Rev. Rul. 86-41

1986-1 C.B. 300, 1986-12 I.R.B. 9.

TRANSFERS; REAL PROPERTY; ADJUSTMENT TO PORTION TRANSFERRED BASED ON

SERVICE'S VALUATION

Published: March 24, 1986

Section 2503.-Taxable Gifts 26 CFR 25.2503-3: Future interest in property.  

(Also Section 2501, 2511: 25.2501-1, 25.2511-2.)

  Transfers; real property; adjustment to portion transferred based on Service's valuation. The value of a gift will be determined without regard to an adjustment clause that provides for the recharacterization of the transaction depending on the Service's valuation of the property.

ISSUE

  What are the federal gift tax consequences in the two situations described below where a donor transfers a specified portion of real property under terms that provide for an adjustment to the portion transferred depending on the determination by the Internal Revenue Service of the value of the property for federal gift tax purposes?

FACTS

  Situation 1.

  In 1982, A transferred an interest in a tract of income producing real property to B. Under the deed of transfer, B received a one-half undivided interest in the tract. However, the deed further provided that if the one-half interest received by B were ever determined by the Internal Revenue Service to have a value for federal gift tax purposes in excess of $10,000, then B's fractional interest would be reduced so that its value equaled $10,000. Under local law the adjustment clause operated as a condition subsequent. Thus, if the Service determined that a gift was made in excess of $10,000, the adjustment clause would effectively reconvey to A a fractional share of the tract of real property sufficient to reduce the value of B's interest to

$10,000 as of the date of the gift.

  On A's federal gift tax return, A reported that the fair market value of the one-half interest transferred by gift to B was $10,000 (one-half the value of the entire tract), and applied the annual exclusion against the gift. On examination of A's 1982 federal gift tax return, it was determined that the fair market value of a one-half interest in the tract subject to the transfer to B was $15,000 rather than $10,000.

  Situation 2.

  The facts are the same as in Situation 1, except that B was not required to reconvey any property to A. Rather, the transfer contained the condition that if the Internal Revenue Service determined that B received a gift in excess of

$10,000, B would transfer to A consideration equal to the amount of the excess.

LAW AND ANALYSIS

  Section 2501 of the Internal Revenue Code imposes a tax on the transfer of property by gift. Section 2511(a) provides that the gift tax applies whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible, or intangible. Section

25.2511-2(a) of the Gift Tax Regulations states that the gift tax is not imposed upon the receipt of the property by the donee but rather is an excise upon the donor's act of transfer.

  Section 2503(b) of the Code provides that a donor may exclude from his or her taxable gifts the first $10,000 of gifts of present interest in property made to each donee during the calendar year. Under section 25.2503 of the regulations, a 'resent interest' in property is defined as an unrestricted right to the immediate use, possession, or enjoyment of property or the income from property.

  Rev. Rul. 65-144, 1965-1 C.B. 442, holds that if the terms of a trust provide that the trust terms will be substantially modified to the extent necessary to qualify the transfer in trust for the gift tax charitable deduction under section 2522 of the Code, those terms providing for modification are considered ineffective for federal gift tax purposes. Gifts subject to conditions subsequent of the kind considered in Rev. Rul. 65-144 tend to discourage the enforcement of federal gift tax provisions, because operation of the provisions would either defeat the gift or otherwise render examination of the return ineffective. See also commissioner v. Procter, 142 F2d 824 (4th Cir. 1944), cert. denied, 323 U.S. 756 (1944). The Service, accordingly, will not give effect to such clauses and will consider the terms of the gift as unmodified for federal tax purposes.

  In Situations 1 and 2, the facts demonstrate that A intended to make a gift to B of a present one-half interest in the property. In both cases, the purpose of the adjustment clause was not to preserve or implement the original, bona fide intent of the parties, as in the case of a clause requiring a purchase price adjustment based on an appraisal by an independent third party retained for that purpose . Rather, the purpose of the clause was to recharacterize the nature of the transaction in the event of a future adjustment to A's gift tax return by the Service. As in Rev. Rul. 65-144, the terms of the deed of transfer to B providing for the reduction of the portion transferred would tend to discourage the examination of returns and the collections of tax and therefore are ineffective for federal gift tax purposes. Because the reduction provision is ineffective for federal gift tax purposes, A has made a gift of a present one-half interest in the property, the first $10,000 of which qualifies for the annual exclusion under section 2503 of the Code. The value of the gift is $15,000, the fair market value of a one-half interest in the tract as determined on examination. The fact that, in Situation 2, the adjustment of the gift was to be made by recharacterizing the transfer as a part-gift/part-sale is irrelevant.

HOLDING

  In both Situations 1 and 2, if the donor transfers a specified portion of real property under terms that provide for a recharacterization of the transaction depending on the Service's valuation of the property for federal gift tax purposes, the adjustment clause will be disregarded for federal tax purposes. Consequently, in both cases the value of the gift will be determined without regard to the adjustment clause and the first $10,000 in the value of the gift, as so determined, will qualify for the annual exclusion from gift tax.

Rev. Rul. 86-41, 1986-1 C.B. 300, 1986-12 I.R.B. 9.