BENEFICIARY WHO IS TREATED AS OWNER OF TRUST WHICH OWNS BENEFICIARY'S RESIDENCE IS ENTITLED TO ONE-TIME EXCLUSION OF GAIN FROM SALE OF RESIDENCE

Rev. Rul. 85-45

ISSUE

Is a beneficiary of a trust that owns a residence entitled to the one-time exclusion of gain from the sale of the residence under section 121 of the Internal Revenue Code, when the beneficiary has attained age 55 and is considered the owner of the entire trust under section 678(a) of the Code?

FACTS

H died in 1978. H's will provided for the establishment of a marital deduction trust for the benefit of H's surviving spouse W. Under the terms of the trust, W was entitled to receive all trust income for life and any trust corpus W requested from the trustee. The trust agreement also gave W the unrestricted power to vest the entire trust corpus or trust income in any person, including W.

At the time of H's death, H and W had lived in their principal residence since 1970. H and W's principal residence was made part of the corpus of the marital trust in 1979, the year the trust was established. The residence continued to be W's principal residence until 1983, when it was sold at a price in excess of its adjusted basis. The amount of the gain was less than $125,000. W was 70 years old in 1983. In computing W's 1983 federal income tax return, W treated the gain from the sale of the residence as excludable from gross income under section 121 of the Code. At the time of the sale W had not remarried, and neither H nor W had ever elected to utilize the exclusion provided by section 121 with respect to any prior sale or exchange.

LAW AND ANALYSIS

Section 678(a)(1) of the Code provides that a person other than the grantor shall be treated as the owner of any portion of a trust over which the person has the sole power to vest the trust corpus or income in that person.

Section 671 of the Code provides that if a grantor or other person is treated as the owner of any portion of a trust, then those items of income, deductions, and credits against tax of the trust that are attributable to that portion of the trust must be included in computing the taxable income and credits of the grantor or other person.

Section 121 of the Code provides a one-time exclusion from gross income of gain from the sale or exchange of property if the taxpayer has attained the age of 55 before the date of the sale or exchange and the taxpayer has owned and used the property as the taxpayer's principal residence for 3 of the last 5 years ending on the date of the sale or exchange. The maximum amount of gain that may be excluded under section 121 is limited to $125,000.

Rev. Rul. 66-159, 1966-1 C.B. 162, considers whether the gain realized from the sale of a trust of property used by the grantor as the grantor's principal residence qualifies for nonrecognition under section 1034 of the Code (relating to rollover of gain on sale of principal residence). The ruling holds that, because the grant is treated as the owner of the entire trust under sections 676 and 671 of the Code, the sale by the trust will be treated as if made by the grantor.

In the present case, under H's will, W had the sole power to vest the trust corpus or income therefrom in any person, including W. Therefore, under section 678 of the Code, W is treated as the owner of the entire trust for federal income tax purposes, and must, under section 671 of the Code, include items of income, deductions, and credits attributable to the trust in computing W's taxable income and credits.

Since W is treated as the owner of the entire trust under sections 678 and 671 of the Code, the sale by the trust will be treated for federal income tax purposes as if made by W. Therefore, if W makes the election under section 121 on W's tax return, W may exclude from gross income the gain from the sale of the trust property, as the requirements of section 121 of the Code have otherwise been met.

HOLDING

W, a beneficiary who is treated under section 678 as the owner of a trust that owns W's residence, is treated as the owner of the residence for purposes of the one-time exclusion of gain from the sale of a residence under section 121 of the Code.