Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 76-100

1976-1 C.B. 123

Section 453
Section 691
Section 1014

IRS Headnote

Disposition of installment obligation; community property trust. No disposition of an installment obligation results from the revocation by, or the death of, a husband or wife who transferred a community property installment obligation to a trust, revocable by either with respect to their one-half community interest, and irrevocable with respect to the one-half interest included in the decedent's estate on the death of either with the survivor receiving all income therefrom for life. The one-half community interest held by the trust, included in the estate of the first spouse to die, will result in income in respect of a decedent and the one-half community interest of the survivor, although not includible in the decedent's estate, will, by operation of section 1014 of the Code, also be treated as income in respect of a decedent.

Full Text

Rev. Rul. 76-100

Advice has been requested concerning the Federal income tax treatment, under the circumstances described below, of an installment obligation held by a trust.

In 1973, A and B, a married couple residing in a community property state, sold certain real property owned by them as community property and elected to report their gain using the installment method of accounting under section 453 of the Internal Revenue Code of 1954. In 1974, the remaining term of the installment obligation was 20 years. At that time, A and B entered into an agreement whereby, as grantors, they transferred the installment obligation to a trust that was revocable by either one or both of them during their lifetimes with respect to their one-half community interest in such obligation.

The trust agreement provides that upon the death of A or B, whoever dies first, the decedent's interest in the installment obligation will remain in the trust, which will then be irrevocable with respect to the decedent's interest, and all the income therefrom will be paid to the survivor for the survivor's life. On the death of the survivor, the assets remaining in the trust, including the installment obligation, will pass to their children.

The first question asked is whether a transfer of the installment obligation back to A and B, if either or both of them revoke the trust, will be treated as a taxable disposition of the installment obligation in whole or in part under section 453(d) of the Code.

The transfer of an installment obligation to a trust by the grantor who retained the right to revoke the trust and acquire title to the trust assets is not a disposition of such obligation within the meaning of section 453(d) of the Code. See  Rev. Rul. 74-613, 1974-2 C.B. 153.

The reasoning underlying Rev. Rul. 74-613 is that since the grantor is considered the owner of the trust under subpart E of the Code, and thus, as owner, must continue to report the income from the installment obligation in the same manner as before its transfer to the trust, no significant change has taken place in the ownership of the installment obligation or the income therefrom, and thus no disposition of the installment obligation is deemed to have occurred. The same principal applies to the transfer of an installment obligation from a revocable trust back to the grantor.

Accordingly, no disposition of any part of the installment obligation held by the revocable trust will be deemed to have occurred if either or both of the grantors revoke the trust with respect to their one-half comunity interest in such obligation.

Assuming that A is the first spouse to die, the next question asked is whether the death of A will result in a disposition of A's community interest in the installment obligation held by the trust giving rise to gain or loss under section 453(d) of the Code. Section 453(d) of the Code provides the rules for determining the gain or loss when an installment obligation is satisfied at other than its face value or distributed, transmitted, sold, or otherwise disposed of. However, section 453(d)(3) states that except as provided in section 691 (relating to recipients of income in respect of a decedent), section 453(d) shall not apply to the transmission of installment obligations at death.

Under section 691(a)(1) of the Code, the amount of all items of gross income in respect of a decedent that are not properly includible in respect of the taxable period in which falls the date of the decedent's death or a prior period shall be included in the gross income, for the taxable year when received, of, (1) the estate of the decedent, if the right to receive the amount is acquired by the decedent's estate from the decedent; (2) the person who, by reason of the death of the decedent, acquires the right to receive the amount, if the right to receive the amount is not acquired by the decedent's estate from the decedent; or (3) the person who acquires from the decedent the right to receive the amount by bequest, devise, or inheritance, if the amount is received after a distribution by the decedent's estate of such right.

Section 691(a)(4) of the Code provides, in part, that in the case of an installment obligation received by a decedent on the sale or other disposition of property, the income from which was properly reportable by the decedent on the installment basis under section 453, if such obligation is acquired by the decedent's estate from the decedent or by any person by reason of the death of the decedent or by bequest, devise, or inheritance from the decedent, an amount equal to the excess of the face amount of such obligation over the basis of the obligation in the hands of the decedent (determined under section 453(d)) shall, for the purpose of section 691(a)(1), be considered as an item of gross income in respect of a decedent.

Accordingly, under section 453(d)(3) of the Code, the transmission at death of A's one-half interest in the installment obligation is not a disposition that gives rise to gain or loss except as provided in section 691. Under section 691, the installment obligation is considered to be income in respect of a decedent to the extent of one-half its face amount over the basis of the obligation in the hands of the decedent, such basis having been determined under section 453(d)(2). Under the provisions of subchapter J of the Code, B, as beneficiary, is taxable on the distributive share of trust income derived from A's one-half interest in the installment obligation.

The last question asked is the effect of the death of A on the basis of and the income from that part of the installment obligation held by the trust, which represents B's one-half interest in the obligation.

Section 1014(a) of the Code provides, in part, that except as otherwise provided in section 1014, the basis of property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent shall, if not sold, exchanged, or otherwise disposed of before the decedent's death by such person, be the fair market value at the date of the decedent's death, or, in the case of an election under section 2032, its value at the valuation date prescribed by that section.

Under section 1014(b) of the Code, for purposes of section 1014(a), certain property shall be considered to have been acquired from or to have passed from the decedent. Under section 1014(b)(6) such property includes, in the case of decedents dying after December 31, 1947, property that represents the surviving spouse's one-half share of community property held by the decedent and the surviving spouse under the community property laws of any State, Territory, or possession of the United States or any foreign country, if at least one-half of the whole of the community interest in such property was includible in determining the value of the decedent's gross estate under chapter 11 of subtitle B (section 2001 and following, relating to estate tax).

However, section 1014(c) of the Code provides that section 1014 shall not apply to property that is a right to receive an item of income in respect of a decedent under section 691.

A's one-half community interest in the installment obligation held by the trust will be includible in determining the value of A's gross estate for Federal estate tax purposes. Since section 1014(c) of the Code provides that section 1014 shall not apply to property that is a right to receive income in respect of a decedent under section 691, the rules of section 691, and not those of section 1014(a), will apply to A's interest as set forth above. Thus, the basis to the trust of A's interest in the installment obligation is the same as it was in the hands of A under section 453(d).

B's one-half community interest in the installment obligation held by the trust, although not includible in A's gross estate for Federal estate tax purposes, is, under section 1014 of the Code, required to be treated as if it had been acquired by B from A. Therefore, for purposes of determining its basis to the trust, the trust will be deemed to have acquired B's one-half community interest in the installment obligation by reason of A's death.

Accordingly (consistent with the treatment of the one-half community interest of A held by the trust at the time of A's death), under section 453(d)(3) of the Code a disposition of B's interest giving rise to gain or loss is not considered to have occurred at the time of A's death except as provided in section 691. B's interest in the installment obligation held by the trust is also considered as income in respect of a decedent to the extent of the excess of one-half of the face amount of the installment obligation over one-half its basis in the hands of the trust of which B was an owner at the time of A's death, such basis having been determined under section 453(d)(2). This income is reportable by B as the owner of that portion of the trust after A's death. Compare Bessie Stanley v. Commissioner, 338 F.2d 434 (9th Cir. 1964), involving the same principle except that the installment obligation was not held in a grantor trust. Also see Rev. Rul. 68-506, 1968-2 C.B. 332, wherein the income element of a vested community interest in an employees' trust passes to the surviving spouse. In that case, as in the instant case, the surviving spouse does not acquire a basis under section 1014, but receives income in respect of a decedent under section 691 with respect to the one-half community interest in the trust included in the decedent's estate as well as the one-half community interest held by the surviving spouse.