Certain Transfers to Trusts Are Listed Transactions

February 18, 2008 | Roger McEowen


In Notice 2008-34, IRS has indicated that certain transfers to trusts are listed transactions that will be subject to the reportable transaction rules of Treas. Reg. §1.6011-4 and also to the requirements in I.R.C. §§6111-6112 as well as the stringent Circular 230 written opinion rules for listed transactions. 

The transaction IRS is targeting is one in which distressed assets with high basis and low value are transferred to a trust by a tax-indifferent party - for example, a foreigner who is not subject to U.S. tax, or a tax-exempt organization.  Here is how the transaction works:  The trust is established by the tax-indifferent party, and the U.S. taxpayer contributes cash or a note for the net value (a very low amount).  Next, the trustee then establishes a sub-trust for that beneficiary, which is claimed to be treated tax-wise as a separately standing grantor trust because of the beneficiary's right to direct the trustee as to the corpus of the sub-trust, with the same high basis in the assets as the original grantor's basis.  An interest in the trust is then sold to a U.S.taxpayer.  The transaction is known as a "Distressed Asset Trust Transaction" and its purpose is to provide the U.S. taxpayer with a loss.  In other words, the idea is to shift the loss in the assets to the U.S. taxpayer who has not actually incurred an economic loss.

In essence, the trust transaction attempts to do in a grantor trust what has now been eliminated in partnerships through changes to partnership tax law as a result of enactment of the American Jobs Creation Act of 2004.  Those changes prevented taxpayers from shifting a built-in loss to a U.S. taxpayer through the use of a partnership.  The new rules require certain basis adjustments when built-in loss property is contributed to a partnership or distributed by a partnership, or when sales of partnerships with such property occur, in order to prevent shifting a built-in loss from an indifferent taxpayer to another partner who has not incurred the economic loss.  IRS published a coordinated issue paper on the matter last year.  IRS Coordinated Issue Paper on Distresses Asset/Debt Tax Shelters (Apr. 18, 2007).

In accordance with the Notice, the Service may use any or all of the following arguments to defeat the taxpayer's claims:

  • The transfer of cash or notes for the establishment of a sub-trust with the assets is a recognition exchange;
  • The main trust does not satisfy the requirements of a non business entity "trust" under I.R.C. §301.7701-4;
  • One or more of the trusts is a partnership for tax purposes, and therefore the 2004 amendments to the partnership rules apply;
  • The loss is not a deductible loss in a transaction entered into for profit under I.R.C. §165;
  • Where the assets are distressed debt, the debt was worthless at the time of contribution; and/or (v) one or more of the judicial doctrines.

The Notice is applicable to transactions entered into after Oct. 22, 2004.  Failure to disclose the transaction may subject taxpayers to a penalty that applies to returns and statements due after that date.  Some taxable entities may be subject to disclosure obligations that apply to "prohibited tax shelter transactions."  However, IRS indicated that some taxpayers may have filed tax returns taking the position that they were entitled to the purported tax benefits of this type of transaction.  Those taxpayers must now take the appropriate corrective action and ensure that their transactions are disclosed properly.

Download list of transactions: IRSCircular230.pdf