Page 135 - TaxAdviser_2022

ESTATES, TRUSTS & GIFTS

and ordinary income recapture related surviving spouse’s use of the $25,000
Taxpayers that fail tive participation is determined based
thereto will be eliminated. offset for rental real estate activities. Ac-
Material and active participation to coordinate the on the facts and circumstances of each
of a trust or estate insurance policies situation. Factors that contribute to the
Material participation in an activity can determination include participation in
be relevant when determining whether with the buy-sell management activities and day-to-day
agreement can create
losses will be allowed under Sec. 469 as tasks of operation, etc.
well as when assessing whether the net unnecessary tax
investment income tax under Sec. 1411 Passive activity, basis, and
issues for everyone at-risk suspended losses upon
may apply. The material participation
rules under Sec. 469 and the related involved. estate or trust termination or
regulations do not attribute the partici- disposition of an interest
pation of a deceased taxpayer to his or Passive activity, basis, and at-risk sus-
her estate and do not provide guidance pended losses during the administration
regarding how an estate or trust can As a result of Aragona, trusts with and termination of an estate or trust
materially or actively participate. one or more active trustees may consider typically will not reach the beneficiary
The issue of material participation taking the position that the trust meets of that estate or trust as an allowed loss.
for a trust was first litigated in Mattie the material participation requirements. When an estate or trust distributes an
K. Carter Trust,2⁷ a 2003 federal district Although Treasury intends to issue interest with suspended losses due to
court case. The court held that the trust’s regulations under Sec. 469 as to what lack of basis, those losses will disappear
participation should be determined by facts constitute material participation for upon the transfer of interests to its
including the participation of agents a trust and an estate, it has yet to do so. beneficiaries.
who conducted business on behalf of There is no case law related to an estate’s Different types of estate bequests
the trust. The IRS rejected the court’s material participation, but an executor may occur during estate administra-
rationale and subsequently issued a may equate the decision in Aragona to tion. A pecuniary bequest is a bequest
private letter ruling and technical advice an estate’s executor and consider taking a of a fixed-dollar amount, and a specific
memoranda that focused on the trustee’s similar position. bequest is a bequest of a specific asset
participation in a fiduciary capacity.28 Like Aragona, an electing small or dollar amount. A residuary bequest
A taxpayer may want to consider taking business trust’s (ESBT’s) participation is a bequest of the assets that are left
the position that the participation of its is based on the ESBT trustee’s par- after funding pecuniary bequests and
agents is sufficient to constitute partici- ticipation. The S portions of qualified specific bequests. There are special rules
pation of the trust but should be aware Subchapter S trusts (QSST) are treated that govern the treatment of suspended
that the IRS will likely disagree with as grantor trusts under Sec. 678. As a at-risk and passive activity losses based
that position. result, participation is based on the cur- on the type of estate distribution. A
This issue was later litigated in Frank rent income beneficiary’s participation. residuary bequest allows the basis of the
Aragona Trust,29 a 2014 Tax Court case. However, when a QSST sells S corpora- activity distributed by the estate or trust
The case addressed the material partici- tion stock, material participation will be to be increased by the amount of at-risk
pation of a trust in reference to its trust- based on the trustee’s level of participa- or passive activity suspended losses that
ees. Three of the six co-trustees were tion because that gain will be taxed to are allocable to that interest.31
full-time employees of the LLC that the trust, not the beneficiary.30 However, when the disposition of
managed the rental properties owned by Sec. 469(i)(4) does attribute the ac- the interest is in satisfaction of a pecuni-
the trust. The court concluded that the tive participation for rental real estate ary bequest (a fixed-dollar amount),
trustees were regularly and continuously activities of a deceased taxpayer to there will be significantly different tax
active in the business and, thus, the trust her estate for a two-year period with ramifications from funding a residuary
was active as well. a potential reduction based on the bequest. A distribution by an estate, in

27. Mattie K. Carter Trust, 256 F. Supp. 2d 536 (N.D. Tex. 2003). 29. Frank Aragona Trust, 142 T.C. 165 (2014).
28. IRS Letter Ruling 201029014 and Technical Advice Memoranda 30. Sec. 1361(d)(1)(C).
200733023 and 201317010. 31. Sec. 469(j)(12) and Prop. Regs. Sec. 1.465-67.

26 March 2022 The Tax Adviser