestate does not exercise the right of recoveryfrom the trust granted under section 2207A.Under local law, the beneficiaries of S’sresiduary estate (which bears all estate taxesunder the will) could compel the executor toexercise the right of recovery but do not do so.Solely for purposes of chapter 13, the benefici-aries of the residuary estate are not treated ashaving made an addition to the trust by reason oftheir failure to exercise their right of recovery.Because of the reverse QTIP election, for GSTpurposes, the trust property is not treated asincludible in S’s gross estate and, under thosecircumstances, no right of recovery exists.

Example 8. Effect of reverse QTIP election onconstructive additions. S, the surviving spouse ofT, dies testate. At the time of S’s death, S wasthe beneficiary of a trust with respect to whichT’s executor made a QTIP election under section2056(b)(7). Thus, the trust is includible in S’sgross estate under section 2044. T’s executoralso made the reverse QTIP election with respectto the trust. S’s will provides that all death taxes

payable with respect to the trust are payablefrom S’s residuary estate. Since the transferor ofthe property is determined without regard tosection 2044 and section 2207A, S is not treatedas making a constructive addition to the trust byreason of the tax apportionment clause in S’swill.

Example 9. Exercise of a nongeneral power ofappointment. On May 15, 1990, T established anirrevocable trust under which the trust income isto be paid to T’s child, C, for life. C is given atestamentary power to appoint the remainder infurther trust for the benefit of C’s issue. Indefault of C’s exercise of the power, theremainder is to pass to charity. C dies onFebruary 3, 1997, survived by two children and asibling, S (who was born prior to May 15, 1990).C exercises the power in a manner that validlyextends the trust in favor of C’s issue until thelater of May 15, 2070 (80 years from the datethe trust was created), or the death of S. C’sexercise of the power is considered a transfer byC that is subject to the estate or gift tax becauseit may extend the term of the trust beyond theperpetuities period.

Example 10. Exercise of a nongeneral powerof appointment. The facts are the same as inExample 9, except local law provides that theeffect of C’s exercise is to extend the term of thetrust until May 15, 2070, whether or not Ssurvives that date. C is not treated as havingmade a transfer to the trust as a result of theexercise of the power because the exercise of thepower does not extend the term of the trustbeyond a period of 90 years measured from thecreation of the trust. The result would be thesame if the effect of C’s exercise is either toextend the term of the trust until the death of Sor to extend the term of the trust until the first tooccur of May 15, 2070, or the death of S.

Example 11. Split-gift transfers. T transfers$100,000 to an inter vivos trust that provides Twith an annuity payable for ten years or until T’sprior death. The annuity satisfies the definitionof a qualified interest under section 2702(b).When the trust terminates, the corpus is to bepaid to T’s grandchild, GC. T’s spouse, S,consents under section 2513 to have the gifttreated as made one-half by S. Under section2513, only the actuarial value of the gift to GCis eligible to be treated as made one-half by S.However, because S is treated as the donor ofone-half of the gift to GC, S becomes thetransferor of one-half of the entire trust($50,000) for purposes of Chapter 13.

(b) Trust defined—(1) In general. Atrust includes any arrangement (otherthan an estate) that has substantially thesame effect as a trust. Thus, forexample, arrangements involving lifeestates and remainders, estates foryears, and insurance and annuity con-tracts are trusts. Generally, a transfer asto which the identity of the transfereeis contingent upon the occurrence of anevent is a transfer in trust; however, atransfer of property included in thetransferor’s gross estate, as to whichthe identity of the transferee is con-tingent upon an event that must occurwithin 6 months of the transferor’sdeath, is not considered a transfer in


778/20047/28MAY96/A29-008

40

trust solely by reason of the existenceof the contingency.

(2) Examples. The following exam-ples illustrate the provisions of thisparagraph (b):

Example 1. Uniform gifts to minors transfers.T transfers cash to an account in the name of T’schild, C, as custodian for C’s child, GC (who isa minor), under a state statute substantiallysimilar to the Uniform Gifts to Minors Act. Forpurposes of chapter 13, the transfer to thecustodial account is treated as a transfer to atrust.

Example 2. Contingent transfers. T bequeaths$200,000 to T’s child, C, provided that if C doesnot survive T by more than 6 months, thebequest is payable to T’s grandchild, GC. C dies4 months after T. The bequest is not a transfer intrust because the contingency that determines therecipient of the bequest must occur within 6months of T’s death. The bequest to GC is adirect skip.

Example 3. Contingent transfers. The facts arethe same as in Example 2, except C must surviveT by 18 months to take the bequest. The bequestis a transfer in trust for purposes of chapter 13,and the death of C is a taxable termination.

(c) Trustee defined. The trustee of atrust is the person designated as trusteeunder local law or, if no such person isso designated, the person in actual orconstructive possession of propertyheld in trust.

(d) Executor defined. For purposesof chapter 13, the executor is theexecutor or administrator of the dece-dent’s estate. However, if no executoror administrator is appointed, qualifiedor acting within the United States, theexecutor is the fiduciary who is pri-marily responsible for payment of thedecedent’s debts and expenses. If thereis no such executor, administrator orfiduciary, the executor is the person inactual or constructive possession of thelargest portion of the value of thedecedent’s gross estate.

(e) Interest in trust. See §26.2612–1(e) for the definition of interest intrust.

§26.2652–2 Special election forqualified terminable interest property.

(a) In general. If an election is madeto treat property as qualified terminableinterest property (QTIP) under section2523(f) or section 2056(b)(7), theperson making the election may, forpurposes of chapter 13, elect to treatthe property as if the QTIP electionhad not been made (reverse QTIPelection). An election under this sectionis irrevocable. An election under thissection is not effective unless it is

made with respect to all of the propertyin the trust to which the QTIP electionapplies. See, however, §26.2654–1(b)(1). Property that qualifies for adeduction under section 2056(b)(5) isnot eligible for the election under thissection.

(b) Time and manner of makingelection. An election under this sectionis made on the return on which theQTIP election is made. If a protectiveQTIP election is made, no electionunder this section is effective unless aprotective reverse QTIP election is alsomade.

(c) Transitional rule. If a reverseQTIP election is made with respect to atrust prior to December 27, 1995, andGST exemption has been allocated tothat trust, the transferor (or the trans-feror’s executor) may elect to treat thetrust as two separate trusts, one ofwhich has a zero inclusion ratio byreason of the transferor’s GST exemp-tion previously allocated to the trust.The separate trust with the zero inclu-sion ratio consists of that fractionalshare of the value of the entire trustequal to the value of the nontax portionof the trust under §26.2642–4(a). Thereverse QTIP election is treated asapplying only to the trust with the zeroinclusion ratio. An election under thisparagraph (c) is made by attaching astatement to a copy of the return onwhich the reverse QTIP election wasmade under section 2652(a)(3). Thestatement must indicate that an electionis being made to treat the trust as twoseparate trusts and must identify thevalues of the two separate trusts. Thestatement is to be filed in the sameplace in which the original return wasfiled and must be filed before June 24,1996. A trust subject to the electiondescribed in this paragraph is treated asa trust that was created by twotransferors. See §26.2654–1(a)(2) forspecial rules involving trusts withmultiple transferors.

(d) Examples. The following exam-ples illustrate the provisions of thissection:

Example 1. Special (reverse QTIP) electionunder section 2652(a)(3). T transfers $1,000,000to a trust providing that all trust income is to bepaid to T’s spouse, S, for S’s lifetime. On S’sdeath, the trust principal is payable to GC, agrandchild of S and T. T elects to treat all of thetransfer as a transfer of QTIP and also makes thereverse QTIP election for all of the property.Because of the reverse QTIP election, T con-tinues to be treated as the transferor of theproperty after S’s death for purposes of chapter

13. A taxable termination rather than a directskip occurs on S’s death.

Example 2. Election under transition rule. In1994, T died leaving $4 million in trust for thebenefit of T’s surviving spouse, S. On January16, 1995, T’s executor filed T’s Form 706 onwhich the executor elects to treat the entire trustas qualified terminable interest property. Theexecutor also makes a reverse QTIP election.The reverse QTIP election is effective withrespect to the entire trust even though T’sexecutor could allocate only $1 million of GSTexemption to the trust. T’s executor may elect totreat the trust as two separate trusts, one havinga value of 25% of the value of the single trustand an inclusion ratio of zero, but only if theelection is made prior to June 24, 1996. If theexecutor makes the transitional election, theother separate trust, having a value of 75% of thevalue of the single trust and an inclusion ratio ofone, is not treated as subject to the reverse QTIPelection.

Example 3. Denominator of the applicablefraction of QTIP trust. T bequeaths $1,500,000to a trust in which T’s surviving spouse, S,receives an income interest for life. Upon thedeath of S, the property is to remain in trust forthe benefit of C, the child of T and S. Upon C’sdeath, the trust is to terminate and the trustproperty paid to the descendants of C. Thebequest qualifies for the estate tax maritaldeduction under section 2056(b)(7) as QTIP. Theexecutor does not make the reverse QTIPelection under section 2652(a)(3). As a result, Sbecomes the transferor of the trust at S’s deathwhen the value of the property in the QTIP trustis included in S’s gross estate under section2044. For purposes of computing the applicablefraction with respect to the QTIP trust upon S’sdeath, the denominator of the fraction is reducedby any Federal estate tax (whether imposedunder section 2001, 2101 or 2056A(b)) and Statedeath tax attributable to the trust property that isactually recovered from the trust.

§26.2653–1 Taxation of multipleskips.

(a) General rule. If property is heldin trust immediately after a GST, solelyfor purposes of determining whetherfuture events involve a skip person, thetransferor is thereafter deemed to oc-cupy the generation immediately abovethe highest generation of any personholding an interest in the trust imme-diately after the transfer. If no personholds an interest in the trust imme-diately after the GST, the transferor istreated as occupying the generationabove the highest generation of anyperson in existence at the time of theGST who then occupies the highestgeneration level of any person whomay subsequently hold an interest inthe trust. See §26.2612–1(e) for rulesdetermining when a person has aninterest in property held in trust.

(b) Examples. The following exam-ples illustrate the provisions of thissection:


778/20047/28MAY96/A29-008

41

Example 1. T transfers property to an irrevoca-ble trust for the benefit of T’s grandchild, GC,and great-grandchild, GGC. During GC’s life, thetrust income may be distributed to GC and GGCin the trustee’s absolute discretion. At GC’sdeath, the trust property passes to GGC. BothGC and GGC have an interest in the trust forpurposes of chapter 13. The transfer by T to thetrust is a direct skip, and the property is held intrust immediately after the transfer. After thedirect skip, the transferor is treated as being onegeneration above GC, the highest generationindividual having an interest in the trust.Therefore, GC is no longer a skip person anddistributions to GC are not taxable distributions.However, because GGC occupies a generationthat is two generations below the deemedgeneration of T, GGC is a skip person anddistributions of trust income to GGC are taxabledistributions.

Example 2. T transfers property to an irrevoca-ble trust providing that the income is to be paidto T’s child, C, for life. At C’s death, the trustincome is to be accumulated for 10 years andadded to principal. At the end of the 10-yearaccumulation period, the trust income is to bepaid to T’s grandchild, GC, for life. Upon GC’sdeath, the trust property is to be paid to T’sgreat-grandchild, GGC, or to GGC’s estate. AGST occurs at C’s death. Immediately after C’sdeath and during the 10-year accumulationperiod, no person has an interest in the trustwithin the meaning of section 2652(c) and §26.2612–1(e) because no one can receivecurrent distributions of income or principal.Immediately after C’s death, T is treated asoccupying the generation above the generation ofGC (the trust beneficiary in existence at the timeof the GST who then occupies the highestgeneration level of any person who maysubsequently hold an interest in the trust). Thus,subsequent income distributions to GC are nottaxable distributions.

§26.2654–1 Certain trusts treated asseparate trusts.

(a) Single trust treated as separatetrusts—(1) Substantially separate andindependent shares—(i) In general. If asingle trust consists solely of substan-tially separate and independent sharesfor different beneficiaries, the shareattributable to each beneficiary (orgroup of beneficiaries) is treated as aseparate trust for purposes of chapter13. The phrase ‘‘substantially separateand independent shares’’ generally hasthe same meaning as provided in§1.663(c)–3 of this chapter. However, aportion of a trust is not a separate shareunless such share exists from and at alltimes after the creation of the trust. Forpurposes of this paragraph (a)(1), atrust is treated as created at the date ofdeath of the grantor if the trust isincludible in its entirety in the grantor’sgross estate for Federal estate taxpurposes. Further, treatment of a singletrust as separate trusts under thisparagraph (a)(1) does not permit treat-

ment of those portions as separatetrusts for purposes of filing returns andpayment of tax or for purposes ofcomputing any other tax imposed underthe Internal Revenue Code. Also, addi-tions to, and distributions from, suchtrusts are allocated pro rata among theseparate trusts, unless the governinginstrument expressly provides other-wise.

(ii) Certain pecuniary amounts. Forpurposes of this section, if a personholds the current right to receive amandatory (i.e., nondiscretionary andnoncontingent) payment of a pecuniaryamount at the death of the transferorfrom an inter vivos trust that isincludible in the transferor’s grossestate, or a testamentary trust, thepecuniary amount is a separate andindependent share if—

(A) The trustee is required to payappropriate interest (as defined in§26.2642–2(b)(4)(i) and (ii)) to theperson; or

(B) If the pecuniary amount is pay-able in kind on the basis of value otherthan the date of distribution value ofthe assets, the trustee is required toallocate assets to the pecuniary pay-ment in a manner that fairly reflects netappreciation or depreciation in thevalue of the assets in the fund availableto pay the pecuniary amount measuredfrom the date of death to the date ofpayment.

(2) Multiple transferors with respectto single trust—(i) In general. If thereis more than one transferor with respectto a trust, the portions of the trustattributable to the different transferorsare treated as separate trusts for pur-poses of chapter 13. Treatment of asingle trust as separate trusts under thisparagraph (a)(2) does not permit treat-ment of those portions as separatetrusts for purposes of filing returns andpayment of tax or for purposes ofcomputing any other tax imposed underthe Internal Revenue Code. Also, addi-tions to, and distributions from, suchtrusts are allocated pro rata among theseparate trusts unless otherwise ex-pressly provided in the governinginstrument.

(ii) Addition by a transferor. If anindividual makes an addition to a trustof which the individual is not the soletransferor, the portion of the singletrust attributable to each separate trustis determined by multiplying the fairmarket value of the single trust imme-diately after the contribution by a

fraction. The numerator of the fractionis the value of the separate trustimmediately after the contribution. Thedenominator of the fraction is the fairmarket value of all the property in thesingle trust immediately after thetransfer.

(3) Severance of a single trust. Asingle trust treated as separate trustsunder paragraphs (a)(1) or (2) of thissection may be divided at any time intoseparate trusts to reflect that treatment.For this purpose, the rules of paragraph(b)(1)(ii)(C) of this section apply withrespect to the severance and funding ofthe severed trusts.

(4) Allocation of exemption—(i) Ingeneral. With respect to a separateshare treated as a separate trust underparagraph (a)(1) or (2) of this section,an individual’s GST exemption isallocated to the separate trust. See§26.2632–1 for rules concerning theallocation of GST exemption.

(ii) Automatic allocation to directskips. If the transfer is a direct skip toa trust that occurs during the trans-feror’s lifetime and is treated as atransfer to separate trusts under para-graphs (a)(1) or (a)(2) of this section,the transferor’s GST exemption notpreviously allocated is automaticallyallocated on a pro rata basis among theseparate trusts. The transferor mayprevent an automatic allocation of GSTexemption to a separate share of asingle trust by describing on a timely-f i led United States Gif t (andGeneration-Skipping Transfer) Tax Re-turn (Form 709) the transfer and theextent to which the automatic alloca-tion is not to apply to a particularshare. See §26.2632–1(b) for rules foravoiding the automatic allocation ofGST exemption.

(5) Examples. The following exam-ples illustrate the principles of thissection (a):

Example 1. Separate shares as separate trusts.T transfers $100,000 to a trust under whichincome is to be paid in equal shares for 10 yearsto T’s child, C, and T’s grandchild, GC (or theirrespective estates). The trust does not permitdistributions of principal during the term of thetrust. At the end of the 10-year term, the trustprincipal is to be distributed to C and GC inequal shares. The shares of C and GC in the trustare separate and independent and, therefore, aretreated as separate trusts. The result would notbe the same if the trust permitted distributions ofprincipal unless the distributions could only bemade from a one-half separate share of the initialtrust principal and the distributee’s future rightswith respect to the trust are correspondinglyreduced. T may allocate part of T’s GST


778/20047/28MAY96/A29-008

42

exemption under section 2632(a) to the shareheld for the benefit of GC.

Example 2. Separate share rule inapplicable.The facts are the same as in Example 1, exceptthe trustee holds the discretionary power todistribute the income in any proportion betweenC and GC during the last year of the trust. Theshares of C and GC in the trust are not separateand independent shares throughout the entireterm of the trust and, therefore, are not treated asseparate trusts for purposes of chapter 13.

Example 3. Pecuniary payment as separateshare. T creates a lifetime revocable trustproviding that on T’s death $500,000 is payableto T’s spouse, S, with the balance of theprincipal to be held for the benefit of T’sgrandchildren. The value of the trust is includiblein T’s gross estate upon T’s death. Under theterms of the trust, the payment to S is required tobe made in cash, and under local law S isentitled to receive interest on the payment at anannual rate of 6 percent, commencing imme-diately upon T’s death. For purposes of chapter13, the trust is treated as created at T’s death,and the $500,000 payable to S from the trust istreated as a separate share. The result would bethe same if the payment to S could be satisfiedusing noncash assets at their value on the date ofdistribution. Further, the result would be thesame if the decedent’s probate estate poured overto the revocable trust on the decedent’s deathand was then distributed in accordance with theterms of the trust.

Example 4. Pecuniary payment not treated asseparate share. The facts are the same as inExample 3, except the bequest to S is to be paidin noncash assets valued at their values as finallydetermined for Federal estate tax purposes.Neither the trust instrument nor local lawrequires that the assets distributed in satisfactionof the bequest fairly reflect net appreciation ordepreciation in all the assets from which thebequest may be funded. S’s $500,000 bequest isnot treated as a separate share and the trust istreated as a single trust for purposes of chapter13.

Example 5. Multiple transferors to single trust.A transfers $100,000 to an irrevocablegeneration-skipping trust; B simultaneouslytransfers $50,000 to the same trust. As of thetime of the transfers, the single trust is treated astwo trusts for purposes of chapter 13. Because Acontributed 2⁄3 of the value of the initial corpus,2⁄3 of the single trust principal is treated as aseparate trust created by A. Similarly, because Bcontributed 1⁄3 of the value of the initial corpus,1⁄3 of the single trust is treated as a separate trustcreated by B. A or B may allocate their GSTexemption under section 2632(a) to the respec-tive separate trusts.

Example 6. Additional contributions. A trans-fers $100,000 to an irrevocable generation-skipping trust; B simultaneously transfers$50,000 to the same trust. When the value of thesingle trust has increased to $180,000, Acontributes an additional $60,000 to the trust. Atthe time of the additional contribution, theportion of the single trust attributable to eachgrantor’s separate trust must be redetermined.The portion of the single trust attributable to A’sseparate trust immediately after the contributionis 3⁄4 ((2⁄3 3 $180,000) + $60,000)/$240,000).The portion attributable to B’s separate trustafter A’s addition is 1⁄4.

Example 7. Distributions from a separateshare. The facts are the same as in Example 6,except that, after A’s second contribution,

$50,000 is distributed to a beneficiary of thetrust. Absent a provision in the trust instrumentthat charges the distribution against the contribu-tion of either A or B, 3⁄4 of the distribution istreated as made from the separate trust of whichA is the transferor and 1⁄4 from the separate trustof which B is the transferor.

Example 8. Separate share rule inapplicable.T creates an irrevocable trust that provides thetrustee with the discretionary power to distributeincome or corpus to T’s children and grand-children. The trust provides that, when T’syoungest child reaches age 21, the trust will bedivided into separate shares, one share for eachchild of T. The income from a respective child’sshare will be paid to the child during the child’slife with the remainder passing to such child’schildren (grandchildren of T). The separateshares that come into existence when theyoungest child reaches age 21 will not berecognized as separate trusts for purposes ofChapter 13 because the shares did not exist fromand at all times after the creation of the trust.Any allocation of GST exemption to the trusteither before or after T’s youngest child reachesage 21 will apply with respect to the entire trust.Thus, the inclusion ratio will be the same withrespect to any distribution from the trust or theseparate shares. The result would be the same if,the trust instrument provided that the trust was tobe divided into separate trusts when T’s youngestchild reached age 21.

(b) Division of a trust included inthe gross estate—(1) In general. Theseverance of a trust that is included inthe transferor’s gross estate (or createdunder the transferor’s will) into two ormore trusts is recognized for purposesof chapter 13 if—

(i) The trust is severed pursuant to adirection in the governing instrumentproviding that the trust is to be dividedupon the death of the transferor; or

(ii) The governing instrument doesnot require or otherwise direct sever-ance but the trust is severed pursuant todiscretionary authority granted eitherunder the governing instrument orunder local law; and

(A) The terms of each of the newtrusts provide for the same successionof interests and beneficiaries as areprovided in the original trust;

(B) The severance occurs (or areformation proceeding, if required, iscommenced) prior to the date pre-scribed for filing the Federal estate taxreturn (including extensions actuallygranted) for the estate of the transferor;and

(C) Either—(1) The new trusts are severed on a

fractional basis. If severed on a frac-tional basis, the separate trusts need notbe funded with a pro rata portion ofeach asset held by the undivided trust.The trusts may be funded on a nonprorata basis provided funding is based on

either the fair market value of theassets on the date of funding or in amanner that fairly reflects the netappreciation or depreciation in thevalue of the assets measured from thedate of death to the date of funding; or

(2) If the severance is required (bythe terms of the governing instrument)to be made on the basis of a pecuniaryamount, the pecuniary payment issatisfied in a manner that would meetthe requirements of paragraph (a)(1)(ii)of this section if it were paid to anindividual.

(2) Special rule. If a court ordersevering the trust has not been issuedat the time the Federal estate tax returnis filed, the executor must indicate on astatement attached to the return that aproceeding has been commenced tosever the trust and describe the mannerin which the trust is proposed to besevered. A copy of the petition or otherinstrument used to commence the pro-ceeding must also be attached to thereturn. If the governing instrument of atrust or local law authorizes the sever-ance of the trust, a severance pursuantto that authorization is treated asmeeting the requirement of paragraph(b)(1)(ii)(B) of this section if theexecutor indicates on the Federal estatetax return that separate trusts will becreated (or funded) and clearly setsforth the manner in which the trust isto be severed and the separate trustsfunded.

(3) Allocation of exemption. An indi-vidual’s GST exemption under §2632may be allocated to the separate trustscreated pursuant to this section at thediscretion of the executor or trustee.

(4) Examples. The following exam-ples illustrate the provisions of thissection (b):

Example 1. Severance of single trust. T’s willestablishes a testamentary trust providing thatincome is to be paid to T’s spouse for life. Atthe spouse’s death, one-half of the corpus is tobe paid to T’s child, C, or C’s estate (if C failsto survive the spouse) and one-half of the corpusis to be paid to T’s grandchild, GC, or GC’sestate (if GC fails to survive the spouse). If therequirements of paragraph (b) of this section areotherwise satisfied, T’s executor may divide thetestamentary trust equally into two separatetrusts, one trust providing an income interest tospouse for life with remainder to C, and theother trust with an income interest to spouse forlife with remainder to GC. Furthermore, if therequirements of paragraph (b) of this section aresatisfied, the executor or trustee may furtherdivide the trust for the benefit of GC. GSTexemption may be allocated to any of the dividedtrusts.

Example 2. Severance of revocable trust. Tcreates an inter vivos revocable trust providing


778/20047/28MAY96/A29-008

43

that, at T’s death and after payment of all taxesand administration expenses, the remainingcorpus will be divided into two trusts. One trust,for the benefit of T’s spouse, is to be fundedwith the smallest amount that, if qualifying forthe marital deduction, will reduce the estate taxto zero. The other trust, for the benefit of T’sdescendants, is to be funded with the balance ofthe revocable trust corpus. The trust corpus isincludible in T’s gross estate. Each trust isrecognized as a separate trust for purposes ofchapter 13.

26.2662–1 Generation-skippingtransfer tax return requirements.

(a) In general. Chapter 13 imposes atax on generation-skipping transfers (asdefined in section 2611). The require-ments relating to the return of taxdepend on the type of generation-skipping transfer involved. This sectioncontains rules for filing the required taxreturn. Paragraph (c)(2) of this sectionprovides special rules concerning thereturn requirements for generation-skipping transfers pursuant to certaintrust arrangements (as defined in para-graph (c)(2)(ii) of this section), such aslife insurance policies and annuities.

(b) Form of return—(1) Taxabledistributions. Form 706GS(D) must befiled in accordance with its instructionsfor any taxable distribution (as definedin section 2612(b)). The trust involvedin a transfer described in the precedingsentence must file Form 706GS(D–1)in accordance with its instructions. Acopy of Form 706GS(D–1) shall besent to each distributee.

(2) Taxable terminations. Form706GS(T) must be filed in accordancewith its instructions for any taxabletermination (as defined in section2612(a)).

(3) Direct skip—(i) Inter vivos di-rect skips. Form 709 must be filed inaccordance with its instructions for anydirect skip (as defined in section2612(c)) that is subject to chapter 12and occurs during the life of thetransferor.

(ii) Direct skips occurring atdeath—(A) In general. Form 706 orForm 706NA must be filed in accord-ance with its instructions for any directskips (as defined in section 2612(c))that are subject to chapter 11 and occurat the death of the decedent.

(B) Direct skips payable from atrust. Schedule R–1 of Form 706 mustbe filed in accordance with its instruc-tions for any direct skip from a trust ifsuch direct skip is subject to chapter11. See paragraph (c)(2) of this section

for special rules relating to the personliable for tax and required to make thereturn under certain circumstances.

(c) Person liable for tax and re-quired to make return—(1) In general.Except as otherwise provided in thissection, the following person is liablefor the tax imposed by section 2601and must make the required taxreturn—

(i) The transferee in a taxable dis-tribution (as defined in section2612(b));

(ii) The trustee in the case of ataxable termination (as defined in sec-tion 2612(a));

(iii) The transferor (as defined insection 2652(a)(1)(B)) in the case of aninter vivos direct skip (as defined insection 2612(c));

(iv) The trustee in the case of adirect skip from a trust or with respectto property that continues to be held intrust; or

(v) The executor in the case of adirect skip (other than a direct skipdescribed in paragraph (c)(1)(iv) of thissection) if the transfer is subject tochapter 11. See paragraph (c)(2) of thissection for special rules relating todirect skips to or from certain trustarrangements (as defined in paragraph(c)(2)(ii) of this section).

(2) Special rule for direct skips oc-curring at death with respect to prop-erty held in trust arrangements—(i) Ingeneral. In the case of certain propertyheld in a trust arrangement (as definedin paragraph (c)(2)(ii) of this section)at the date of death of the transferor,the person who is required to make thereturn and who is liable for the taximposed by chapter 13 is determinedunder paragraphs (c)(2)(iii) and (iv) ofthis section.

(ii) Trust arrangement defined. Forpurposes of this section, the term trustarrangement includes any arrangement(other than an estate) which, althoughnot an explicit trust, has the sameeffect as an explicit trust. For purposesof this section, the term ‘‘explicittrust’’ means a trust described in§301.7701–4(a).

(iii) Executor’s liability in the caseof transfers with respect to decedentsdying on or after June 24, 1996, if thetransfer is less than $250,000. In thecase of a direct skip occurring at death,the executor of the decedent’s estate isliable for the tax imposed on that directskip by chapter 13 and is required to

file Form 706 or Form 706NA (and notSchedule R–1 of Form 706) if, at thedate of the decedent’s death—

(A) The property involved in thedirect skip is held in a trust arrange-ment; and

(B) The total value of the propertyinvolved in direct skips with respect tothe trustee of that trust arrangement isless than $250,000.

(iv) Executor’s liability in the caseof transfers with respect to decedentsdying prior to June 24, 1996, if thetransfer is less than $100,000. In thecase of a direct skip occurring at deathwith respect to a decedent dying priorto June 24, 1996, the rule in paragraph(c)(2)(iii) of this section that imposesliability upon the executor applies onlyif the property involved in the directskip with respect to the trustee of thetrust arrangement, in the aggregate, isless than $100,000.

(v) Executor’s right of recovery. Incases where the rules of paragraphs(c)(2)(iii) and (iv) of this sectionimpose liability for the generation-skipping transfer tax on the executor,the executor is entitled to recover fromthe trustee (if the property continues tobe held in trust) or from the recipientof the property (in the case of atransfer from a trust), the generation-skipping transfer tax attributable to thetransfer.

(vi) Examples. The following exam-ples illustrate the application of thisparagraph (c)(2) with respect to dece-dents dying on or after June 24, 1996:

Example 1. Insurance proceeds less than$250,000. On August 1, 1997, T, the insuredunder an insurance policy, died. The proceeds($200,000) were includible in T’s gross estate forFederal estate tax purposes. T’s grandchild GC,was named the sole beneficiary of the policy.The insurance policy is treated as a trust undersection 2652(b)(1), and the payment of theproceeds to GC is a transfer from a trust forpurposes of chapter 13. Therefore, the paymentof the proceeds to GC is a direct skip. Since theproceeds from the policy ($200,000) are less than$250,000, the executor is liable for the taximposed by chapter 13 and is required to fileForm 706.

Example 2. Aggregate insurance proceeds of$250,000 or more. Assume the same facts as inExample 1, except T is the insured under twoinsurance policies issued by the same insurancecompany. The proceeds ($150,000) from eachpolicy are includible in T’s gross estate forFederal estate tax purposes. T’s grandchild, GC1,was named the sole beneficiary of Policy 1, andT’s other grandchild, GC2, was named the solebeneficiary of Policy 2. GC1 and GC2 are skippersons (as defined in section 2613). Therefore,the payments of the proceeds are direct skips.Since the total value of the policies ($300,000)


778/20047/28MAY96/A29-008

44

exceeds $250,000, the insurance company isliable for the tax imposed by chapter 13 and isrequired to file Schedule R–1 of Form 706.

Example 3. Insurance proceeds of $250,000 ormore held by insurance company. On August 1,1997, T, the insured under an insurance policy,dies. The policy provides that the insurancecompany shall make monthly payments of $750to GC, T’s grandchild, for life with theremainder payable to T’s great grandchild, GGC.The face value of the policy is $300,000. Sincethe proceeds continue to be held by the insurancecompany (the trustee), the proceeds are treated asif they were transferred to a trust for purposes ofchapter 13. The trust is a skip person (as definedin section 2613(a)(2)) and the transfer is a directskip. Since the total value of the policy($300,000) exceeds $250,000, the insurancecompany is liable for the tax imposed by chapter13 and is required to file Schedule R–1 of Form706.

Example 4. Insurance proceeds less than$250,000 held by insurance company. Assumethe same facts as in Example 3, except the policyprovides that the insurance company shall makemonthly payments of $500 to GC and that theface value of the policy is $200,000. The transferis a transfer to a trust for purposes of chapter 13.However, since the total value of the policy($200,000) is less than $250,000, the executor isliable for the tax imposed by chapter 13 and isrequired to file Form 706.

Example 5. On August 1, 1997, A, the insuredunder a life insurance policy, dies. The insuranceproceeds on A’s life that are payable underpolicies issued by Company X are in theaggregate amount of $200,000 and are includiblein A’s gross estate. Because the proceeds areincludible in A’s gross estate, the generation-skipping transfer that occurs upon A’s death, ifany, will be a direct skip rather than a taxabledistribution or a taxable termination. Accord-ingly, because the aggregate amount of insuranceproceeds with respect to Company X is less than$250,000, Company X may pay the proceedswithout regard to whether the beneficiary is askip person in relation to the decedent-transferor.

(3) Limitation on personal liabilityof trustee. Except as provided inparagraph (c)(3)(iii) of this section, atrustee is not personally liable for anyincreases in the tax imposed by section2601 which is attributable to the factthat—

(i) A transfer is made to the trustduring the life of the transferor forwhich a gift tax return is not filed; or

(ii) The inclusion ratio with respectto the trust, determined by reference tothe transferor’s gift tax return, iserroneous, the actual inclusion ratiobeing greater than the reported inclu-sion ratio.

(iii) This paragraph (c)(3) does notapply if the trustee has or is deemed tohave knowledge of facts sufficient toreasonably conclude that a gift taxreturn was required to be filed or thatthe inclusion ratio is erroneous. Atrustee is deemed to have knowledge of

such facts if the trustee’s agent,employee, partner, or co-trustee hasknowledge of such facts.

(4) Exceptions—(i) Legal or mentalincapacity. If a distributee is legally ormentally incapable of making a return,the return may be made for thedistributee by the distributee’s guardianor, if no guardian has been appointed,by a person charged with the care ofthe distributee’s person or property.

(ii) Returns made by fiduciaries. Seesection 6012(b) for a fiduciary’s re-sponsibilities regarding the returns ofdecedents, returns of persons under adisability, returns of estates and trusts,and returns made by joint fiduciaries.

(d) Time and manner of filing re-turn—(1) In general. Forms 706,706NA, 706GS(D), 706GS(D–1),706GS(T), 709, and Schedule R–1 ofForm 706 must be filed with theInternal Revenue Service office withwhich an estate or gift tax return of thetransferor must be filed. The returnshall be filed—

(i) Direct skip. In the case of adirect skip, on or before the date onwhich an estate or gift tax return isrequired to be filed with respect to thetransfer (see section 6075(b)(3)); and

(ii) Other transfers. In all othercases, on or before the 15th day of the4th month after the close of thecalendar year in which such transferoccurs. See paragraph (d)(2) of thissection for an exception to this rulewhen an election is made under section2624(c) to value property included incertain taxable terminations in accord-ance with section 2032.

(2) Exception for alternative valua-tion of taxable termination. In the caseof a taxable termination with respect towhich an election is made undersection 2624(c) to value property inaccordance with section 2032, a Form706GS(T) must be filed on or beforethe 15th day of the 4th month after theclose of the calendar year in which thetaxable termination occurred, or on orbefore the 10th month following themonth in which the death that resultedin the taxable termination occurred,whichever is later.

(e) Place for filing returns. Seesection 6091 for the place for filingany return, declaration, statement, orother document, or copies thereof,required by chapter 13.

(f) Lien on property. The liens im-posed under sections 6324, 6324A, and6324B are applicable with respect to

the tax imposed under chapter 13.Thus, a lien under section 6324 isimposed in the amount of the taximposed by section 2601 on all prop-erty transferred in a generation-skipping transfer until the tax is fullypaid or becomes uncollectible by rea-son of lapse of time. The lien attachesat the time of the generation-skippingtransfer and is in addition to the lienfor taxes under section 6321.

§26.2663–1 Recapture tax undersection 2032A.

See §26.2642–4(a)(4) for rules relat-ing to the recomputation of the applica-ble fraction and the imposition ofadditional GST tax, if additional estatetax is imposed under section 2032A.

§26.2663–2 Application of chapter 13to transfers by nonresidents notcitizens of the United States.

(a) In general. This section providesrules for applying chapter 13 of theInternal Revenue Code to transfers by atransferor who is a nonresident not acitizen of the United States (NRAtransferor). For purposes of this sec-tion, an individual is a resident orcitizen of the United States if thatindividual is a resident or citizen of theUnited States under the rules of chapter11 or 12 of the Internal Revenue Code,as the case may be. Every NRAtransferor is allowed a GST exemptionof $1,000,000. See §26.2632–1 regard-ing the allocation of the exemption.

(b) Transfers subject to chapter13—(1) Direct skips. A transfer by aNRA transferor is a direct skip subjectto chapter 13 only to the extent that thetransfer is subject to the Federal estateor gift tax within the meaning of§26.2652–1(a)(2). See §26.2612–1(a)for the definition of direct skip.

(2) Taxable distributions and taxableterminations. Chapter 13 applies to ataxable distribution or a taxable termi-nation to the extent that the initialtransfer of property to the trust by aNRA transferor, whether during life orat death, was subject to the Federalestate or gift tax within the meaning of§26.2652–1(a)(2). See §26.2612–1(b)for the definition of a taxable termina-tion and §26.2612–1(c) for the defini-tion of a taxable distribution.

(c) Trusts funded in part with prop-erty subject to chapter 13 and in partwith property not subject to chapter


778/20047/28MAY96/A29-008

45

13—(1) In general. If a single trustcreated by a NRA transferor is in partsubject to chapter 13 under the rules ofparagraph (b) of this section and in partnot subject to chapter 13, the applica-ble fraction with respect to the trust isdetermined as of the date of thetransfer, except as provided in para-graph (c)(3) of this section.

(i) Numerator of applicable fraction.The numerator of the applicable frac-tion is the sum of the amount of GSTexemption allocated to the trust (if any)plus the value of the nontax portion ofthe trust.

(ii) Denominator of applicable frac-tion. The denominator of the applicablefraction is the value of the propertytransferred to the trust reduced asprovided in §26.2642–1(c).

(2) Nontax portion of the trust. Thenontax portion of a trust is a fraction,the numerator of which is the value ofproperty not subject to chapter 13determined as of the date of the initialcompleted transfer to the trust, and thedenominator of which is the value ofthe entire trust. For example, T, a NRAtransferor, transfers property that has avalue of $1,000 to a generation-skipping trust. Of the property trans-ferred to the trust, property having avalue of $200 is subject to chapter 13and property having a value of $800 isnot subject to chapter 13. The nontaxportion is .8 ($800 (the value of theproperty not subject to chapter 13) over$1,000 (the total value of the propertytransferred to the trust).

(3) Special rule with respect to theestate tax inclusion period. For pur-poses of this section, the provisions of§26.2632–1(c), providing rules applica-ble in the case of an estate taxinclusion period (ETIP), apply only ifthe property transferred by the NRAtransferor is subsequently included inthe transferor’s gross estate. If theproperty is not subsequently includedin the gross estate, then the nontaxportion of the trust and the applicablefraction are determined as of the dateof the initial transfer. If the property issubsequently included in the grossestate, then the nontax portion and theapplicable fraction are determined as ofthe date of death.

(d) Examples. The following exam-ples illustrate the provisions of thissection. In each example T, a NRA, isthe transferor; C is T’s child; and GCis C’s child and a grandchild of T:

Example 1. Direct transfer to skip person. Ttransfers property to GC in a transfer that is

subject to Federal gift tax under chapter 12within the meaning of §26.2652–1(a)(2). At thetime of the transfer, C and GC are NRAs. T’stransfer is subject to chapter 13 because thetransfer is subject to gift tax under chapter 12.

Example 2. Transfers of both U.S. and foreignsitus property. (i) T’s will established a testa-mentary trust for the benefit of C and GC. Thetrust was funded with stock in a publicly tradedU.S. corporation having a value on the date ofT’s death of $100,000, and property not situatedin the United States (and therefore not subject toestate tax) having a value on the date of T’sdeath of $400,000.

(ii) On a timely filed estate tax return (Form706NA), the executor of T’s estate allocates$50,000 of GST exemption under section 2632(a)to the trust. The numerator of the applicablefraction is $450,000, the sum of $50,000 (theamount of exemption allocated to the trust) plus$400,000 (the value of the nontax portion of thetrust (4/5 3 $500,000)). The denominator is$500,000. Hence, the applicable fraction withrespect to the trust is .9 ($450,000/$500,000),and the inclusion ratio is .1 (1 – 9/10).

Example 3. Inter vivos transfer of U.S. andforeign situs property to a trust and a timelyallocation of GST exemption. T establishes atrust providing that trust income is payable toT’s child for life and the remainder is to be paidto T’s grandchild. T transfers property to thetrust that has a value of $100,000 and is subjectto chapter 13. T also transfers property to thetrust that has a value of $300,000 but is notsubject to chapter 13. T allocates $100,000 ofexemption to the trust on a timely filed UnitedStates Gift (and Generation-Skipping Transfer)Tax return (Form 709). The applicable fractionwith respect to the trust is 1, determined asfollows: $300,000 (the value of the nontaxportion of the trust) plus $100,000 (the exemp-tion allocated to the trust)/$400,000 (the totalvalue of the property transferred to the trust).

Example 4. Inter vivos transfer of U.S. andforeign situs property to a trust and a lateallocation of GST exemption. (i) In 1996, Ttransfers $500,000 of property to an inter vivostrust the terms of which provide that income ispayable to C, for life, with the remainder to GC.The property transferred to the trust consists ofproperty subject to chapter 13 that has a value of$400,000 on the date of the transfer and propertynot subject to chapter 13 that has a value of$100,000. T does not allocate GST exemption tothe trust. On the transfer date, the nontax portionof the trust is .2 ($100,000/$500,000) and theapplicable fraction is also .2 determined asfollows: $100,000 (the value of the nontaxportion of the trust)/$500,000 (the value of theproperty transferred to the trust).

(ii) In 1999, when the value of the trust is$800,000, T allocates $100,000 of GST exemp-tion to the trust. The applicable fraction of thetrust must be recomputed. The numerator of theapplicable fraction is $260,000 ($100,000 (theamount of GST exemption allocated to the trust))plus $160,000 (the value of the nontax portion ofthe trust as of the date of allocation (.2 3$800,000)). The denominator of the applicablefraction is $800,000. Accordingly, the applicablefraction with respect to the trust after theallocation is .325 ($260,000/$800,000) and theinclusion ratio is .675 (1 – .325).

Example 5. Taxable termination. The facts arethe same as in Example 4 except that, in 2006,when the value of the property is $1,200,000, Cdies and the trust corpus is distributed to GC.

The termination is a taxable termination. If nofurther GST exemption has been allocated to thetrust, the applicable fraction remains .325 and theinclusion ratio remains .675.

Example 6. Estate Tax Inclusion Period. (i) Ttransferred property to an inter vivos trust theterms of which provided T with an annuitypayable for 10 years or until T’s prior death. Theannuity satisfies the definition of a qualifiedinterest under section 2702(b). The trust alsoprovided that, at the end of the trust term, theremainder will pass to GC or GC’s estate. Theproperty transferred to the trust consisted ofproperty subject to chapter 13 that has a value of$100,000 and property not subject to chapter 13that has a value of $400,000. T allocated$100,000 of GST exemption to the trust. If Tdies within the 10 year period, the value of thetrust principal will be subject to inclusion in T’sgross estate to the extent provided in sections2103 and 2104(b). Accordingly, the ETIP ruleunder paragraph (c)(3) of this section applies.

(ii) In year 6 of the trust term, T died. At T’sdeath, the trust corpus had a value of $800,000,and $500,000 was includible in T’s gross estateas provided in sections 2103 and 2104(b). Thus,$500,000 of the trust corpus is subject to chapter13 and $300,000 is not subject to chapter 13.The $100,000 GST exemption allocation iseffective as of T’s date of death. Also, thenontax portion of the trust and the applicablefraction are determined as of T’s date of death.In this case, the nontax portion of the trust is.375, determined as follows: $300,000 (the valueof the trust not subject to chapter 13)/$800,000(the value of the trust). The numerator of theapplicable fraction is $400,000, determined asfollows: $100,000 (GST exemption previouslyallocated to the trust) plus $300,000 (the value ofthe nontax portion of the trust). The denominatorof the applicable fraction is $800,000. Thus, theapplicable fraction with respect to the trust is.50, unless additional exemption is allocated tothe trust by T’s executor or the automaticallocation rules of §26.2632–1(d)(2) apply.

Example 7. The facts are the same as inExample 6 except that T survives the terminationdate of T’s retained annuity and the trust corpusis distributed to GC. Since the trust was notincluded in T’s gross estate, the ETIP rules donot apply. Accordingly, the nontax portion of thetrust and the applicable fraction are determinedas of the date of the transfer to the trust. Thenon t ax po r t i on o f t he t r u s t i s . 80($400,000/$500,000). The numerator of the ap-plicable fraction is $500,000 determined asfollows: $100,000 (GST exemption allocated tothe trust) plus $400,000 (the value of the nontaxportion of the trust). Accordingly, the applicablefraction is 1, and the inclusion ratio is zero.

(e) Transitional rule for allocationsfor transfers made before December27, 1995. If a NRA made a GST (intervivos or testamentary) after December23, 1992, and before December 27,1995, that is subject to chapter 13(within the meaning of §26.2663–2),the NRA will be treated as havingmade a timely allocation of GSTexemption to the transfer in a calendaryear in the order prescribed in section2632(c). Thus, a NRA’s unused GSTexemption will initially be treated as

SEQ 0269 JOB A29-009-005 PAGE-0046 PT 1 PG 46 REVISED 28MAY96 AT 10:53 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS COMPOSITE COLOR

778/20047/28MAY96/A29-009

46

allocated to any direct skips madeduring the calendar year and then toany trusts with respect to which theNRA made transfers during the samecalendar year and from which a taxabledistribution or a taxable terminationmay occur. Allocations within theabove categories are made in the orderin which the transfers occur. Alloca-tions among simultaneous transferswithin the same category are madepursuant to the principles of section2632(c)(2). This transitional allocationrule will not apply if the NRAtransferor, or the executor of theNRA’s estate, as the case may be,elected to have an automatic allocationof GST exemption not apply by de-scribing on a timely-filed Form 709 forthe year of the transfer, or a timelyfiled Form 706NA, the details of thetransfer and the extent to which theallocation was not to apply.

PART 301—PROCEDURE ANDADMINISTRATION

Par. 2. The authority citation for part301 continues to read in part asfollows:

Authority: 26 U.S.C. 7805.* * *Par. 3. Section 301.9100–7T is

amended as follows:a. Paragraph (a)(1) is amended in

the table by removing both entries for‘‘1431(a)’’.

b. Paragraph (a)(4)(i) is amended inthe table by removing the entry‘‘1431(a)’’.

c. Paragraph (a)(4)(iii) is revised toread as follows:

§301.9100–7T Time and manner ofmaking certain elections under theTax Reform Act of 1986.

(a) * * *(4) * * *(iii) Freely revocable election. The

election described in this section under

Act section 311(d)(2) is freely revocable.

* * * * * *

PART 602—OMB CONTROLNUMBERS UNDER THEPAPERWORK REDUCTION ACT

Par. 4. The authority citation for part602 continues to read as follows:

Authority: 26 U.S.C. 7805.Par. 5. In §602.101, paragraph (c) is

amended by adding entries in numeri-cal order in the table to read asfollows:

§602.101 OMB Control numbers.

* * * * * *

(c) * * *

CFR part or section Current OMBwhere identified control numberand described

* * * * * *

26.2601–1 . . . . . . . . . . . . . . 1545–0985

* * * * * *

26.2632–1 . . . . . . . . . . . . . . 1545–0985

* * * * * *

26.2642–1 . . . . . . . . . . . . . . 1545–098526.2642–2 . . . . . . . . . . . . . . 1545–098526.2642–3 . . . . . . . . . . . . . . 1545–098526.2642–4 . . . . . . . . . . . . . . 1545–0985

* * * * * *

26.2652–2 . . . . . . . . . . . . . . 1545–0985

* * * * * *

26.2662–2 . . . . . . . . . . . . . . 1545–0985

* * * * * *

Michael P. Dolan,Deputy Commissioner of

Internal Revenue.

Approved December 14, 1995.

Leslie Samuels,Assistant Secretary of

the Treasury.

(Filed by the Office of the Federal Register onDecember 26, 1995, 8:45 a.m., and publishedin the issue of the Federal Register forDecember 27, 1995, 60 F.R. 66898)


778/20047/28MAY96/A29-010

47

Part III. Administrative, Procedural, and Miscellaneous

Imaging Systems to Retain Booksand Records

Notice 96–10

This notice provides a proposedrevenue procedure that, when finalized,will provide guidance to taxpayers onthe use of an imaging system to satisfythe requirement of § 6001 of theInternal Revenue Code to maintainbooks and records.

The Service is proposing this reve-nue procedure as one means of comply-ing with the requirements of § 6001using electronic technology for recordsstorage. The Service welcomes publiccomments on the proposed revenueprocedure. Comments should be sub-mitted by March 28, 1996, to theInternal Revenue Service, P.O. Box7604, Ben Franklin Station, Wash-ington, DC 20044, Attn: CC:CORP:T:R(ITA Branch 4), Room 5228.

Rev. Proc. 96–A

SECTION 1. PURPOSE

This revenue procedure providesguidance to taxpayers on using animaging system (as defined in section3.01 of this revenue procedure) tomaintain books and records. Recordskept using an imaging system thatcomplies with the requirements of thisrevenue procedure will constitute rec-ords within the meaning of § 6001 ofthe Internal Revenue Code.

SECTION 2. BACKGROUND

.01 Section 6001 provides that everyperson liable for any tax imposed bythe Code, or for the collection thereof,must keep such records, render suchstatements, make such returns, andcomply with such rules and regulationsas the Secretary may from time to timeprescribe. Whenever necessary, theSecretary may require any person, bynotice served upon such person or byregulations, to make such returns,render such statements, or keep suchrecords, as the Secretary deems suffi-cient to show whether or not suchperson is liable for tax.

.02 Section 1.6001–1(a) of the In-come Tax Regulations provides that,except for farmers and wage-earners,

any person subject to income tax orany person required to file a return ofinformation with respect to income,must keep such books and records,including inventories, as are sufficientto establish the amount of gross in-come, deductions, credits, or othermatters required to be shown by suchperson in any return of such tax orinformation.

.03 Section 1.6001–1(e) providesthat the books or records required by§ 6001 must be kept available at alltimes for inspection by authorizedinternal revenue officers or employees,and shall be retained so long as thecontents thereof may become materialin the administration of any internalrevenue law.

SECTION 3. SCOPE

.01 This revenue procedure appliesto all taxpayers that use an imagingsystem to maintain books and records.For purposes of this revenue procedure,an ‘‘imaging system’’ means anelectronic technology used to prepare,record, image, index, store, preserve,retrieve, and reproduce books andrecords, the originals of which are inhardcopy format.

.02 A taxpayer’s use of a servicebureau or time-sharing service toprovide the taxpayer with an imagingsystem for its books and records doesnot relieve the taxpayer of the respon-sibilities described in this revenueprocedure.

.03 The requirements of this revenueprocedure pertain to all matters underthe jurisdiction of the Commissioner ofInternal Revenue including, but notlimited to, income, excise, employment,and estate and gift taxes, as well asemployee plans and exempt organiza-tions.

SECTION 4. IMAGING SYSTEMREQUIREMENTS

.01 General Requirements of anImaging System.

(1) An imaging system for main-taining books and records for purposesof § 6001 must create accurate andcomplete electronic images of hardcopydocuments, and must index, store,preserve, retrieve, and reproduce im-aged documents.

(2) An imaging system mustinclude:

(a) reasonable controls to en-sure the integrity, accuracy, and re-liability of the imaging system, includ-ing a record of where, when, by whom,and on what equipment the image wasproduced, including the hardware andsoftware that was used;

(b) reasonable controls to pre-vent the unauthorized creation of, addi-tion to, alteration of, deletion of, ordeterioration of any imaged document(for instance, one control could be theuse of a non-erasable and non-rewritable media);

(c) an inspection and qualityassurance program evidenced by regu-lar evaluations of the imaging systemincluding periodic checks of imageddocuments;

(d) a retrieval system that in-cludes an indexing system (within themeaning of section 4.02 of this revenueprocedure); and

(e) the ability to reproduce alegible and readable hardcopy (withinthe meaning of section 4.01(5) of thisrevenue procedure) of an imageddocument.

(3) For each imaging system used,the taxpayer must establish, maintain,and retain written procedures that de-scribe in detail the complete imagingsystem. Any changes to the imagingsystem must be documented in writing.These written procedures and all modi-fications must be readily available tothe Service upon request.

(4) The imaging system must pro-vide support for the taxpayer’s booksand records (including books and rec-ords in an automated data processingsystem). For example, the imagingsystem and the taxpayer’s books andrecords must be cross-referenced, sothat all imaged documents that supportan entry in the taxpayer’s books andrecords can be automatically identifiedand retrieved for viewing or printing.

(5) All images reproduced by theimaging system must exhibit a highdegree of legibility and readabilitywhen displayed on a video displayterminal or reproduced on paper. Theterm ‘‘legibility’’ means the observermust be able to identify all letters andnumerals positively and quickly to theexclusion of all other letters or nu-merals. The term ‘‘readability’’ means


778/20047/28MAY96/A29-010

48

that the observer must be able torecognize a group of letters or nu-merals as words or complete numbers.The taxpayer must ensure that thereproduction process maintains the legi-bility and readability of the imagebeing reproduced. Taxpayers may usereasonable data compression or format-ting technologies as part of theirimaging system so long as the require-ments of this revenue procedure aresatisfied.

(6) The taxpayer must retain im-aged documents until their contents areno longer material to the administrationof the Internal Revenue laws under§ 1.6001–1(e).

(7) The taxpayer must be able toretrieve and reproduce imaged docu-ments at the time of a Service examina-tion. Reproduction includes the abilityto print a legible and readable hardcopyof any imaged document.

(8) The taxpayer must provide theService, at the time of an examination,or for the tests described in section 5of this revenue procedure, with theresources (e.g., appropriate hardwareand software, personnel, documenta-tion, etc.) necessary for promptly locat-ing, retrieving, reading, and reproduc-ing on paper any imaged document.

(9) The taxpayer may use morethan one imaging system. In that event,each system must meet the require-ments of this revenue procedure. Im-aged documents that are contained in asystem with respect to which thetaxpayer ceases to maintain the hard-ware and the software necessary tosatisfy the conditions of this revenueprocedure will be deemed destroyed bythe taxpayer unless the existing imageddocuments are converted to a formatcompatible with an imaging system thatthe taxpayer continues to maintain.

(10) An imaging system must notbe subject, in whole or in part, to anyagreement (such as a contract orlicense) that would limit or restrict theService’s access to and use of theimaging system on the taxpayer’spremises (or such other place where theimaging system is maintained), includ-ing personnel, hardware, software, files,indexes and software documentation.

.02 Requirements of an IndexingSystem.

(1) For purposes of this revenueprocedure, an indexing system is asystem that permits the rapid identifica-tion and retrieval for viewing orreproducing of relevant documents

maintained in an imaging system. Forexample, an indexing system mightconsist of assigning each imaged docu-ment a unique identification numberand maintaining a separate databasethat contains descriptions of each im-aged document along with that docu-ment’s identification number. In addi-tion, any system used to maintain,organize, or coordinate multiple imag-ing systems is treated as an indexingsystem under this revenue procedure.The requirement to maintain an index-ing system will be satisfied if theindexing system is functionally com-parable to a reasonable hardcopy filingsystem. The requirement to maintain anindexing system does not require that aseparate imaged document descriptiondatabase be maintained if comparableresults can be achieved without aseparate description database.

(2) Reasonable controls must beundertaken to protect the indexingsystem against the unauthorized crea-tion of, addition to, alteration of,deletion of, or deterioration of anyentries.

.03 Recommended Practices. Theimplementation of records managementpractices is a business decision that issolely within the discretion of thetaxpayer. Records management prac-tices may include the labeling ofdocuments, providing a secure storageenvironment, creating back-up copies,selecting an off-site storage location,retaining hardcopies of illegible docu-ments or documents that cannot be ac-curately or completely imaged or re-produced under the imaging system,and testing to confirm records integrity.

SECTION 5. DISTRICT DIRECTORTESTING

.01 The District Director mayperiodically initiate tests of a tax-payer’s imaging system. These testsmay include an evaluation (by actualuse) of a taxpayer’s equipment andsoftware, as well as the proceduresused by a taxpayer to prepare, record,image, index, store, preserve, retrieve,and reproduce imaged documents. Insome instances, the District Directormay choose to review the internalcontrols, security procedures, and docu-mentation associated with the tax-payer’s imaging system.

.02 The tests described in section5.01 of this revenue procedure are notan ‘‘examination,’’ ‘‘investigation,’’ or

‘‘inspection’’ of the books and recordswithin the meaning of § 7605(b), or aprior audit for purposes of § 530 of theRevenue Act of 1978, 1978–3 (Vol.1)C.B. 119, because the evaluation is notdirectly related to the determination ofthe tax liability of a taxpayer for aparticular taxable period.

.03 The District Director must in-form the taxpayer of the results of anyperiodic tests.

SECTION 6. COMPLIANCE

.01 A taxpayer’s imaging systemthat meets the requirements of thisrevenue procedure will be treated asbeing in compliance with the rec-ordkeeping requirements of § 6001 andthe regulations thereunder.

.02 A taxpayer’s imaging systemthat fails to meet the requirements ofthis revenue procedure may be treatedas not being in compliance with therecordkeeping requirements of § 6001and the regulations thereunder. Seesection 8 for applicable penalties. How-ever, even though a taxpayer’s imagingsystem fails to meet the requirementsof this revenue procedure, the penaltiesdescribed in section 8 may not apply ifthe taxpayer maintains its originalbooks and records, or maintains itsbooks and records in micrographicform in conformity with Rev. Proc. 81–46, 1981–2 C.B. 621.

SECTION 7. DESTRUCTION OFHARDCOPY DOCUMENTS

This revenue procedure permits thedestruction of hardcopy documents af-ter the taxpayer:

(1) has completed its own testingof the imaging system that establishesthat hardcopy documents are beingimaged in compliance with all theprovisions of this revenue procedure;and

(2) has instituted procedures thatensure its continued compliance withall the provisions of this revenueprocedure.

SECTION 8. PENALTIES

The District Director may issue aNotice of Inadequate Records pursuantto § 1.6001–1(d) if the taxpayer’sbooks and records are available only asimaged documents and the taxpayer’simaging system fails to meet the


778/20047/28MAY96/A29-010

49

requirements of this revenue procedure.Taxpayers whose imaging systems failto meet the requirements of this reve-nue procedure may also be subject toapplicable penalties under subtitle F ofthe Code including the § 6662(a)accuracy-related civil penalty and the§ 7203 willful failure criminal penalty.

DRAFTING INFORMATION

The principal author of this notice isCelia Gabrysh of the Office of theAssistant Chief Counsel (Income Taxand Accounting). For further informa-tion regarding this notice, contact Ms.Gabrysh on (202) 622-4940 (not a toll-free call).

Delegation Order No. 232 (Rev. 2)

Delegation of Authority

AGENCY: Internal Revenue Service(IRS), Treasury

ACTION: Delegation of authority torescind TAOs.

SUMMARY: The Commissioner, InternalRevenue Service is issuing this Delega-tion Order to limit the modification orrescission of Taxpayer AssistanceOrders (‘‘TAO’’) to the Commissioner,Deputy Commissioner or TaxpayerOmbudsman. The Ombudsman’s Dele-gation Order 232 (Rev. 1) providingmore expansive rescission authority ishereby superseded.


FOR FURTHER INFORMATION CONTACT:Doug Peterson, C:PRP, Room 1027,1111 Constitution Avenue, NW., Wash-ington, DC 20224, 202-622-4315 (not atoll-free call).

Authority to Modify or RescindTaxpayer Assistance Orders (TAO)

Section 7811 of the Code states thatTAOs ‘‘may be modified or rescindedonly by the Ombudsman, a districtdirector, a service center director, acompliance center director, a regionaldirector of appeals, or any superior ofany such person.’’ The Commissioner

wishes to reassure taxpayers that TAOswill be accorded the greatest respectand consideration by the IRS. Thisdelegation order accordingly limits thediscretionary modification or rescissionauthority under §7811 to only theCommissioner, Deputy Commissioneror Taxpayer Ombudsman.

This delegation order supersedesOmbudsman’s Del. Order 232 (Rev. 1)which provided more expansive au-thority to local IRS officials.

Dated: January 5, 1996.

Margaret M. Richardson,Commissioner.

(Filed by the Office of the Federal Register onJanuare 9, 1996, 8:45 a.m., and published inthe issue of the Federal Register for January10, 1996, 61 F.R. 764)

Delegation Order No. 239 (Rev. 1)

Delegation of authority

AGENCY: Internal Revenue Service(IRS), Treasury

ACTION: Delegation of authority.

SUMMARY: The Commissioner, InternalRevenue Service, amends DelegationOrder 239 to clarify that the TaxpayerOmbudsman is delegated the authorityto issue Taxpayer Assistance Orders(‘‘TAO’’) to intervene on behalf oftaxpayers and take positive action withrespect to taxpayer cases.

The Commissioner further amendsDelegation Order 239 to direct theOmbudsman to prepare an annual re-port of the most serious problemstaxpayers face when conducting busi-ness with the IRS and to suggestadministrative and legislative solutionsto these problems, if applicable.

Finally, Delegation Order 239 isfurther amended to give the Ombuds-man the authority to establish a systemto track the response of IRS officials tothe administrative problems identifiedin the Ombudsman’s annual report.


FOR FURTHER INFORMATION CONTACT:Doug Peterson, C:PRP, Room 1027,1111 Constitution Avenue, NW., Wash-

ington, DC 20224, 202-622-4315 (not atoll-free call).

Amendment of Delegation Order 239

The Commissioner in DelegationOrder 239 delegated to the TaxpayerOmbudsman the authority to issueTAOs in addition to the situationsspecified in section 7811 of the InternalRevenue Code. The Commissionerwishes to amend Delegation Order 239to clarify that such authority gives theTaxpayer Ombudsman the ability tointervene on behalf of taxpayers to takepositive action with respect to tax-payers’ cases. Thus, for example, theOmbudsman may issue a TAO to speeda refund to a taxpayer to relieve severefinancial hardship on the part of thetaxpayer. Likewise, the Ombudsmanmay issue a TAO to stay an enforce-ment action to ensure review ofwhether such action is appropriate.

The Commissioner also amends Del-egation Order 239 to direct the Om-budsman to prepare an annual report ofthe most serious problems taxpayersface when conducting business with theService and to suggest administrativeand legislative solutions to these prob-lems, if applicable. The purpose of theannual report is to provide an inde-pendent mechanism to identify andresolve the problems taxpayers mayencounter with the Service.

The Commissioner also hereby dele-gates to the Ombudsman the authorityto establish a system to track theService’s response to administrativechanges suggested in the Ombudsman’sreport. The tracking system shouldidentify which IRS official ideallyshould respond to the suggestion andhow that official responded. Addi-tionally, the Ombudsman’s annual re-port should include a section detailingthis information concerning the Serv-ice’s response to any administrativechanges suggested in the prior year’sreport.

Dated: January 5, 1996.

Margaret M. Richardson,Commissioner.

(Filed by the Office of the Federal Register onJanuary 9, 1996, 8:45 a.m., and published inthe issue of the Federal Register for January10 1996, 61 F.R. 763)


778/20047/28MAY96/A29-011

501996–22 I.R.B.

Part IV. Items of General Interest

Notice of Proposed Rulemaking andNotice of Public Hearing

Distribution of Marketable Securitiesby a Partnership

PS–2–95

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Notice of proposed rulemak-ing and notice of public hearing.

SUMMARY: This document containsproposed regulations relating to thetreatment of a distribution of marketa-ble securities by a partnership undersection 731(c) of the Internal RevenueCode of 1986, as amended (Code).These proposed regulations providetaxpayers with guidance needed tocomply with certain changes made bythe Uruguay Round Agreements Act of1994. This document also providesnotice of a public hearing on theseproposed regulations.

DATES: Written comments and re-quests to speak (with outlines of oralcomments) at a public hearing sched-uled for 10 a.m. on Wednesday, April3, 1996 must be received by Wednes-day, March 13, 1996.

ADDRESSES: Send submissions to:CC:DOM:CORP:R (PS–2–95), Room5228, Internal Revenue Service, POB7604, Ben Franklin Station, Wash-ington, DC 20044. In the alternative,submissions may be hand deliveredbetween the hours of 8 a.m. and 5 p.m.to: CC:DOM:CORP:R (PS–2–95), Cou-rier’s Desk, Internal Revenue Service,1111 Constitution Avenue NW., Wash-ington, DC. The public hearing will beheld in the IRS Auditorium.

FOR FURTHER INFORMATIONCONTACT: Concerning the regula-tions, Terri A. Belanger or William M.Kostak, (202) 622-3080; concerningsubmissions and the hearing, ChristinaVasquez, (202) 622-7190 (not toll-freenumbers).


Introduction

This document proposes to add§1.731–2 to the Income Tax Regula-

tions (26 CFR part 1) under section731(c) of the Code. Section 731(c) wasamended by section 741(a) of theUruguay Round Agreements Act of1994 (Public Law 103–465).

Background

Section 731(a)(1) of the Codeprovides that a partner must recognizegain on a distribution from a part-nership to the extent that any moneydistributed exceeds the adjusted basisof the partner’s interest in the part-nership immediately before the dis-tribution. Section 737 provides that apartner must recognize gain on adistribution of property other thanmoney in an amount equal to the lesserof (i) the partner’s net precontributiongain or (ii) the excess of the fairmarket value of the distributed propertyover the partner’s basis in the part-nership interest.

Section 731(c) provides that the termmoney includes marketable securitiesfor purposes of section 731(a)(1) andsection 737. As discussed in thelegislative history accompanying sec-tion 731(c), treating marketable se-curities as money for this purpose isappropriate because marketable se-curities are economically equivalent tomoney. Section 731(c) affects only thetax consequences to the distributeepartner; section 731(c) does not requirethe partnership or any partner otherthan the distributee partner to recognizegain on a distribution of marketablesecurities.

Explanation of Provisions

Marketable securities treated asmoney

Distributions of marketable securitiesare treated as distributions of moneyunder section 731(c) only for purposesof sections 731(a)(1) and 737. Forexample, a distribution of marketablesecurities is not treated as a distributionof money to the extent it is subject tosection 707 or section 751(b) becausethe distribution is not subject to section731(a)(1) or section 737. In addition,marketable securities are not treated asmoney for purposes of section 731(a)-(2), so that a partner does not recognizea loss on a distribution of marketable

securities. Finally, marketable securitiescontributed by a partner are treated asproperty other than money for purposesof determining the partner’s net pre-contribution gain under section 737(b).

Reduction of amount treated asmoney

Under section 731(c)(3)(B), theamount of marketable securities that istreated as money is reduced by theexcess of (i) the partner’s share of thenet gain of the partnership’s securitiesof the same class and issuer as thedistributed securities immediately be-fore the distribution over (ii) thepartner’s share of such net gain imme-diately after the distribution. Thisprovision allows a partner to withdrawthe partner’s share of appreciation inthe partnership’s marketable securitieswithout recognizing gain on the dis-tribution. As a result, section 731(c)generally applies only when a partnerreceives a distribution of marketablesecurities in exchange for the partner’sshare of appreciated assets other thanmarketable securities.

Under the authority of section731(c)(3)(B), the proposed regulationsprovide that all marketable securitiesheld by a partnership are treated asmarketable securities of the same classand issuer as the distributed securities.Treating all marketable securities as asingle asset for this purpose is consis-tent with the basic rationale of section731(c) that marketable securities arethe economic equivalent of money. Asa result, the amount of the distributionthat is not treated as money will de-pend on the partner’s share of the netappreciation in all partnership se-curities, not on the partner’s share ofthe appreciation in the type of se-curities distributed.

Definition of marketable securities

In general, the term marketablesecurities includes any financialinstruments—such as stocks, options,and derivatives-that are actively tradedwithin the meaning of section1092(d)(1). In addition, section731(c)(2)(B)(v) provides that an inter-est in an entity is a marketable securityif substantially all of the assets of theentity consist of marketable securities


778/20047/28MAY96/A29-011

51 1996–22 I.R.B.

or money. The proposed regulationsprovide that substantially all of theassets of an entity consist of marketa-ble securities or money only if 90percent or more of the assets of theentity at the time of the distributionconsist of such assets.

Section 731(c)(2)(B)(vi) providesthat, to the extent provided in regula-tions, an interest in an entity notdescribed in section 731(c)(2)(B)(v) isa marketable security to the extent thatthe value of such interest is attributableto marketable securities or money. Theproposed regulations provide that aninterest in an entity is a marketablesecurity to the extent that the value ofthe interest is attributable to marketablesecurities or money that constitute lessthan 90 percent but 20 percent or moreof the assets of the entity. The 20percent threshold means that an interestin an entity holding only a smallamount of marketable securities willnot be treated as a marketable security.

The proposed regulations also pro-vide that a marketable security willcontinue to be treated as a marketablesecurity, even if the partnership or itspartners are restricted by agreement orotherwise from selling or exchangingthe security. This provision is intendedto prevent a partnership from avoidingsection 731(c) by temporarily restrict-ing the transferability of the distributedsecurity.

Exceptions

Consistent with the provisions ofsection 731(c)(3)(A), the proposed reg-ulations provide three exceptions tosection 731(c). First, the proposedregulations provide that if the marketa-ble security was contributed to thepartnership by the distributee partner,section 731(c) does not apply to thedistribution of that security.

Second, the proposed regulationsprovide that section 731(c) does notapply to the distribution of a marketa-ble security to the extent that thesecurity was acquired by the part-nership in a nonrecognition transactionin exchange for property other thanmarketable securities or cash and (i)the security is actively traded as of thedate of distribution and (ii) the securityis distributed by the partnership withinfive years of either the date the securitywas acquired by the partnership or, iflater, the date the security becameactively traded. For example, if a

partnership contributed substantially allof its assets to a corporation in atransaction described in section 351and the stock of the corporation be-came marketable, the distribution of thestock by the partnership within fiveyears would not be subject to section731(c). This exception recognizes thatthe marketable security in these situa-tions is simply a substitute for theunderlying assets exchanged in thenonrecognition transaction.

The proposed regulations also pro-vide that section 731(c) does not applyto the distribution of a marketablesecurity if (i) the security was notactively traded on the date acquired bythe partnership and the entity to whichthe security relates had no outstandingactively traded securities at the time thesecurity was acquired by the part-nership; (ii) the security is activelytraded as of the date of distribution;and (iii) the security was held by thepartnership for at least six monthsbefore it became actively traded andthe security was distributed by thepartnership within five years of thedate on which the security becameactively traded.

In addition, the proposed regulationsprovide a successor security rule thatapplies to these exceptions. This ruleprovides that the exceptions continue toapply to a security acquired in anonrecognition transaction in exchangefor a security that was already subjectto an exception.

Investment partnerships

Section 731(c) does not apply to thedistribution of marketable securities byan investment partnership to an eligiblepartner. An investment partnership isdefined as a partnership that has neverbeen engaged in a trade or business andsubstantially all of the assets of whichconsist of the investment assets de-scribed in section 731(c)(3)(C)(i). Theproposed regulations provide that apartner can qualify as an eligiblepartner even if the partner contributedservices to the partnership. In addition,the proposed regulations provide that apartnership will not be treated asengaged in a trade or business if thepartnership provides reasonable andcustomary management services to alower-tier investment partnership. Thisexception allows an upper-tier invest-ment partnership to manage the invest-ments and other activities of a lower-

tier investment partnership withoutdisqualifying the upper-tier partnershipas an investment partnership. The ex-ception does not extend to managementservices provided to lower-tier part-nerships other than investment part-nerships because, as discussed below,the tiering rules of section 731(c)(3)-(C)(iv) treat the upper-tier managementpartnership as engaged in the trade orbusiness of the lower-tier partnership,thereby preventing the upper-tier part-nership from qualifying as an invest-ment partnership.

The proposed regulations also pro-vide that a partnership will not betreated as engaged in a trade orbusiness if the partnership providesreasonable and customary services inassisting the formation, capitalization,expansion, or offering of interests in anentity in which the partnership holds asignificant equity interest, provided thatthe anticipated receipt of compensationfor the services does not represent asignificant purpose for the partnership’sinvestment in the entity and is inciden-tal to the investment in the entity.

Section 731(c)(3)(C)(iv) providesthat, except as otherwise provided inregulations, a partnership is treated asengaged in any trade or businessengaged in by (and as holding theassets of) any partnership in which thepartnership holds an interest. The pro-posed regulations provide that thislook-through rule does not apply if theupper-tier partnership does not partici-pate in the management of the lower-tier partnership and the interest held bythe upper-tier partnership is less than10 percent of the total profits andcapital interests in the lower-tierpartnership.

Coordination with other sections

The proposed regulations providerules for coordinating section 731(c)with section 704(c)(1)(B) and section737. This coordination is necessarybecause a distribution of marketablesecurities could occur as part of alarger distribution in which propertycontributed by the distributee partner isdistributed to another partner (section704(c)(1)(B)) or the distributee partnerreceives property in addition to mar-ketable securities (section 737).

Under the proposed regulations, thebasis increase in the partner’s interestin the partnership as a result of anygain recognized by the partner under


778/20047/28MAY96/A29-011

521996–22 I.R.B.

section 704(c)(1)(B) is taken into ac-count in determining the distributeepartner’s gain under section 731(c) andthe partner’s basis in the distributedsecurities. Taking the stepped-up basisinto account for purposes of section731 reflects the fact that the generaleffect of section 704(c)(1)(B) is to treatthe contributing partner as having con-tributed property with a full fair marketvalue basis at the time of contribution.The proposed regulations, however,provide that the basis increase in thepartner’s interest as a result of any gainrecognized by the partner under section737 is not taken into account for thesepurposes. The proposed regulations areconsistent with section 737, whichgenerally treats a distribution of moneyas occurring before, and independentof, a distribution of other property.

Anti-abuse rule

The proposed regulations providethat the provisions of section 731(c)and this section must be applied in amanner that is consistent with thepurpose of section 731(c) and thesubstance of the transaction.

Proposed effective date

This section is proposed to apply todistributions of marketable securities bya partnership to a partner on or afterFriday, December 29, 1995.

Special Analyses

It has been determined that thisnotice of proposed rulemaking is not asignificant regulatory action as definedin EO 12866. Therefore, a regulatoryassessment is not required. It also hasbeen determined that section 553(b) ofthe Administrative Procedure Act (5U.S.C. chapter 5) and the RegulatoryFlexibility Act (5 U.S.C. chapter 6) donot apply to these regulations, and,therefore, a Regulatory FlexibilityAnalysis is not required. Pursuant tosection 7805(f) of the Internal RevenueCode, this notice of proposed rulemak-ing will be submitted to the ChiefCounsel for Advocacy of the SmallBusiness Administration for commenton its impact on small business.

Comments and Public Hearing

Before these proposed regulationsare adopted as final regulations, consid-

eration will be given to any writtencomments (a signed original and eight(8) copies) that are timely submitted tothe IRS. All comments will be avail-able for public inspection and copying.

A public hearing has been scheduledfor Wednesday, April 3, 1996 at 10:00a.m. in the Auditorium of the InternalRevenue Building, 1111 ConstitutionAvenue NW., Washington, DC. Be-cause of access restrictions, visitorswill not be admitted beyond the Inter-nal Revenue Building lobby more than15 minutes before the hearing starts.

The rules of 26 CFR 601.601(a)(3)apply to the hearing.

Persons that wish to present oralcomments at the hearing must submitwritten comments by Wednesday,March 13, 1996 and submit an outlineof the topics to be discussed and thetime to be devoted to each topic(signed original and eight (8) copies)by Wednesday, March 13, 1996.

A period of 10 minutes will beallotted to each person for makingcomments.

An agenda showing the schedulingof the speakers will be prepared afterthe deadline for receiving outlines haspassed. Copies of the agenda will beavailable free of charge at the hearing.


The principal authors of these reg-ulations are Terri A. Belanger andWilliam M. Kostak, Office of AssistantChief Counsel (Passthroughs and Spe-cial Industries), IRS. However, otherpersonnel from the IRS and TreasuryDepartment participated in theirdevelopment.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and rec-ordkeeping requirements.

Proposed Amendments to theRegulations

Accordingly, 26 CFR part 1 isproposed to be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citationfor part 1 is amended by adding anentry in numerical order to read asfollows:

Authority: 26 U.S.C. 7805. * * *Section 1.731–2 also issued under 26U.S.C. 731(c). * * *

Par. 2. Section 1.731–2 is added toread as follows:

§1.731–2 Partnership distributions ofmarketable securities.

(a) Marketable securities treated asmoney. Except as otherwise provided insection 731(c) and this section, forpurposes of section 731(a)(1) and 737,the term money includes marketablesecurities and such securities are takeninto account at their fair market valueas of the date of the distribution.

(b) Reduction of amount treated asmoney—(1) Aggregation of securities.For purposes of section 731(c)(3)(B)and this paragraph (b), all marketablesecurities held by a partnership aretreated as marketable securities of thesame class and issuer as the distributedsecurity.

(2) Amount of reduction. Theamount of the distribution of marketa-ble securities that is treated as adistribution of money under section731(c) and paragraph (a) of this sectionis reduced (but not below zero) by theexcess, if any, of—

(i) The distributee partner’s distribu-tive share of the net gain, if any, whichwould be recognized if all the marketa-ble securities held by the partnershipwere sold (immediately before thetransaction to which the distributionrelates) by the partnership for fairmarket value; over

(ii) The distributee partner’s dis-tributive share of the net gain, if any,which is attributable to the marketablesecurities held by the partnership im-mediately after the transaction, deter-mined by using the same fair marketvalue as used under paragraph (b)(2)(i)of this section.

(3) Distributee partner’s share ofnet gain. For purposes of section731(c)(3)(B) and paragraph (b)(2) ofthis section, a partner’s distributiveshare of net gain is determined—

(i) By taking into account any basisadjustments under section 743(b) withrespect to that partner; and

(ii) Without taking into account anyspecial allocations adopted with aprincipal purpose of avoiding the effectof section 731(c) and this section.

(c) Marketable securities—(1) Ac-tively traded. For purposes of section


778/20047/28MAY96/A29-011

53 1996–22 I.R.B.

731(c) and this section, a financialinstrument is actively traded (and thusis a marketable security) if it is of atype that is, as of the date of distribu-tion, actively traded within the meaningof section 1092(d)(1). Thus, for exam-ple, if XYZ common stock is listed on anational securities exchange, particularshares of XYZ common stock that aredistributed by a partnership are mar-ketable securities even if those particu-lar shares cannot be resold by thedistributee partner for a designatedperiod of time.

(2) Interests in an entity—(i) Sub-stantially all. For purposes of section731(c)(2)(B)(v) and this section, sub-stantially all of the assets of an entityconsist (directly or indirectly) of mar-ketable securities, money, or both onlyif 90 percent or more of the assets ofthe entity (by value) at the time of thedistribution of an interest in the entityconsist (directly or indirectly) of mar-ketable securities, money, or both.

(ii) Less than substantially all. Forpurposes of section 731(c)(2)(B)(vi)and this section, an interest in an entityis a marketable security to the extentthat the value of the interest is at-tributable (directly or indirectly) tomarketable securities, money, or both,if less than 90 percent but 20 percentor more of the assets of the entity (byvalue) at the time of the distribution ofan interest in the entity consist (directlyor indirectly) of marketable securities,money, or both.

(d) Exceptions—(1) Previously con-tributed property. Section 731(c) andthis section do not apply to the dis-tribution of a marketable security if thesecurity was contributed to the part-nership by the distributee partner,except to the extent that the value ofthe distributed security is attributable tomarketable securities or money contrib-uted (directly or indirectly) by thepartnership to the entity to which thedistributed security relates.

(2) Security acquired in nonrecogni-tion transaction. Section 731(c) andthis section do not apply to the distri-bution of a marketable security to theextent that—

(i) The security was acquired by thepartnership in a nonrecognition transac-tion in exchange for any propertyexcept money or marketable securities(including a security that would havebeen treated as a marketable securityunder paragraph (c)(2) of this section ifdistributed at the time of theexchange);

(ii) The distributed security is ac-tively traded as of the date of distribu-tion; and

(iii) The security is distributedwithin five years of either the date onwhich the security was acquired by thepartnership or, if later, the date onwhich the security became activelytraded.

(3) Security not marketable when ac-quired. Section 731(c) and this sectiondo not apply to the distribution of amarketable security if—

(i) The security was not activelytraded as of the date acquired by thepartnership and the entity to which thesecurity relates had no outstandingactively traded securities on that date;

(ii) The security is actively traded asof the date of distribution; and

(iii) The security was held by thepartnership for at least six monthsbefore the date the security becameactively traded and the security wasdistributed within five years of the dateon which the security became activelytraded.

(4) Successor security. Section731(c) and this section do not apply tothe distribution of a marketable securityto the extent that the security wasacquired by the partnership in a non-recognition transaction in exchange fora security the distribution of whichimmediately prior to the exchangewould have been excepted under thisparagraph (d).

(e) Investment partnerships—(1) Ingeneral. Section 731(c) and this sectiondo not apply to the distribution ofmarketable securities by an investmentpartnership (as defined in section731(c)(3)(C)(i)) to an eligible partner(as defined in section 731(c)(3)(C)(iii)).

(2) Eligible partner. For purposes ofsection 731(c)(3)(C)(iii) and this sec-tion, a partner is not treated as apartner other than an eligible partnersolely because the partner contributedservices to the partnership.

(3) Trade or business activities. Forpurposes of section 731(c)(3)(C) andthis section, a partnership is not treatedas engaged in a trade or business byreason of—

(i) Any activity undertaken as aninvestor, trader, or dealer in any assetdescribed in section 731(c)(3)(C)(i),including the receipt of commitmentfees, break-up fees, guarantee fees,director’s fees, or similar fees that arecustomary in and incidental to any

activities of the partnership as aninvestor, trader, or dealer in suchassets;

(ii) Reasonable and customary man-agement services (including the receiptof reasonable and customary fees inexchange for such management serv-ices) provided to an investment part-nership (within the meaning of section731(c)(3)(C)(i)) in which the part-nership holds a partnership interest; or

(iii) Reasonable and customary serv-ices provided by the partnership inassisting the formation, capitalization,expansion, or offering of interests in acorporation (or other entity) in whichthe partnership holds or acquires asignificant equity interest (including theprovision of advice or consulting serv-ices, bridge loans, guarantees of obliga-tions, or service on a company’s boardof directors), provided that the antici-pated receipt of compensation for theservices, if any, does not represent asignificant purpose for the partnership’sinvestment in the entity and is inciden-tal to the investment in the entity.

(4) Partnership tiers. For purposesof section 731(c)(3)(C)(iv) and thissection, a partnership (upper-tier part-nership) is not treated as engaged in atrade or business engaged in by, or asholding (instead of a partnership inter-est) a proportionate share of the assetsof, a partnership (lower-tier part-nership) in which the partnership holdsa partnership interest if—

(i) The upper-tier partnership doesnot participate in the management ofthe lower-tier partnership; and

(ii) The interest held by the upper-tier partnership is less than 10 percentof the total profits and capital interestsin the lower-tier partnership.

(f) Basis rules—(1) Partner’sbasis—(i) Partner’s basis in distributedsecurities. The distributee partner’sbasis in distributed marketable se-curities with respect to which gain isrecognized by reason of section 731(c)and this section is the basis of thesecurity determined under section 732,increased by the amount of such gain.Any increase in the basis of themarketable securities attributable togain recognized by reason of section731(c) and this section is allocated tomarketable securities in proportion totheir respective amounts of unrealizedappreciation in the hands of the partnerbefore such increase.

(ii) Partner’s basis in partnershipinterest. The basis of the distributee


778/20047/28MAY96/A29-011

541996–22 I.R.B.

partner’s interest in the partnership isdetermined under section 733 as if nogain were recognized by the partner onthe distribution by reason of section731(c) and this section.

(2) Basis of partnership property.No adjustment is made to the basis ofpartnership property under section 734as a result of any gain recognized by apartner, or any step-up in the basis inthe distributed marketable securities inthe hands of the distributee partner, byreason of section 731(c) and thissection.

(g) Coordination with other sec-tions—(1) Section 704(c)(1)(B). Thebasis of the distributee partner’s inter-est in the partnership for purposes ofdetermining the amount of gain, if any,recognized by reason of section 731(c)(and for determining the basis of themarketable securities in the hands ofthe distributee partner) includes theincrease, if any, in the partner’s basisthat occurs under section 704(c)(1)(B)-(iii) as a result of a distribution toanother partner of property contributedby the distributee partner in a distribu-tion that is part of the same distributionas the marketable securities.

(2) Section 737—(i) Marketable se-curities as other property. A distribu-tion of marketable securities is treatedas a distribution of property other thanmoney for purposes of section 737 tothe extent that the marketable securitiesare not treated as money under section731(c). In addition, marketable se-curities contributed to the partnershipare treated as property other thanmoney in determining the contributingpartner’s net precontribution gain undersection 737(b).

(ii) Basis increase under section737. The basis of the distributeepartner’s interest in the partnership forpurposes of determining the amount ofgain, if any, recognized by reason ofsection 731(c) (and for determining thebasis of the marketable securities in thehands of the distributee partner) doesnot include the increase, if any, in thepartner’s basis that occurs under sec-tion 737(c)(1) as a result of a distribu-tion of property to the distributeepartner in a distribution that is part ofthe same distribution as the marketablesecurities.

(h) Anti-abuse rule. The provisionsof section 731(c) and this section mustbe applied in a manner consistent withthe purpose of section 731(c) and the

substance of the transaction. Accord-ingly, if a principal purpose of atransaction is to achieve a tax resultthat is inconsistent with the purpose ofsection 731(c) and this section, theCommissioner can recast the transac-tion for federal tax purposes as appro-priate to achieve tax results that areconsistent with the purpose of section731(c) and this section. Whether a taxresult is inconsistent with the purposeof section 731(c) and this section mustbe determined based on all the factsand circumstances. For example, underthe provisions of this paragraph (h)—

(1) A change in partnership alloca-tions or distribution rights with respectto marketable securities may be treatedas a distribution of the marketablesecurities subject to section 731(c) ifthe change in allocations or distributionrights is, in substance, a distribution ofthe securities;

(2) A distribution of substantially allof the assets of the partnership otherthan marketable securities and moneyto some partners may also be treated asa distribution of marketable securitiesto the remaining partners if the dis-tribution of the other property and thewithdrawal of the other partners is, insubstance, equivalent to a distributionof the securities to the remainingpartners; and

(3) The distribution of multipleproperties to one or more partners atdifferent times may also be treated aspart of a single distribution if thedistributions are part of a single plan ofdistribution.

(i) [Reserved](j) Examples. The following exam-

ples illustrate the rules of this section.Unless otherwise specified, all se-curities held by a partnership aremarketable securities within the mean-ing of section 731(c); the partnershipholds no marketable securities otherthan the securities described in theexample; all distributions by the part-nership are subject to section 731(a)and are not subject to sections704(c)(1)(B), 751(b), or 737; and nosecurities are eligible for an exceptionto section 731(c).

Example 1. Recognition of gain. (i) A and Bform partnership AB as equal partners. Acontributes property with a fair market value of$1,000 and an adjusted tax basis of $250. Bcontributes $1,000 cash. AB subsequently pur-chases Security X for $500 and immediatelydistributes the security to A in a current

distribution. The basis in A’s interest in thepartnership at the time of distribution is $250.

(ii) The distribution of Security X is treated asa distribution of money in an amount equal tothe fair market value of Security X on the date ofdistribution ($500). (The amount of the distribu-tion that is treated as money is not reduced undersection 731(c)(3)(B) and paragraph (b) of thissection because, if Security X had been soldimmediately before the distribution, there wouldhave been no gain recognized by AB and A’sdistributive share of the gain would thereforehave been zero.) As a result, A recognizes $250of gain under section 731(a)(1) on the distribu-tion ($500 distribution of money less $250adjusted tax basis in A’s partnership interest).

Example 2. Reduction in amount treated asmoney—in general. (i) A and B form partnershipAB as equal partners. AB subsequently distributesSecurity X to A in a current distribution.Immediately before the distribution, AB heldsecurities with the following fair market values,adjusted tax bases, and unrecognized gain orloss:

Value Basis Gain (Loss)

Security X 100 70 30Security Y 100 80 20Security Z 100 110 (10)

(ii) If AB had sold the securities for fairmarket value immediately before the distributionto A, the partnership would have recognized $40of net gain ($30 gain on Security X plus $20gain on Security Y minus $10 loss on SecurityZ). A’s distributive share of this gain would havebeen $20 (one-half of $40 net gain). If AB hadsold the remaining securities immediately afterthe distribution of Security X to A, the part-nership would have $10 of net gain ($20 of gainon Security Y minus $10 loss on Security Z). A’sdistributive share of this gain would have been$5 (one-half of $10 net gain). As a result, thedistribution resulted in a decrease of $15 in A’sdistributive share of the net gain in AB’ssecurities ($20 net gain before distribution minus$5 net gain after distribution).

(iii) Under paragraph (b) of this section, theamount of the distribution of Security X that istreated as a distribution of money is reduced by$15. The distribution of Security X is thereforetreated as a distribution of $85 of money to A($100 fair market value of Security X minus $15reduction).

Example 3. Reduction in amount treated asmoney—carried interest. (i) A and B formpartnership AB. A contributes $1,000 andprovides substantial services to the partnership inexchange for a 60 percent interest in partnershipprofits. B contributes $1,000 in exchange for a40 percent interest in partnership profits. ABsubsequently distributes Security X to A in acurrent distribution. Immediately before thedistribution, AB held securities with the follow-ing fair market values, adjusted tax bases, andunrecognized gain:

Value Basis Gain

Security X 100 80 20Security Y 100 90 10


778/20047/28MAY96/A29-011

55 1996–22 I.R.B.

(ii) If AB had sold the securities for fairmarket value immediately before the distributionto A, the partnership would have recognized $30of net gain ($20 gain on Security X plus $10gain on Security Y). A’s distributive share of thisgain would have been $18 (60 percent of $30 netgain). If AB had sold the remaining securitiesimmediately after the distribution of Security Xto A, the partnership would have $10 of net gain($10 gain on Security Y). A’s distributive shareof this gain would have been $6 (60 percent of$10 net gain). As a result, the distributionresulted in a decrease of $12 in A’s distributiveshare of the net gain in AB’s securities ($18 netgain before distribution minus $6 net gain afterdistribution).

(iii) Under paragraph (b) of this section, theamount of the distribution of Security X that istreated as a distribution of money is reduced by$12. The distribution of Security X is thereforetreated as a distribution of $88 of money to A($100 fair market value of Security X minus $12reduction).

Example 4. Reduction in amount treated asmoney—change in partnership allocations. (i) Ais admitted to partnership ABC as a partner witha 1 percent interest in partnership profits. At thetime of A’s admission, ABC held no securities.ABC subsequently acquires Security X. A’sinterest in partnership profits is subsequentlyincreased to 2 percent for securities acquiredafter the increase. A retains a 1 percent interestin all securities acquired before the increase.ABC then acquires Securities Y and Z and laterdistributes Security X to A in a currentdistribution. Immediately before the distribution,the securities held by ABC had the following fairmarket values, adjusted tax bases, and unrecog-nized gain or loss:

Value Basis Gain (Loss)

Security X 1,000 500 200Security Y 1,000 800 200Security Z 1,000 1,100 (100)

(ii) If ABC had sold the securities for fairmarket value immediately before the distributionto A, the partnership would have recognized$600 of net gain ($500 gain on Security X plus$200 gain on Security Y minus $100 loss onSecurity Z). A’s distributive share of this gainwould have been $7 (1 percent of $500 gain onSecurity X plus 2 percent of $200 gain onSecurity Y minus 2 percent of $100 loss onSecurity Z).

(iii) If ABC had sold the remaining securitiesimmediately after the distribution of Security Xto A, the partnership would have $100 of netgain ($200 gain on Security Y minus $100 losson Security Z). A’s distributive share of this gainwould have been $2 (2 percent of $200 gain onSecurity Y minus 2 percent of $100 loss onSecurity Z). As a result, the distribution resultedin a decrease of $5 in A’s distributive share ofthe net gain in ABC’s securities ($7 net gainbefore distribution minus $2 net gain afterdistribution).

(iv) Under paragraph (b) of this section, theamount of the distribution of Security X that istreated as a distribution of money is reduced by$5. The distribution of Security X is thereforetreated as a distribution of $95 of money to A($100 fair market value of Security X minus $5reduction).

Example 5. Basis consequences—distributionof marketable security. (i) A and B form

partnership AB as equal partners. A contributesnondepreciable real property with a fair marketvalue and adjusted tax basis of $100.

(ii) AB subsequently distributes Security Xwith a fair market value of $120 and an adjustedtax basis of $90 to A in a current distribution. Atthe time of distribution, the basis in A’s interestin the partnership is $100. The amount of thedistribution that is treated as money is reducedunder section 731(c)(3)(B) and paragraph (b)(2)of this section by $15 (one-half of $30 net gainin Security X). As a result, A recognizes $5 ofgain under section 731(a) on the distribution(excess of $105 distribution of money over $100adjusted tax basis in A’s partnership interest).

(iii) A’s adjusted tax basis in Security X is $95($90 adjusted basis of Security X determinedunder section 732(a)(1) plus $5 of gain recog-nized by A by reason of section 731(c)). Thebasis in A’s interest in the partnership is $10 asdetermined under section 733 ($100 pre-distribution basis minus $90 basis allocated toSecurity X under section 732).

Example 6. Basis consequences—distributionof marketable security and other property. (i) Aand B form partnership AB as equal partners. Acontributes nondepreciable real property, with afair market value of $100 and an adjusted taxbasis of $10.

(ii) AB subsequently distributes Security Xwith a fair market value and adjusted tax basis of$40 to A in a current distribution and, as part ofthe same distribution, AB distributes Property Zto A with an adjusted tax basis and fair marketvalue of $40. At the time of distribution, thebasis in A’s interest in the partnership is $10. Arecognizes $30 of gain under section 731(a) onthe distribution (excess of $40 distribution ofmoney over $10 adjusted tax basis in A’spartnership interest).

(iii) A’s adjusted tax basis in Security X is $35($5 adjusted basis determined under section732(a)(2) plus $30 of gain recognized by A byreason of section 731(c)). A’s basis in Property Zis $5, as determined under section 732(a)(2). Thebasis in A’s interest in the partnership is $0 asdetermined under section 733 ($10 pre-distribution basis minus $10 basis allocatedbetween Security X and Property Z under section732).

(iv) AB’s adjusted tax basis in the remainingpartnership assets is unchanged unless thepartnership has a section 754 election in effect.If AB made such an election, the aggregate basisof AB’s assets would be increased by $70 (thedifference between the $80 combined basis ofSecurity X and Property Z in the hands of thepartnership before the distribution and the $10combined basis of the distributed property in thehands of A under section 732 after the distribu-tion). Under section 731(c)(5), no adjustment ismade to partnership property under section 734as a result of any gain recognized by A by reasonof section 731(c) or as a result of any step-up inbasis in the distributed marketable securities inthe hands of A by reason of section 731(c).

Example 7. Coordination with section 737. (i)A and B form partnership AB. A contributesProperty A, nondepreciable real property with afair market value of $200 and an adjusted basisof $100 in exchange for a 25 percent interest inpartnership capital and profits. AB owns marketa-ble Security X.

(ii) Within five years of the contribution ofProperty A, AB subsequently distributes Security

X, with a fair market value of $120 and anadjusted tax basis of $100, to A in a currentdistribution that is subject to section 737. As partof the same distribution, AB distributes PropertyY to A with a fair market value of $20 and anadjusted tax basis of $0. At the time ofdistribution, there has been no change in the fairmarket value of Property A or the adjusted taxbasis in A’s interest in the partnership.

(iii) If AB had sold Security X for fair marketvalue immediately before the distribution to A,the partnership would have recognized $20 ofgain. A’s distributive share of this gain wouldhave been $5 (25 percent of $20 gain). BecauseAB has no other marketable securities, A’sdistributive share of gain in partnership securitiesafter the distribution would have been $0. As aresult, the distribution resulted in a decrease of$5 in A’s share of the net gain in AB’s securities($5 net gain before distribution minus $0 netgain after distribution). Under paragraph (b)(2)of this section, the amount of the distribution ofSecurity X that is treated as a distribution ofmoney is reduced by $5. The distribution ofSecurity X is therefore treated as a distribution of$115 of money to A ($120 fair market value ofSecurity X minus $5 reduction). The portion ofthe distribution of the marketable security that isnot treated as a distribution of money ($5) istreated as other property for purposes of section737.

(iv) A recognizes total gain of $40 on thedistribution. A recognizes $15 of gain undersection 731(a)(1) on the distribution of theportion of Security X treated as money ($115distribution of money less $100 adjusted taxbasis in A’s partnership interest). A recognizes$25 of gain under section 737 on the distributionof Property Y and the portion of Security X thatis not treated as money. A’s section 737 gain isequal to the lesser of (i) A’s precontribution gain($100) or (ii) the excess of the fair market valueof property received ($20 fair market value ofProperty Y plus $5 portion of Security X nottreated as money) over the adjusted basis in A’sinterest in the partnership immediately before thedistribution ($100) reduced (but not below zero)by the amount of money received in thedistribution ($115).

(v) A’s adjusted tax basis in Security X is$115 ($100 basis of Security X determined undersection 732(a) plus $15 of gain recognized byreason of section 731(c)). A’s adjusted tax basisin Property Y is $0 under section 732(a). Thebasis in A’s interest in the partnership is $25($100 basis before distribution minus $100 basisallocated to Security X under section 732(a) plus$25 gain recognized under section 737).

(k) Effective date. This section ap-plies to distributions of marketablesecurities made on or after Friday,December 29, 1995.

Margaret Milner Richardson,Commissioner of

Internal Revenue.

(Filed by the Office of the Federal Register onDecember 29, 1995, 8:45 a.m., and publishedin the issue of the Federal Register for January2, 1996, 61 F.R. 28)


778/20047/28MAY96/A29-011

561996–22 I.R.B.

Correction to Publication 595, TaxGuide for Commercial Fishermen

Announcement 96–8

The following correction should be

made to the Capital Construction Fund(CCF) discussion on page 47 of Pub-lication 595.

In the discussion of CCF Accounts,the first item of the numbered list

under the heading ‘‘Capital gain ac-count’’ should be corrected to read‘‘more than 6 months.’’ It currentlysays ‘‘6 months or less.’’

SEQ 0295 JOB A29-050-002 PAGE-0057 ANN DISBARMENT REVISED 28MAY96 AT 11:16 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS COMPOSITE COLOR

778/20047/28MAY96/A29-050

57

Announcement of the Disbarment, Suspension, or Consent to VoluntarySuspension of Attorneys, Certified Public Accountants, Enrolled Agents andEnrolled Actuaries From Practice Before the Internal Revenue Service

Under 31 Code of Federal Regula-tions, Part 10, an attorney, certifiedpublic accountant, enrolled agent or en-rolled actuary, in order to avoid the in-stitution or conclusion of a proceedingfor his disbarment or suspension frompractice before the Internal RevenueService, may offer his consent tosuspension from such practice. TheDirector of Practice, in his discretion,may suspend an attorney, certifiedpublic accountant, enrolled agent orenrolled actuary in accordance with theconsent offered.

Attorneys, certified public account-ants, enrolled agents and enrolled actu-aries are prohibited in any Internal

Revenue Service matter from directlyor indirectly employing, acceptingassistance from, being employed by,or sharing fees with, any practi-tioner disbarred or suspended frompractice before the Internal RevenueService.

To enable attorneys, certified publicaccountants, enrolled agents and en-rolled actuaries to identify practitionersunder consent suspension from practicebefore the Internal Revenue Service,the Director of Practice will announcein the Internal Revenue Bulletin thenames and addresses of practitionerswho have been suspended from suchpractice, their designation as attor-

ney, certified public accountant, en-rolled agent or enrolled actuary anddate or period of suspension. This an-nouncement will appear in the weeklyBulletin at the earliest practicable dateafter such action and will continue toappear in the weekly Bulletins for fivesuccessive weeks or for as many weeksas is practicable for each attorney,certified public accountant, enrolledagent or enrolled actuary so suspendedand will be consolidated and publishedin the Cumulative Bulletin.

The following individuals have beenplaced under consent suspension frompractice before the Internal RevenueService:

Name Address Designation Date of Suspension

Isdaner, Thomas M. Crofton, MD CPA October 31, 1995 to October 30, 1996Cacciola, Marlene Pittsburg, CA Enrolled

AgentNovember 9, 1995 to May 8, 1996

Goldman, William D. Hot Springs, AR Attorney November 9, 1995 to November 8, 1996Armstrong, David L. Norman, OK CPA Indefinite from November 10, 1995Heckathorn, Ben Red Oak, TX CPA/

AttorneyIndefinite from November 28, 1995

Tisdel, Linda Seattle, WA EnrolledAgent

November 28, 1995 to May 27, 1997

Webb, Herbert M. Gainsville, FL Attorney December 21, 1995 to June 20, 1997Hipp, Robert J. Evanston, IL CPA December 28, 1995 to April 27, 1996Ruff, James M. Willmar, MN CPA January 1, 1996 to March 31, 1996Mulkerin, John J. Wheaton, IL CPA January 5, 1996 to April 4, 1996Redwitz, Robert Irvine, CA CPA February 15, 1996 to May 14, 1996Lind, Stanley L. Milwaukee, WI Attorney March 1, 1996 to February 28, 1997Dais, Robert E. Plano, TX CPA March 1, 1996 to February 28, 1997

Under Section 330, Title 31 of theUnited States Code, the Secretary ofthe Treasury, after due notice andopportunity for hearing, is authorizedto suspend or disbar from practicebefore the Internal Revenue Serviceany person who has violated the rulesand regulations governing the recogni-tion of attorneys, certified public ac-countants, enrolled agents or enrolledactuaries to practice before the InternalRevenue Service.

Attorneys, certified public account-ants, enrolled agents, and enrolledactuaries are prohibited in any InternalRevenue Service matter from directly

or indirectly employing, accepting as-sistance from, being employed by orsharing fees with, any practitionerdisbarred or under suspension frompractice before the Internal RevenueService.

To enable attorneys, certified publicaccountants, enrolled agents andenrolled actuaries to identify suchdisbarred or suspended practitioners,the Director of Practice will announcein the Internal Revenue Bulletin thenames and addresses of practitionerswho have been suspended from suchpractice, their designation as attorney,certified public accountant, enrolled

agent or enrolled actuary, and the dateof disbarment or period of suspension.This announcement will appear in theweekly Bulletin for five successiveweeks or as long as it is practicable foreach attorney, certified public account-ant, enrolled agent or enrolled actuaryso suspended or disbarred and will beconsolidated and published in theCumulative Bulletin.

After due notice and opportunityfor hearing before an administrativelaw judge, the following individualshave been disbarred from further prac-tice before the Internal RevenueService:

SEQ 0296 JOB A29-050-002 PAGE-0058 ANN DISBARMENT REVISED 28MAY96 AT 11:16 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS COMPOSITE COLOR

778/20047/28MAY96/A29-050

58

Name Address Designation Effective Date

Muraskin, David New York, NY Attorney November 6, 1995Kelsey, Patrick Poolesville, MD CPA November 13, 1995

Announcement of the Expedited Suspension of Attorneys, Certified PublicAccountants, Enrolled Agents, and Enrolled Actuaries From Practice Before theInternal Revenue Service

Under title 31 of the Code of FederalRegulations, section 10.76, the Directorof Practice is authorized to immediatelysuspend from practice before the Inter-nal Revenue Service any practitionerwho, within five years, from the datethe expedited proceeding is instituted,(1) has had a license to practice as anattorney, certified public accountant, oractuary suspended or revoked forcause; or (2) has been convicted of anycrime under title 26 of the UnitedStates Code or, of a felony under title18 of the United States Code involvingdishonesty or breach of trust.

Attorneys, certified public account-ants, enrolled agents, and enrolled ac-tuaries are prohibited in any Internal

Revenue Service matter from directlyor indirectly employing, accepting as-sistance from, being employed by, orsharing fees with, any practitionerdisbarred or suspended from practicebefore the Internal Revenue Service.

To enable attorneys, certified publicaccountants, enrolled agents, and en-rolled actuaries to identify practitionersunder expedited suspension from prac-tice before the Internal Revenue Serv-ice, the Director of Practice will an-nounce in the Internal Revenue Bulletinthe names and addresses of practition-ers who have been suspended from suchpractice, their designation as attorney,certified public accountant, enrolled

agent, or enrolled actuary, and date orperiod of suspension. This announce-ment will appear in the weekly Bulletinat the earliest practicable date aftersuch action and will continue to appearin the weekly Bulletins for five succes-sive weeks or for as many weeks as ispracticable for each attorney, certifiedpublic accountant, enrolled agent, orenrolled actuary so suspended and willbe consolidated and published in theCumulative Bulletin.

The following individuals have beenplaced under suspension from practicebefore the Internal Revenue Service byvirtue of the expedited proceedingprovisions of the applicable regulations:

Name Address Designation Date of Suspension

Trebatch, Henry T. Great Neck, NY CPA Indefinite from November 6, 1995Roomberg, Alan Minersville, PA CPA Indefinite from November 10, 1995Elfenbein, Emanuel B. Miami, FL Enrolled

AgentIndefinite from November 27, 1995

Cerullo, Louis, J. Boca Raton, FL CPA Indefinite from November 27, 1995Fogel, Harold St. Paul, MN CPA Indefinite from December 13, 1995Glover, Paul L. Downers Grove, IL Attorney Indefinite from December 13, 1995Miller, John R. Akron, OH Attorney Indefinite from December 13, 1995Pofahl, Charles Dallas, TX Attorney Indefinite from December 18, 1995Walburg, Douglas Mahtomedi, MN CPA Indefinite from December 18, 1995Hibler, Thomas M. Plymouth, MI CPA/

AttorneyIndefinite from December 18, 1995

Oringer, Ronald Flanders, NJ CPA Indefinite from December 29, 1995Butcher, Frederick Stillwater, NJ CPA Indefinite from December 29, 1995Tokars, Frederic Atlanta, GA Attorney Indefinite from December 29, 1995Atkins, Sanford I. Moreland Hills, OH Attorney Indefinite from December 29, 1995

SEQ 0297 JOB A29-051-002 PAGE-0059 TERMS REVISED 28MAY96 AT 11:16 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS COMPOSITE COLOR

778/20047/28MAY96/A29-051

59

Definition of TermsRevenue rulings and revenue proce-dures (hereinafter referred to as ‘‘rul-ings’’) that have an effect on previousrulings use the following defined termsto describe the effect:

Amplified describes a situation whereno change is being made in a priorpublished position, but the prior posi-tion is being extended to apply to avariation of the fact situation set forththerein. Thus, if an earlier ruling heldthat a principle applied to A, and thenew ruling holds that the same princi-ple also applies to B, the earlier rulingis amplified. (Compare with modified,below).

Clarified is used in those instanceswhere the language in a prior ruling isbeing made clear because the languagehas caused, or may cause, some confu-sion. It is not used where a position ina prior ruling is being changed.

Distinguished describes a situationwhere a ruling mentions a previouslypublished ruling and points out anessential difference between them.

Modified is used where the substanceof a previously published position isbeing changed. Thus, if a prior rulingheld that a principle applied to A butnot to B, and the new ruling holds thatit applies to both A and B, the prior

ruling is modified because it corrects apublished position. (Compare with am-plified and clarified, above).

Obsoleted describes a previouslypublished ruling that is not considereddeterminative with respect to futuretransactions. This term is most com-monly used in a ruling that listspreviously published rulings that areobsoleted because of changes in law orregulations. A ruling may also beobsoleted because the substance hasbeen included in regulations subse-quently adopted.

Revoked describes situations wherethe position in the previously publishedruling is not correct and the correctposition is being stated in the newruling.

Superseded describes a situationwhere the new ruling does nothingmore than restate the substance andsituation of a previously publishedruling (or rulings). Thus, the term isused to republish under the 1986 Codeand regulations the same position pub-lished under the 1939 Code and regula-tions. The term is also used when it isdesired to republish in a single ruling aseries of situations, names, etc., thatwere previously published over aperiod of time in separate rulings. If

If the new ruling does more thanrestate the substance of a prior ruling, acombination of terms is used. Forexample, modified and superseded de-scribes a situation where the substanceof a previously published ruling isbeing changed in part and is continuedwithout change in part and it is desiredto restate the valid portion of thepreviously published ruling in a newruling that is self contained. In thiscase the previously published ruling isfirst modified and then, as modified, issuperseded.

Supplemented is used in situations inwhich a list, such as a list of the namesof countries, is published in a rulingand that list is expanded by addingfurther names in subsequent rulings.After the original ruling has beensupplemented several times, a newruling may be published that includesthe list in the original ruling and theadditions, and supersedes all priorrulings in the series.

Suspended is used in rare situationsto show that the previous publishedrulings will not be applied pendingsome future action such as the issuanceof new or amended regulations, theoutcome of cases in litigation, or theoutcome of a Service study.

AbbreviationsThe following abbreviations in current use andformerly used will appear in material publishedin the Bulletin.

A—Individual.Acq.—Acquiescence.B—Individual.BE—Beneficiary.BK—Bank.B.T.A.—Board of Tax Appeals.C.—Individual.C.B.—Cumulative Bulletin.CFR—Code of Federal Regulations.CI—City.COOP—Cooperative.Ct.D.—Court Decision.CY—County.D—Decedent.DC—Dummy Corporation.DE—Donee.Del. Order—Delegation Order.DISC—Domestic International Sales Corporation.DR—Donor.E—Estate.EE—Employee.

E.O.—Executive Order.ER—Employer.ERISA—Employee Retirement Income Security Act.EX—Executor.F—Fiduciary.FC—Foreign Country.FICA—Federal Insurance Contribution Act.FISC—Foreign International Sales Company.FPH—Foreign Personal Holding Company.F.R.—Federal Register.FUTA—Federal Unemployment Tax Act.FX—Foreign Corporation.G.C.M.—Chief Counsel’s Memorandum.GE—Grantee.GP—General Partner.GR—GrantorIC—Insurance Company.I.R.B.—Internal Revenue Bulletin.LE—Lessee.LP—Limited Partner.LR—Lessor.M—Minor.Nonacq.—Nonacquiescence.O—Organization.P—Parent Corporation.

PHC—Personal Holding Company.PO—Possession of the U.S.PR—Partner.PRS—Partnership.PTE—Prohibited Transaction Exemption.Pub. L.—Public Law.REIT—Real Estate Investment Trust.Rev. Proc.—Revenue Procedure.Rev. Rul.—Revenue Ruling.S—Subsidiary.S.P.R.—Statements of Procedural Rules.Stat.—Statutes at Large.T—Target Corporation.T.C.—Tax Court.T.D.—Treasury Decision.TFE—Transferee.TFR—Transferor.T.I.R.—Technical Information Release.TP—Taxpayer.TR—Trust.TT—Trustee.U.S.C.—United States Code.X—Corporation.Y—Corporation.Z—Corporation.

SEQ 0298 JOB A29-052-004 PAGE-0060 FINDING LIST REVISED 28MAY96 AT 11:16 BY LR DEPTH: 65.01 PICAS WIDTH 32.08 PICAS COMPOSITE COLOR

778/20047/28MAY96/A29-052

60

Numerical Finding List1

Bulletins 1996–1 through 1996–6

Announcements:

96–1, 1996–2 I.R.B. 5796–2, 1996–2 I.R.B. 5796–3, 1996–2 I.R.B. 5796–4, 1996–3 I.R.B. 5096–5, 1996–4 I.R.B. 9996–6, 1996–5 I.R.B. 4396–7, 1996–5 I.R.B. 44

Notices:

96–2, 1996–2 I.R.B. 1596–1, 1996–3 I.R.B. 3096–4, 1996–4 I.R.B. 6996–5, 1996–6 I.R.B. 2296–6, 1996–5 I.R.B. 2796–7, 1996–6 I.R.B. 2296–8, 1996–6 I.R.B. 2396–9, 1996–6 I.R.B. 26

Proposed Regulations:

DL–1–95, 1996–6 I.R.B. 28EE–20–95, 1996–5 I.R.B. 15EE–34–95, 1996–3 I.R.B. 49EE–35–95, 1996–5 I.R.B. 19EE–53–95, 1996–5 I.R.B. 23IA–33–95, 1996–4 I.R.B. 99INTL–3–95, 1996–6 I.R.B. 29INTL–9–95, 1996–5 I.R.B. 25

Revenue Procedures:

96–1, 1996–1 I.R.B. 896–2, 1996–1 I.R.B. 6096–3, 1996–1 I.R.B. 8296–4, 1996–1 I.R.B. 9496–5, 1996–1 I.R.B. 12996–6, 1996–1 I.R.B. 15196–7, 1996–1 I.R.B. 18596–8, 1996–1 I.R.B. 18796–9, 1996–2 I.R.B. 1596–10, 1996–2 I.R.B. 1796–11, 1996–2 I.R.B. 1896–12, 1996–3 I.R.B. 3096–13, 1996–3 I.R.B. 3196–14, 1996–3 I.R.B. 4196–15, 1996–3 I.R.B. 4196–16, 1996–3 I.R.B. 4596–17, 1996–4 I.R.B. 6996–18, 1996–4 I.R.B. 7396–19, 1996–4 I.R.B. 8096–20, 1996–4 I.R.B. 8896–21, 1996–4 I.R.B. 9696–22, 1996–5 I.R.B. 2796–23, 1996–5 I.R.B. 2796–24, 1996–5 I.R.B. 28

1A cumulative list of all Revenue Rulings,Revenue Procedures, Treasury Decisions, etc.,published in Internal Revenue Bulletins 1995–27through 1995–52 will be found in InternalRevenue Bulletin 1996–1, dated January 2, 1996.

Revenue Rulings:

96–1, 1996–1 I.R.B. 796–2, 1996–2 I.R.B. 596–3, 1996–2 I.R.B. 1496–6, 1996–2 I.R.B. 896–4, 1996–3 I.R.B. 1696–5, 1996–3 I.R.B. 2996–7, 1996–3 I.R.B. 1296–8, 1996–4 I.R.B. 6296–9, 1996–4 I.R.B. 596–10, 1996–4 I.R.B. 2796–11, 1996–4 I.R.B. 2896–14, 1996–6 I.R.B. 20

Treasury Decisions:

8630, 1996–3 I.R.B. 198631, 1996–3 I.R.B. 78632, 1996–4 I.R.B. 68633, 1996–4 I.R.B. 208634, 1996–3 I.R.B. 178635, 1996–3 I.R.B. 58636, 1996–4 I.R.B. 648637, 1996–4 I.R.B. 298638, 1996–5 I.R.B. 58639, 1996–5 I.R.B. 128640, 1996–2 I.R.B. 108641, 1996–6 I.R.B. 4

SEQ 0299 JOB A29-052-004 PAGE-0061 FINDING LIST REVISED 28MAY96 AT 11:16 BY LR DEPTH: 65.01 PICAS WIDTH 41.08 PICAS COMPOSITE COLOR

778/20047/28MAY96/A29-052

61

Finding List of Current Action onPreviously Published Items1

Bulletins 1996–1 through 1996–6

*Denotes entry since last publication

Revenue Procedures:

65–17Modified by96–14, 1996–3 I.R.B. 41

66–49Modified by96–15, 1996–3 I.R.B. 41

88–32Obsoleted by96–15, 1996–3 I.R.B. 41

88–33Obsoleted by96–15, 1996–3 I.R.B. 41

89–19Superseded by96–17, 1996–4 I.R.B. 69

89–48Superseded in part by96–17, 1996–4 I.R.B. 69

91–22Modified by96–1, 1996–1 I.R.B. 8

91–22Amplified by96–13, 1996–3 I.R.B. 31




92–20Modified by96–1, 1996–1 I.R.B. 8

92–85Modified by96–1, 1996–1 I.R.B. 8



1A cumulative finding list for previouslypublished items mentioned in Internal RevenueBulletins 1995–27 through 1995–52 will befound in Internal Revenue Bulletin 1996–1, datedJanuary 2, 1996.

Revenue Procedures—Continued

Superseded by96–18, 1996–4 I.R.B. 73
















96–3Amplified by96–12, 1996–3 I.R.B. 30

Revenue Rulings:

66–307Obsoleted by96–3, 1996–2 I.R.B. 14

72–437Modified by96–13, 1996–3 I.R.B. 31

80–80Obsoleted by96–3, 1996–2 I.R.B. 14

82–80Modified by96–14, 1996–3 I.R.B. 41

92–19Supplemented in part96–2, 1996–2 I.R.B. 5

92–75Clarified by96–13, 1996–3 I.R.B. 31

95–10Supplemented and superseded by96–4, 1996–3 I.R.B. 16

95–11Supplemented and superseded by96–5, 1996–3 I.R.B. 29