GRANTOR TRUST MAY BUY REPLACEMENT PROPERTY THAT QUALIFIES GRANTOR FOR SECTION 1033 NONRECOGNITION TREATMENT.

Rev. Rul. 88-103

ISSUE

If a taxpayer's property is involuntarily converted into money and the taxpayer's grantor trust purchases replacement property, can the purchase qualify the taxpayer's gain for nonrecognition under section 1033 of the Internal Revenue Code?

FACTS

A owned property that was involuntarily converted into money, resulting in a realized gain. A had previously established a trust, and, under subpart E of subchapter J of the Code, A is treated as the owner of the entire corpus and income of the trust. Within the time prescribed by section 1033(a)(2)(B) of the Code, the trustee purchased property that, had it been purchased by A, would have enabled A to defer the gain under section 1033(a)(2)(A).

LAW AND ANALYSIS

Section 1033(a)(2)(A) of the Code provides that, at the election of the taxpayer, the gain realized upon the involuntary conversion of property into money is recognized only to the extent that the amount realized upon the conversion exceeds the cost of purchasing other property similar or related in service or use to the converted property.

Section 671 of the Code provides the general rule that, when the grantor is treated as the owner of a trust under subpart E of subchapter J of the Code, there shall then be included in computing the grantor's income those items of income, deductions, and credits against tax of the trust that would be taken into account in computing the taxable income or credits against tax of an individual. If a grantor is treated as the owner of an entire trust, the grantor includes in income all items of trust income to which the grantor would have been entitled had the trust not been in existence. Section 1.671-3(a)(1) of the Income Tax Regulations.

Under section 1033(a)(2) of the Code, the owner of the property that is involuntarily converted into money is the taxpayer who may purchase qualifying replacement property and elect to defer gain arising from the conversion. The Service generally treats the owner of a grantor trust, as determined under subpart E of subchapter J of the Code, as the owner of the trust assets for income tax purposes. See Rev. Rul. 85-13, 1985-1 C.B. 184. Whether replacement property is purchased by the grantor or by the grantor's trust is of no consequence for purposes of section 1033, therefore, since the grantor is treated as the owner of the property.

In Rev. Rul. 70-376, 1970-2 C.B. 164, property held in a grantor trust was sold by the trust under threat of condemnation. The revenue ruling holds that the grantor is the taxpayer eligible to elect to defer gain under section 1033 because, in the absence of the deferral of gain provided in section 1033, the grantor is required to include the gain in income.

In the instant situation, A is treated as the owner of the entire corpus and income of the trust under subpart E of subchapter J of the Code. The trust is disregarded in determining A's income tax liability for purposes of section 671 of the Code and the regulations thereunder. For income tax purposes, the trust's replacement of the condemned property is equivalent to A purchasing the replacement property directly. Therefore, A is the true "taxpayer" in the purchase of the qualifying replacement property and is the person responsible for complying with all other administrative provisions set out in section 1033(a)(2)(A) of the Code and the regulations thereunder.

HOLDING

If a taxpayer's property is involuntarily converted into money and the taxpayer's grantor trust purchases replacement property, the purchase can qualify the taxpayer's gain for nonrecognition under section 1033 of the Internal Revenue Code.

EFFECT ON OTHER DOCUMENTS

Rev. Rul. 70-376 is amplified by providing that the trust can acquire qualifying replacement property under section 1033 of the Code.

DRAFTING INFORMATION

The principal author of this revenue ruling is Karl T. Walli of the Office of Assistant Chief Counsel, Financial Institutions and Products. For further information regarding this revenue ruling contact Mr. Walli on (202) 566-3297 (not a toll-free call).