Rev. Rul. 79-77

ISSUE

What is the classification, for federal income tax purposes, of an arrangement formed under the circumstances described below?

FACTS

Individuals A, B, and C, who owned a commercial building and the land upon which it was situated as tenants in common, established a trust with a bank as trustee. Simultaneously, A, B, and C transferred the land and building to the trust and named themselves as beneficiaries. A, B, and C receive proportionate quarterly distributions of all net income of the trust.

The trust agreement provides that the purpose of the trust is to empower the trustee to act on behalf of the beneficiaries as signatory of leasing agreements and management agreements, to hold title to the land and building and to the proceeds and income of the property, to distribute all trust income and to protect and conserve the property.

The beneficiaries' interests in the trust are evidenced by certificates that are transferable only on the death of a beneficiary or by unanimous written agreement of the beneficiaries. In addition, after the initial contribution no additional contributions may be made to the trust.

The beneficiaries must approve all agreements entered into by the trustee and they are personally liable for all debts of the trust. The trustee may determine whether to allow minor nonstructural alterations to the building and can institute legal or equitable action to enforce any provisions of a lease. The trust will terminate upon the sale of substantially all its assets or upon unanimous agreement of the beneficiaries.

The beneficiaries directed the trustee to sign a lease of the property to X, a corporation, for 20 years with options for three six-year extensions. X is to pay all taxes, assessments, fees or other charges imposed on the property by federal, state or local authorities. In addition, X is to pay for all insurance, maintenance, repairs, and utilities relating to the property.

The trustee as lessor prepared the building for X's use and can approve additional alterations by X only if the alterations protect and conserve the building or are required by law. The rent remains fixed for 20 years, but if the lease is renewed the rent will be recomputed based on the fair market value of the property. X has an option to purchase the property every tenth year during the term of the initial lease for an amount equal to the greater of the property's cost to the owners or its fair market value.

LAW AND ANALYSIS

Section 301.7701-4(a) of the Procedure and Administration Regulations provides that the term "trust" as used in the Internal Revenue Code of 1954 refers to an arrangement created by will or by an inter vivos declaration whereby trustees take title to property for the purpose of protecting or conserving it for the beneficiaries under the ordinary rules applied in chancery or probate courts. Generally speaking, an arrangement will be treated as a trust under the Code if it can be shown that the purpose of the arrangement is to vest in trustees responsibility for the protection and conservation of property for beneficiaries who cannot share in the discharge of this responsibility and, therefore, are not associates in a joint enterprise for the conduct of business for profit.

Section 301.7701-4(b) of the regulations states that there are other arrangements that are known as trusts because the legal title to property is conveyed to trustees for the benefit of beneficiaries, but which are not classified as trusts for purposes of the Code because they are not simply arrangements to protect or conserve the property for the beneficiaries. These trusts, which are often known as business or commercial trusts, generally are created by the beneficiaries simply as a device to carry on a profit-making business that normally would have been carried on through business organizations that are classified as corporations or partnerships under the Code.

In Wyman Building Trust v. Commissioner, 45 B.T.A. 155 (1941), acq., 1941-2 C.B. 14, the United States Board of Tax Appeals held that a trust created by the heirs of a decedent, who owned a single piece of property under lease, was not a corporation. The Board in Wyman found that the trust's purpose was to provide a convenient authority for executing and extending the lease on behalf of the more cumbersome group of beneficial owners, and for receiving and distributing the income of the property. In Wyman, the trustees were restricted to dealing with a single piece of property and the lessee of the property was required to pay all expenses, including taxes and repairs. The Board found these factors persuasive in determining that the trust was not carrying on a business and dividing the gains therefrom, but was performing the functions of a trust by protecting and conserving property.

Rev. Rul. 78-371, 1978-2 C.B. 344, concerns a trust that was established by the heirs to a number of contiguous parcels of real estate. Under the trust agreement the trustees have the power to purchase and sell contiguous or adjacent real estate, and to accept and retain contributions of contiguous or adjacent real estate from the beneficiaries or members of their families. The trustees have the power to raze or erect any building or other structure and make any improvements they deem proper on the land originally contributed to the trust or on any adjacent or contiguous land subsequently acquired by the trust. The trustees are also empowered to borrow money and to mortgage and lease the property. Since these powers, when considered in the aggregate, indicate that the trustees are empowered to do more than merely protect and conserve the trust property, Rev. Rul. 78-371 holds that the trust is an association taxable as a corporation.

This case is distinguishable from Rev. Rul. 78-371 in that the trustee is restricted to dealing with a single piece of property subject to a net lease. Further, the trustee has none of the powers described in Rev. Rul. 78-371. Thus, the arrangement is similar to the trust held not to be a corporation in the Wyman case.

HOLDING

The arrangement is classified as a trust for federal income tax purposes. Further, A, B, and C are the owners of the trust and are taxable on the income therefrom under subpart E of subchapter J, chapter 1 of the Code (sections 671-678).

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 78-371 is distinguished.