Internal Revenue Service
Revenue Ruling
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smRev. Rul. 54-9
1954-1 C.B. 20
Sec. 61
Sec. 162
Caution: Modified by Rev. Rul. 57-315
IRS Headnote
The transfer of real property to a trust for a 10-year period for the benefit of grantor's children with his wife as one of two trustees, with the corpus to go to the grantor's wife in the event of his death prior to the expiration of the 10-year period, and with a privilege of leasing back such property from the trustees constitutes a transfer in form rather than substance. Rental payments made to the trust by the grantor will not constitute deductible business expenses. The grantor will remain the owner of the property during the term of the trust for purposes of Federal income and gift taxes and the rental payments when made will constitute gifts.
Full Text
Rev. Rul. 54-9
Advice is requested as to the Federal income and gift tax consequences resulting from the transfer of property to a trust under circumstances hereinafter described.
The grantor owns and operates a restaurant on property which he proposes to transfer in trust for the benefit of his children naming his wife as one of two trustees to hold title to the property. Trust income may at the discretion of the trustees be distributed or accumulated. At the expiration of 10 years the corpus of the trust will revert to the grantor if he is living and in the event of his death the corpus will go to the grantor's wife. Upon termination of the trust any accumulated income will be paid to the beneficiaries. During the term of the trust the grantor by prearrangement has the privilege of renting the restaurant property constituting the corpus of the trust from the trustees at a rental to be determined by reputable real estate experts.
The conveyance of property to the trust by the grantor in the instant case for the benefit of his children with a privilege of renting back such property, presents a form of reallocation of income within a family group. Attempts at reallocation of family income have been sought to be accomplished in the form of a trust, Helvering v. George B. Clifford , 309 U.S. 331, Ct. D. 1444, C.B. 1940-1, 105; family partnership, Commissioner v. Francis E. Tower , 327 U.S. 280, Ct. D. 1670, C.B. 1946-1, 11; Commissioner v. William O. Culbertson, Sr. et ux. , 337 U.S. 733, Ct. D. 1723, C.B. 1949-2, 5; assignment of income, Helvering v. Paul R. G. Horst , 311 U.S. 112, Ct. D. 1472, C.B. 1940-2, 206; or royalty payments to members of a family corporation, Ingle Coal Corporation v. Commissioner , 10 T.C. 1199, affirmed, 174 Fed.(2d) 569. The Supreme Court examined the practical effects of the transfer in each instance to determine whether the transferor retained control or enjoyment of the income or property transferred. The controlling consideration in intrafamily assignments has been the tax consequences flowing from the substance of a transaction rather than from its form. See Commissioner v. Joseph Sunnen , 333 U.S. 591, Ct. D. 1698, C.B. 1948-1, 7. Economic fact is emphasized rather than legal title and technicalities, Higgins v. John Thomas Smith , 308 U.S. 473, Ct. D. 1434, C.B. 1940-1, 127.
The promise to pay `rent' is analogous to the promise to pay `interest.' In F. Coit Johnson v. Commissioner , 86 Fed.(2d) 710, Ct. D. 1228, C.B. 1937-1, 187, where the taxpayer gave his wife money which she placed in trust to be loaned back to him, the Court stated that the `interest' paid by the husband to the wife by way of a trust constituted gifts and were not deductible as a business expense. The husband had not made a gift of the money placed in trust but merely had made gratuitous promises to pay interest. Similar results were reached in two recent district court opinions in George L. Sall et ux. v. Francis R. Smith, D.C., E.D., Pa., October 28, 1952, and in Henry Kirschenmann et ux. v. Harry C. Westover , D.C., S.D., Calif., June 30, 1952 (pending appeal).
In the Sall case the taxpayer transferred certain sums of money to three trusts set up for the benefit of his children. Immediately thereafter the money was loaned by the trusts to a partnership controlled by the taxpayer, and the trusts received three binding promissory notes and an agreement to pay, in lieu of interest, a percentage of the partnership profits. In his instructions to the jury, the District Court judge noted the factors of reallocation of income in a family transaction, the legal and binding effect of the notes, the gift of the money on the condition that it be reinvested in the partnership, and the fact that a majority of the trustees were not family members and had a right to exercise their independent judgment and invest the money in any way they thought proper. The jury returned a verdict in favor of the collector who had disallowed the so-called interest deductions. In the Kirschenmann case the taxpayer purchased farmland for which he had been paying a rental of about $4,500 for a term of 5 years. The taxpayer then made a `gift' of the land to his 12-year old daughter. The taxpayer's brother, who was appointed guardian for the daughter, leased the land to the taxpayer for a term of 5 years. Some $19,000 was paid as `rent' during the first year of the lease. While the high `rent' figured in the decision of the court in denying the deduction, it is also noted that the court found that the taxpayer exercised the same possession and control over the land after the gift and the setting up of the guardianship as he had prior thereto.
A contrary result was reached in A. A. Skemp v. Commissioner , (1948) 168 Fed.(2d) 598, reversing 8 T.C. 415, and Helen C. Brown, et al. v. Commissioner , (1950) 180 Fed.(2d) 926, reversing 12 T.C. 1095, cert. den. 340 U.S. 814. However, see E. Field White v. Fitzpatrick (1951) 193 Fed.(2d) 398, cert. den. 343 U.S. 928, in which the Skemp and Brown cases were distinguished. It is believed that the Skemp and Brown opinions in the Court of Appeals conflict in principle with the leaseback decisions in Helvering v. Lazarus and Co. 308 U.S. 252, Ct. D. 1430, C.B. 1939-2, 208 (sale and leaseback in reality a loan and security for the loan); W. H. Armston Co., Inc., et al. v. Commissioner , (1951) 188 Fed.(2d) 531; Stearns Magnetic Manufacturing Co. v. Commissioner , T.C. Memo. Op. Docket No. 23509, dated May 29, 1952; Ingle Coal Corporation, supra; and 58th Street Plaza Theater, Inc. v. Commissioner (1952) 195 Fed.(2d) 724 (sublease to wife of principal stockholder by family corporation).
In applying the foregoing principles to the instant case it is evident that the transaction will be carried out under a prearranged plan. The independence of the trustee in reality disappears under circumstances where the transaction is prearranged. The grantor of the proposed trust will merely transfer the property to the trust with control reserved, thereby retaining the use and enjoyment of the property. The business of the grantor and the property in which it is conducted will remain undisturbed; there has been no parting with a real interest in the property involved which is requisite to the passage of a gift. In substance the grantor remains the owner of the property.
Accordingly, it is held that the transfer of real property to a trust for a 10-year period for the benefit of grantor's children with his wife as one of two trustees, with the corpus to go to the grantor's wife in the event of his death prior to the expiration of a 10-year period, and with a privilege of leasing back such property from the trustees constitutes a transfer in form rather than substance. Rental payments made to the trust by the grantor will not constitute deductible business expenses. The grantor will remain the owner of the property during the term of the trust for purposes of Federal income and gift taxes, and the rental payments when made will constitute gifts.