PLR 200004037: A severed homesite can enter a qualified personal residence trust

Plain-English summary

A taxpayer and spouse owned a 14.3-acre parcel with a house and barn on about 2.5 acres; the remaining land was rented to a farmer. They proposed to separate the homesite, have the spouse give her interest in it to the taxpayer, and place it in a 15-year qualified personal residence trust (QPRT). The IRS ruled that the 2.5-acre plot, including the house and barn, qualifies as a personal residence under the QPRT regulation, but said separating it from the rented farmland was essential. If the land is severed and transferred as proposed, the trust meets the QPRT requirements and the transfer qualifies for the residence-trust exception to the retained-interest valuation rule in § 2702(a).

Ruling snapshot

• Question: Does the severed 2.5-acre homesite qualify as a personal residence, and does the proposed trust qualify as a QPRT?
• Outcome: Approved, if the homesite is severed and transferred to the trust as proposed.
• Key authorities: IRC § 2702(a)(3)(A)(ii); Treas. Reg. § 25.2702-5(c).

Full text (IRS public release)

200004037
Internal Revenue Service                       Department of the Treasury
Index Number: 2702.02-02                     Washington, DC 20224
Person to Contact:
Telephone Number:
Refer Reply To:
CC:DOM:P&SI:4/PLR-109080-99
Date: October 26, 1999
Re:

Legend
Taxpayer -
Father -
Community -
Parcel A -

Dear :

This is in response to your letter dated , , and prior
correspondence in which you requested rulings concerning the transfer of property to a
proposed qualified personal residence trust.

Taxpayer and Taxpayer’s spouse own a fee simple title to Parcel A, located in
Community, which they acquired in 1965. Parcel A is approximately 14.3 acres and
includes a house and barn that occupy approximately 2.5 acres of the total acres. The
remaining acreage in Parcel A is farmland that is leased to a tenant farmer in exchange
for nominal rent and a percentage of the profits. The house on Parcel A is the
permanent residence of Taxpayer and Taxpayer's spouse and the barn is used for
storage of household items and some farming equipment.

Taxpayer proposes to create an irrevocable trust that is intended to satisfy the
requirements of a qualified personal residence trust (QPRT) under § 25.2702-5(c) of
the Gift Tax Regulations. Prior to creating the trust, Taxpayer and Taxpayer's spouse
will sever Parcel A into two parcels. One parcel will consist of the 2.5 acre plot
(Subplot A) that includes the residence and barn and the other parcel will consist of the
remaining 11.8 acre plot that is currently leased for farming use. The Taxpayer's
spouse will then transfer by gift her entire interest in Subplot A to Taxpayer. Taxpayer
will transfer Subplot A to the trust.

Under the terms of the proposed trust, Taxpayer's spouse will serve as trustee.
The trust will terminate upon the earlier of 15 years or the Taxpayer's death. During
the term of the trust, Taxpayer will have use of the residence on the property and the
trustee will pay Taxpayer all of the trust income, at least annually. Distributions of
principal during the term of the trust to anyone other than Taxpayer will be prohibited.
Taxpayer will pay all expenses of the property. In addition, the trust will include the
following provisions:

1. The trust shall not hold any property other than a single residence for
use as a personal residence by Taxpayer, except for other property that is
permitted under §§ 25.2702-5(c)(5)(ii) and (c)(8).

2. Improvements may be made-to the property provided the residence, as
improved, satisfies the requirements of a personal residence under
§ 25.2702-5(c)(2).

3. Any additions of cash will be held in a separate account and will be
subject to the provisions of § 25.2702-5(c)(5)(ii)(A)(1) and (2).

4. Proceeds from the sale of the residence will be held in a separate
account as provided by § 25.2702-5(c)(5)(ii)(C) and insurance policies on
the residence and proceeds of insurance for damage to or destruction of
the residence (and amounts receivable upon an involuntary conversion as
provided in § 1033) will also be held in a separate account.

5. The trust will cease to be a qualified personal residence trust if the
residence ceases to be used or held for use as a personal residence by
Taxpayer, or, as to proceeds of sale or insurance proceeds, if such
proceeds are held in trust longer than provided under § 25.2702-5(c)(7)(ii).
6. The trust may not be commuted (prepaid).

7. If damage or destruction renders the residence not usable as a
residence, § 25.2702-5(c)(7)(iii) will apply.

8. If the trust ceases to be a qualified personal residence trust as to any
property, that property shall, within 30 days, be held in a separate share
and the Taxpayer's interest shall be converted into a qualified annuity
interest, as defined in § 25.2702-3. The requirements for a qualified
annuity interest as described in § 25.2702-3 are made a part of the trust
instrument by incorporation. The annuity amount shall be the smallest

fixed payment permitted under § 25.2702-5(c)(8) for the balance of the
term. The commencement date of the qualified annuity interest shall be
determined in accordance with § 25.2702-5(c)(8)(ii)(B).

9. The trustee may not sell or otherwise transfer the residence in a
manner that conflicts with § 25.2702-5(c)(9).

If Taxpayer dies before the expiration of the 15 year term, the trust principal will
be distributed to Taxpayer's estate. If the 15 year term expires before the Taxpayer's
death, the trust assets will be held in a separate trust (family trust). During this period,
Taxpayer's spouse may occupy the residence, if owned by the family trust. Upon the
death of Taxpayer's spouse or, in the event that the spouse no longer wishes to reside
in the residence, the Taxpayer may lease the residence at a fair market value.

Under the terms of the proposed trust, Taxpayer may appoint a successor
trustee (other than Taxpayer or Taxpayer's spouse) to serve in place of any trustee
who may resign or, for any other reason, may no longer be acting as trustee. Taxpayer
may also remove a trustee of the proposed trust or any trust created under the
proposed trust and appoint a successor trustee who is not related or subordinate to the
Taxpayer or the Taxpayer's spouse within the meaning of § 672(c) of the Internal
Revenue Code. Under the terms of the family trust, the trustee has discretion to apply
the income and principal for the benefit of Taxpayer's spouse and Taxpayer's issue.
However, the proposed trust also provides that any person serving as trustee to whom
or for whose benefit a discretionary payment of income or principal may be made may
not participate in any decision involving the exercise of the discretionary power in his or
her own favor or the exercise of the power in favor of any person the trustee is
obligated to support or maintain.

Upon the death of the last to die of Taxpayer and Taxpayer’s spouse, the family
trust assets will be divided equally among the Taxpayer's issue, per stirpes, and held in
separate trusts for their benefit. The trustee will have discretion to distribute income
and principal to the Taxpayer’s children and their issue during the term of each trust.
Upon the death of a child of the Taxpayer, that child’s trust will terminate and be
distributed pursuant to the terms of a testamentary nongeneral power of appointment
exercised by the respective Taxpayer's child.

You have requested the following rulings:
(1) The 2.5 acre portion (Subplot A) of Parcel A that includes the current

residence and barn, which Taxpayer will transfer to the proposed trust, meets the
requirements of a personal residence, as defined in § 25.2702-5(c)(2).

(2) The proposed trust meets the requirements of a qualified personal residence
trust under § 25.2702-5(c), and therefore, the transfer will qualify for the exception to
§ 2702(a) that is provided in § 2702(a)(3)(A)(ii).

Law and Analysis

Section 2702(a)(1) provides that solely for purposes of determining whether a
transfer of an interest in trust to (or for the benefit of) a member of the transferor's
family is a gift (and the value of such transfer), the value of any interest in such trust
retained by the transferor or any applicable family member (as defined in § 2701(e)(2))
is determined as provided in § 2702(a)(2).

Section 2702(a)(2) provides that the value of any retained interest that is not a
qualified interest is treated as being zero. The value of any retained interest that is a
qualified interest is determined under § 7520.

Section 2702(a)(3)(A)(ii) provides an exception to § 2702(a)(2) if such transfer
involves the transfer of an interest in trust and the property transferred consists of a
residence to be used as a personal residence by persons holding term interests in such
trust.

Section 25.2702-5(a) provides, in part, that a transfer in trust meeting the
requirements of a “qualified personal residence trust" as defined in § 25.2702-5(c) will
be treated as satisfying the requirements of § 2702(a)(3)(A)(ii).

Section 25.2702-5(c)(1) provides that, in order to qualify as a qualified personal
residence trust, the provisions of the governing instrument must satisfy all the
requirements of a qualified personal residence trust throughout the term of the trust.

Section 25.2702-5(c)(2)(i) provides that a personal residence of a term holder is
either the personal residence of the term holder (within the meaning of § 1034), one
other residence of the term holder (within the meaning of § 280A(d)(1) but without
regard to § 280A(d)(2)), or an undivided fractional interest in either.

Section 25.2702-5(c)(2)(ii) provides that a personal residence may include
appurtenant structures used by the term holder for residential purposes and adjacent
land not in excess of that which is reasonably appropriate for residential purposes
(taking into account the residence's size and location). The fact that a residence is
subject to a mortgage does not affect its status as a personal residence. The term
personal residence does not include any personal property (e.g., household
furnishings).

Section 25.2702-5(c)(3) provides that, in general, the governing instrument of a
qualified personal residence trust must require that any income of the trust be
distributed to the term holder not less frequently than annually.

Section 25.2702-5(c)(4) provides that the governing instrument must prohibit
distributions of corpus to any beneficiary other than the transferor prior to the expiration
of the retained term interest.

Section 25.2702-5(c)(5)(i) provides that, in general, the governing instrument of
a qualified personal residence trust must prohibit the trust from holding, for the entire
term of the trust, any asset other than one residence to be used or held for use as a
personal residence of the term holder. Under § 25.2702-5(c)(5)(ii), the trust may hold
certain assets listed in that section in addition to the personal residence.

Section 25.2702-5(c)(6) provides that the governing instrument must prohibit
commutation (prepayment) of the term holder's interest.

Section 25.2702-5(c)(7)(i) provides that the governing instrument must provide
that a trust ceases to be a qualified personal residence trust if the residence ceases to
be used or held for use as a personal residence of the term holder. A residence is held
for use as a personal residence of the term holder so long as the residence is not
occupied by any other person (other than the spouse or a dependent of the term
holder) and is available at all times for use by the term holder as a personal residence.

Section 25.2702-5(c)(8) provides that the governing instrument must provide
that, within 30 days after the date on which the trust ceases to be a qualified personal
residence trust with respect to certain assets, the assets must be either distributed
outright to the term holder, or converted to and held for the balance of the term holder's
term in a separate share of the trust meeting the requirements of a qualified annuity
interest. If the assets are to be converted to and held as a qualified annuity interest,
the governing instrument must contain all the provisions required by § 25.2702-3 with
respect to a qualified annuity interest.

Section 25.2702-5(c)(9) provides generally that the governing instrument must
prohibit the trust from selling or transferring the residence, directly or indirectly, to the
grantor, the grantor’s spouse, or an entity controlled by the grantor or the grantor’s
spouse during the retained term interest of the trust, or at any time after the retained
term interest during which the trust is a grantor trust (under § 671, et. seq.).

In this case, the structures on Subplot A of Parcel A are used for residential
purposes. Severance of Subplot A from the remaining portion of Parcel A (the acreage
rented to the tenant farmer) is essential for the qualification of Subplot A as a personal
residence. Consequently, we conclude that Subplot A of Parcel A, the 2.5 acre plot
that includes the current residence and barn as described above, constitutes a
personal residence within the meaning of § 25.2702-5(c)(2).

Based on the information submitted and the representations made, we conclude
that, if Subplot A is severed from Parcel A and then transferred to the proposed trust,
as proposed, the trust will meet the requirements for a qualified personal residence
trust under § 25.2702-5(c) and therefore, the transfer to the trust will qualify for the
exception to § 2702(a) that is provided in § 2702(a)(3)(A)(ii).

A copy of this letter should be attached to any gift, estate, or generation-skipping
transfer tax returns that you may file relating to these matters.

The rulings contained in this letter are based upon information and
representations submitted by the taxpayer and accompanied by a penalty of perjury
statement executed by the appropriate party. While this office has not verified any of
the material submitted in support of the request for rulings, it is subject to verification on
examination.

Except as specifically set forth above, no opinion is expressed concerning the
Federal tax consequences of the facts described above under the cited provisions or
any other provision of the Code.

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3)
of the Code provides that it may not be used or cited as precedent.

Sincerely,

Assistant Chief Counsel
(Passthroughs and Special
Industries)

By James Hogan
Acting Assistant to the Branch Chief
Branch 4

Enclosure
Copy for 6110 purposes