Trust division preserves assets’ basis, other tax attributes

In IRS Letter Ruling 202133005 released Aug. 20, 2021, the IRS ruled on the tax consequences of the division of a trust. While the IRS has ruled many times on the tax consequences of this issue, this ruling addresses what happens to the tax attributes of the original trust upon division.

The grantors created a trust for the benefit of their descendants. At the time of the proposed division, the trust held limited liability company (LLC) member interests and limited partner interests in entities that owned passive investments and nonoperating oil and gas working interests and related royalty interests.

The trust provided that the trustees had the discretion to make distributions of income and principal for the beneficiaries’ support, maintenance, health, and education. In addition, an independent trustee could distribute to the beneficiaries so much of the income and principal as the trustee determined. Upon the death of the last of the grantors to die, the trustee was to divide the trust into separate trusts, one for the benefit of each of the grantors’ children and that child’s descendants.

Upon the death of the first grantor, the second grantor and the children petitioned the court to have the trust divided pro rata into separate trusts for each of the children and their descendants prior to the date provided in the trust instrument, which did not prohibit the early division of the trust.

The ruling request requested the following rulings, which were granted by the IRS:

1. The pro rata transfer of assets from the original trust to the newly created trusts would not be a distribution for purposes of Secs. 661 and 662.
2. The pro rata transfer of assets from the original trust to the newly created trusts would not result in the realization of any income, gain, or loss under Sec. 61 or Sec. 1001.
3. The newly created trusts would be treated as separate trusts for federal income tax purposes pursuant to Sec. 643(f).
4. The tax basis that the newly created trusts would have in the assets of the original trust after the division would be the same as their tax basis in the original trust.
5. Each asset of the original trust would have the same holding period after the transfer that the asset had before the division.
6. On the division of the original trust into the newly created trusts, each of the newly created trusts would succeed to and take into account an equal portion of any net operating loss carryforward, net capital loss, and other tax attributes of the original trust, including passive activity losses and credit carryforwards and statutory depletion deductions. Each asset transferred to the newly created trusts would have the same tax attributes immediately after the division that it had immediately before the division.
7. The GST tax-exempt status of the original trust would not be affected by the division.

The IRS has previously ruled favorably in all of the above rulings on the division or severance of a trust except Ruling No. 6. Although not stated in this ruling request, the premise for these rulings is that the IRS has opined that the division or severance of a trust — at least, if accomplished during the same tax year — is a continuation of the old trust (except maybe Ruling No. 3, which requests that the resulting trusts be treated as separate trusts).³ Although the Service does not provide any analysis for Ruling No. 6, this ruling is consistent with the IRS’s opinion that the trusts resulting from a division or severance are a continuation of the old trust.