The IRS recently issued Rev. Rul. 2008-41, confirming that charitable remainder trusts (CRTs) can be divided into separate but equal trusts for each recipient without adverse tax consequences. If properly effected, the separate trusts will continue to qualify as CRTs, no private foundation termination excise taxes will arise under Sec. 507(c), and the division will not be treated as a sale, will not constitute an act of self-dealing under Sec. 4941, and will not constitute a taxable expenditure under Sec. 4945.
Specifically, the ruling addressed two situations in which a CRT is divided pro rata into two or more separate trusts. Such divisions are common when the income recipients want to separate their interests and when joint income recipients divorce.
The ruling clarified that a trust’s division into separate trusts does not disqualify the separate trusts as CRTs under Sec. 664(d) as long as the division is pro rata and the separate trusts have the same governing provisions, recipients, remainder beneficiaries, and assets as the original trust, with some exceptions. The Service also ruled that the division is not a sale, exchange, or other disposition producing gain or loss.
This provides greater assurance that in the case of a divorcing couple with concurrent present interests, each party will be able to relinquish its successor interests after the other’s death. The ruling consolidates issues that have been the subject of many previous letter rulings and is similar to Rev. Rul. 2002-28 and Letter Ruling 200616008.
Note that the applicability of this ruling may be a bit limited because many taxpayers do not want pro-rata distribution, and the parties might have different investment strategies. In the ruling, a pro-rata division appears to mean a division in proportion to each annuitant’s share of the individual assets rather than the share of the total assets.
Thus, a CRT that divides in half with two stock holdings must split each stock 50-50, so that each new trust gets half of each of the stocks and maintains the same cost basis in each resulting trust. That works for assets that are divisible and that have a readily ascertainable value. However, it may pose difficulties for certain types of assets that cannot be split due to minimum unit sizes or other reasons, such as real estate or closely held interests that are not divisible because they are not broken down into units or shares.
For those cases, the taxpayer-trustee may want to consider undivided interests and titling the property properly, and possibly liquidating or converting the difficult-to-split assets to cash before splitting the CRT. However, the remainder beneficiaries’ interests must also be considered, especially if it is a fire sale or a highly appreciating asset. They could also consider forming an LLC to hold the hard-to-value assets in order to equally split them, but the ex-spouses would still be associated with each other in the LLC. Another issue to consider is that two securities with the same current fair market value may not have the same ownership risk.
Also note that private letter ruling requests will likely continue because this revenue ruling does not deal with various additional scenarios addressed in other letter rulings covering the division of CRTs incident to a divorce—for example, CRTs that are designed to pay consecutively, first to one spouse and then to the other at the death of the first spouse (see Letter Ruling 200824022).