REV-RUL, Computation of gain or loss., Rev. Rul. 69-486, 1969-2 CB 159, (Jan. 01, 1969)
Rev. Rul. 69-486, 1969-2 CB 159

Section 1001.--Determination of Amount of and Recognition of Gain or Loss

26 CFR 1.1001-1:  Computation of gain or loss.
Treatment of a non-pro rata distribution of trust property in kind by a trustee who has no authority to make such distribution but did so as a result of a mutual agreement between the two beneficiaries.

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Advice has been requested as to the Federal income tax treatment of a final distribution of property in kind by a trustee to the two beneficiaries of a trust under the circumstances described below.

Under terms of the trust instrument, the trustee is required to distribute currently all trust income to B for her life and upon her death distribute one-half of the trust corpus to C, an individual, and one-half to X, a charitable organization exempt from tax under section 501(c)(3) of the Internal Revenue Code of 1954.

B died on July 1, 1967.  At the time of her death, the trust had ordinary income of 20x dollars to be reported in its current calendar year period.  Subsequent to B’s death the trust received no income up to its termination on August 1, 1967.  The distributable net income of the trust for 1967 as defined by section 643(a) of the Code was 20x dollars.  The trustee properly distributed currently 20x dollars to B’s successor in interest.

At the time of B’s death, the trust corpus to be distributed to C and X consisted in part of notes that had been purchased by the trust and that had a total adjusted basis of 300x dollars and a total fair market value of an equal amount.  The balance of the trust corpus consisted of common stock acquired by purchase with a total adjusted basis of 100x dollars and a total fair market value of 300x dollars.

The trust instrument as well as local law was silent as to the authority of the trustee to make a non-pro rata distribution of property in kind.

By mutual agreement, the two beneficiaries requested that the trustee distribute all of the notes to C and all of the common stock to X.  The trustee complied with this request on August 1, 1967.

The first issue to be decided is how the non-pro rata distribution by the trustee to C and X will be treated for Federal income tax purposes.

Since the trustee was not authorized to make a non-pro rata distribution of property in kind but did so as a result of the mutual agreement between C and X, the non-pro rata distribution by the trustee to C and X is equivalent to a distribution to C and X of the notes and common stock pro rata by the trustee, followed by an exchange between C and X of C’s pro rata share of common stock for X’s pro rata share of notes.

The second issue to be decided is the basis of the pro rata share of notes and common stock in the hands of C and X.

Section 661 of the Code as implemented by section 1.661(a)-2(f)(3) of the Income Tax Regulations provides, in pertinent part, that the basis of property in the hands of the beneficiary is its fair market value at the time it was paid, credited, or required to be distributed, to the extent such value is included in the gross income of the beneficiary.  To the extent that the value of property distributed in kind is not included in the gross income of the beneficiary, its basis in the hands of the beneficiary is governed by the rules in sections 1014 and 1015 of the Code and the regulations thereunder.

Section 661 of the Code provides for a deduction (limited to the distributable net income of the trust) to the trust for distributions properly made and section 662 of the Code provides for the inclusion of a corresponding amount in gross income of a beneficiary.

Inasmuch as the 20x dollars of income required to be distributed currently to the estate of B is equal to the distributable net income of the trust, no amount is includible in the gross income of C and X as a result of the pro rata distribution of notes and common stock by the trustee.  See section 662(a) of the Code as implemented by section 1.662(a)-2 of the regulations.

The basis of the pro rata shares of notes and common stock in the hands of C and X is the same as the adjusted basis in the hands of the trust.  See section 1.1015-2(b) of the regulations.

Furthermore, C in substance exchanged his pro rata share of common stock with X for X’s pro rata share of notes.  The amount of recognized gain to C is determined under sections 1001 and 1002 of the Code.  Since X is a charitable organization exempt from tax under section 501(c)(3) of the Code, it has no tax consequence as a result of the exchange.