Sage v. Comm’r, 154 T.C. No. 12 | June2, 2020 | Udra, P. | Dkt. No. 3372-16
Short Summary: Petitioner transferred parcels of land into liquidating trusts for the benefit of the mortgage holders of the parcels. In years subsequent to the Petitioner’s transfer of the parcels, the liquidating trusts disposed of the parcels. The Petitioner classified his transfer of the parcels as a loss, which gave him a net operating loss for the year. The Petitioner carried that net operating loss deduction back and also forward. The IRS disallowed the loss on the transfer of the parcel and also adjusted Petitioner’s tax returns for the years in which he used the net operating loss deduction. The Tax Court found in favor of the IRS, ruling that the transfer of the parcels to the liquidating trusts was not effective as Petitioner remained the owner of the trusts, and upholding the disallowing of the loss deduction.
Key Issues: Whether the Petitioner’s transfer of parcels of land into liquidating trusts for the benefit of the parcels’ mortgage holders transferred ownership of the parcels to the beneficiaries of the trust within the meaning of the “grantor” trust provisions?
- The proceeds from the disposition of the parcels of land in the liquidating trusts were applied to discharge certain liabilities of the Petitioner and as such the Petitioner was the owner of the liquidating trusts after the time of the transfer and during the years of disposition, pursuant to the grantor trust provisions.
- As the Petitioner owned the liquidating trusts beyond the year that the Petitioner transferred the parcels of land, there was not a bona fide disposition of the parcels, and the Petitioner could not deduct losses on the transfer of the parcels in the year of transfer.
Key Points of Law:
- A trust grantor is treated as the owner of any portion of a trust whose income without the approval or consent of any adverse party is, or, in the discretion of the grantor or a nonadverse party, or both, may be distributed to him or his spouse. 677(a)(1).
- If a trust grantor is deemed is deemed the owner of the trust, then the trust is not treated as a separate taxable entity for federal income tax purposes.
- The grantor of a trust is treated as an owner where, inter alia, trust income is used to discharge the legal obligation of the grantor.
- A liquidating trust will be taxed as a grantor trust with the creditors treated as the grantors and deemed owners when the debtor transfers its assets to the creditors in exchange for relief from indebtedness to them, and the creditors then transfers those assets to a trust for the purposes of liquidation.
- A taxpayer who unilaterally transfers assets to a trust without the involvement of the beneficiaries will not qualify as a liquidating trust and be simply treated as a grantor trust with the grantor as the owner.
Insight: The Sage case illustrates the importance and necessity of involving creditors, and seeking their approval, before the creation of a liquidating trust. As shown in the Tax Court’s ruling, if the debtor unilaterally creates a liquidating trust, the effect is that a grantor trust has been created with debtor as the owner of the trust for federal tax purposes.
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