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Decedent’s Lifetime Transfers Of Residence And Rental Properties Includible In Her Estate

Estate of Trombetta, TC Memo 2013-234

The Tax Court has ruled that a taxpayer’s lifetime transfers of her residence to one trust and rental properties to another trust were transfers with a retained life estate and thus the properties were includible in her gross estate. It also ruled against the taxpayer with respect to a purported charitable deduction.

Background. Code Sec. 2036(a) includes the value of assets in a decedent’s gross estate when: (1) decedent made an inter vivos transfer of property; (2) decedent’s transfer was not a bona fide sale for adequate and full consideration; and (3) decedent retained an interest or right in the transferred property that she did not relinquish before her death.

Whether a decedent retained an interest in transferred property depends upon whether there is an express or implied agreement at the time of transfer that the transferor will retain lifetime possession or enjoyment of, or right to income from, the transferred property. To avoid characterization as a retained interest, the decedent must have absolutely, unequivocally, irrevocably, and without possible reservations parted with all of her title, possession, and enjoyment of the transferred assets.

Code Sec. 2055 provides a charitable contribution deduction for amounts transferred by a decedent for qualified charitable and religious uses. The transfers, however, must have been made during the decedent’s lifetime or by will. Deductions are not permitted where the amounts passing to a charity turn on the actions of a personal representative.

Facts. Helen Trombetta (Trombetta; decedent) was the grantor and sole beneficiary of an “annuity trust.” She was a trustee of the trust together with some of her children; she had 50% of the trust’s voting rights, and the other trustees, together, had the remaining 50%. She transferred two rental properties, Tierra Plaza and Black Walnut Square, to the trust in return for a 180-month annuity. The properties were both subject to mortgages. After the transfer, the trust paid the mortgages, but the trust never assumed the mortgages.

The annuity trust agreement provided that, if the trust’s income exceeded the periodic payment due, the co-trustees could distribute the excess income to Trombetta or allow the income to accumulate in the trust. At the later of the end of the annuity trust term or the date of her death, the annuity trust property would pass to decedent’s surviving children or grandchildren. Trombetta, in her role as trustee, continued to manage the properties as actively as she had before the transfer.

Trombetta filed a gift tax return in connection of the transfer to the trust, in which she showed that the properties had a value of $1.4 million, that she had a retained interest of $.9 million, and that the amount of her gift was the difference, i.e., $.5 million.

Trombetta was also the grantor, trustee and sole beneficiary of the “residence trust.” The residence trust agreement provided that decedent had the right to use any trust property as a personal residence and the right to receive the net income from the trust. The term of the trust was 180 months, subject to decedent’s power to reduce the term, and the only asset in the trust was Trombetta’s residence. The residence trust provided that: a) if Trombetta was living at termination, the trust property would be distributed equally to her children or their children; and b) if Trombetta was deceased at termination, the trustee would distribute the balance of the trust property as directed by decedent’s will or, if not so directed, equally to decedent’s children or their children.

Similar to the case with the annuity trust, Trombetta filed a gift tax return with respect to the transfer of the residence in which she indicated that she had a retained interest in the residence.

Trombetta later became ill and believed she would die before the termination of the residence trust. She then amended the residence trust such that it would end right after her death. She also amended that trust to instruct the trustee to, after her death, transfer her residence to a charitable remainder trust.

Trombetta then died. The executor created the charitable remainder trust and transferred the residence to it. Thereafter, the executor filed a petition for reformation (i.e., correction) of the residence trust term to provide that the residence trust would terminate on the last day of the month before Trombetta’s death.

Trombetta’s estate tax return showed that the properties in the two trusts were not part of the estate, and it took a charitable deduction with respect to the charitable remainder trust. IRS disagreed with each of these positions.

Treatment of the Properties in the Annuity Trust. IRS argued that Trombetta’s transfers to the annuity trust were includible in the gross estate under Code Sec. 2036(a), and the Court agreed. The issues were: (1) whether decedent’s transfers of the Black Walnut Square and Tierra Plaza properties were bona fide sales for adequate and full consideration; and (2) whether Trombetta retained during her life an interest in the transferred properties.

On the issue of bona fide sale for adequate and full consideration, the taxpayer argued, quoting Estate of Bongard (2005), 124 TC 95, that the crux of the bona fide transfer inquiry is whether the taxpayer can demonstrate that he had legitimate and significant nontax reasons for entering the transaction. Taxpayer argued that its non-tax purposes were to relieve Trombetta of the burden of managing the properties and to have her receive an assured income.

The Court first disagreed that this rule applied here, noting that in Estate of Bongard and all other cases, this rule applied to transfers to family limited partnerships (FLPs) and that FLPs and the annuity trust are not sufficiently similar. Then it also said that taxpayer hadn’t established that Trombetta had substantial nontax reasons for the transfer, reasoning that she continued to manage the properties, that there were more efficient ways for her to get an assured income, and that the transfer to the trust was part of a series of tax- related transactions including executing her will.

The Court then said that the transaction was not a bona fide sale in the sense of an arm’s length transaction because, in effect, Trombetta was on both sides of the transaction because she was the grantor of the trust and the only trustee involved in the transfer transaction.

In ruling that there was a retained interest, the Court noted that decedent made all decisions with respect to the Tierra Plaza and Black Walnut Square properties and that the co-trustees generally acted on decedent’s recommendation. She took the lead role in negotiating the refinancing of the properties following their transfer to the annuity trust. Decedent alone retained signatory authority with respect to the disposition of the properties. She thus retained de facto control over the properties and their disposition. In addition, the annuity trust agreement provided that any additional income could be distributed to decedent at the direction of the trustees. Decedent retained 50% of the voting rights, and the remaining voting rights were divided among her children. Because decedent and her children could make distributions of additional income to decedent when and in the amount they pleased, decedent maintained the same enjoyment of the properties and their income stream as she had before she transferred the properties to the annuity trust.

Treatment of the Residence in the Residence Trust. The Court treated the entire value of the residence as part of the estate, pursuant to Code Sec. 2036(a).

No Charitable Deduction. The Court ruled that the estate was not entitled to an estate tax charitable contribution deduction because the residence trust term ended before decedent’s death and therefore decedent did not possess the right to direct the disposition of the residence to a charitable organization.

The residence trust agreement, both before and after its amendment, provided that if decedent was living at termination, the trust property would be distributed equally to her children or their children, but if decedent was deceased at termination, the trustee would distribute the balance of the trust property as directed by decedent’s will. The residence trust terminated before decedent’s death pursuant to judicial reformation. Decedent provided for the creation of the charitable remainder trust in the amendment to her will. Because the residence trust terminated before decedent’s death, however, the residence should have been distributed equally to decedent’s children or grandchildren rather than distributed as directed by decedent’s will, i.e., into the charitable remainder trust.

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