Discussion:Death before Repay of Install Note from Grantor Trust

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Discussion Forum Index --> Advanced Tax Questions --> Death before Repay of Install Note from Grantor Trust

Discussion Forum Index --> Tax Questions --> Death before Repay of Install Note from Grantor Trust

Michaelg (talk|edits) said:

8 January 2009
Has anyone dealt with tax effect of death before repayment of an installment sale note received from a grantor trust? Client set up IDIT before passing and there were notes outstanding. Is installment note taxable upon death? Do Trusts get stepped up basis? Based on my research the issue appears to be undecided. Basically the estate is looking at distributing receivables to trusts that hold payable and I'm not sure how this should be treated. Looking to see how others have treated this.

Adonini (talk|edits) said:

8 January 2009
The transfer of an installment note as a result of the sellers death is not a taxable distribution. Unreported gain inherent in the installment note constitutes an item of Income in respect of a decedent (IRD). Consequently, the seller/decedent's estate/trust or benefieciary reports the remaining gain from the installment note in the same manner as the seller would have reported it had he lived.

The gross fair market value of the installment note is included in the seller/decedent's estate. However, the recipient of the installment note may reduce the istallment gain reportable for income tax purposes by the amount of estate tax attributable to the unreported gain from the installment note.

Sec. 453B(c)
Sec. 691
Sec. 2031(a)

Dennis (talk|edits) said:

8 January 2009
While the transfer itself has no tax consequence, technically the debt instrument is valued as at date of death. There is a market for notes and bids can be obtained. It is however, extremely unlikely that this value will be higher than the remaining face value resulting in a step down rather than a step up. In practice nobody bothers to revalue. In the case of debt owed by the estate, that value would not change. The net effect of a an encumbered distribution is a reduction in the amount of distribution.

Michaelg (talk|edits) said:

8 January 2009
Adonini - Thanks. Follow up question to your response:

I agree with you for sure if this were an ordinary installment note the unreported gain inherent in the installment note constitutes an item of Income in respect of a decedent (IRD). However, since these were notes from grantor trusts I've read some say that because the payments would not be income to the grantor in the first place under Rev Rul 85-13, they could not be IRD under IRC Sec 691 (see Blattmachr, Gans & Jacobson, Income Tax Effects of Termination of Grantor Trusts Status by Reason of the Grantor's Death, 97 J Tax'n 149, at 153-154 (Sept 2002)). Under Reg. 1.691(a)-5, some commentators say the payments could be IRD under IRC 691(a)(4) only if the original transacation with the grantor was properly reportable as an installment sale subject to IRC 453. Sinc the original transaction was not subject to IRC 453 (it was not even recognized at the time), the payments to the beneficiaries of the note could not be IRD (see Peebles, Death of an IDIT noteholder, 144 Trusts & Estates 28, at 33 (Aug 2005)).

Was wondering if your response was still the same based on above commentary?

Thanks again.

Michaelg (talk|edits) said:

8 January 2009
Dennis -

In this situation, the taxpayer sold his interest in stock to Intentionally Defective Grantor Trusts. He held receivable and Grantor Trusts held payable. Transaction was not recognized for income tax purposes. Taxpayer died less than a month later and no payments on note have been made. Therefore, his estate held receivable which is now distributing to the Grantor Trusts (which are now separate entities) that hold the receivable. In other words the liability is outside of the estate. I think I'm reading that your response indicates that the estate has liability.


Dennis (talk|edits) said:

9 January 2009
Just covering bases. Sale to an IDGT is essentially an estate freeze technique. There is no gain because you are selling to yourself. There is no gift because the trust is presumably paying fair market value on the date of transfer.

There is no step up. Receivable is a taxable asset in decedent's estate. Trust basis is what it paid. The technique is designed to remove future appreciate from the estate. Value as at transfer remains.

As an aside, had decedent received interest payments they would not have been reportable and any payment of income tax resulting from recognition of trust income is not considered a gift to the trust.

PLR 9535026

Michaelg (talk|edits) said:

9 January 2009
So that I'm clear - you think that installment sale note IS income in respect of a decedent? What do you think of the estate distributing receivabe to trust with payable (which would offset each other and therefore go away at trust level?

Dennis (talk|edits) said:

10 January 2009
There is no deferred gain. Stock was transferred to trust in exchange for a note of equivalent value in an unrecognized transaction. What would have been the taxable value of the stock in decedent's estate is now the value of the note. Same dollar amount, just different form. If you want to think of it as sort of a phantom step up to make this easier, go ahead. Essentially estate is always paying tax on the value as at transfer and on disposition trust is always paying tax on future appreciation.

Evlcpa (talk|edits) said:

8 May 2014
Reviving this thread hopefully.

There's no IRD on the note because there was no gain on the original transaction, I get it.

Just to clarify, would there be a step up in basis of the shares held in the trust at death?

Thanks in advance for your time.

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