Trusts And “Material Participation”

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Explore:  Estate Planning Trusts

There is uncertainty in the law as to whether, and how, trusts can meet the “material participation” requirements of Code Section 469 to escape passive loss treatment. These uncertainties include whether a trust can materially participate, whether material participation must be measured solely by trustee activities or whether activities of beneficiaries and agents/employees of the trust can be considered, and whether the special rental real estate exceptions of Code Section 469(c)(7) can be used by trusts. Recently, these questions have taken on further relevancy, per the cross-reference to the passive loss rules in determining when trusts are subject to Obamacare’s new tax on net investment income.

A recent Tax Court case resolves one of these issues, and sheds light on some of the others. In this case, a trust had 5 income beneficiaries. The trustees were those beneficiaries, plus one additional person. The trust owned an interest in a disregarded LLC that conducted management activities in the rental real estate field. The trust was also involved via other holdings in rental real estate, investment real estate, and real estate development. The trust incurred losses, and the IRS sought to characterize them as passive losses. The trust argued for material participation and the application of Code Section 469(c)(7).

Here is what the court held:

a. trusts can use the Code Section 469(c)(7) exception from rental activities being automatically passive activities;

b. a trust can "materially participate" under Code Section 469(h) (and Section 469(c)(7));

   1. there is no statutory nor regulatory guidance on material participation for a trust, and how a trust meets the regular, continuous, and substantial activity requirement for material participation;

   2.  the activities of the individual trustees can be used to measure material participation;

        (i) this is true even if the trustees' activities come from serving as an employee of an affiliated entity;

    (ii) this measurement does not require each individual trustee to materially participate. Here, 3 of 6 trustees were not actively involved; and

  (iii) the court was unclear, and does not appear to have ruled, on whether non-trustee employees of the trust can be used to satisfy the material participation standard.

Other precedent on these issue include Mattie K. Carter Trust v. U.S., 256 F.Supp. 2d 536 (N.D. Tex. 2003) (favorable case extending material participation examination to agents of the trustee), TAM 200733023 (unfavorable case disagreeing with Mattie K. Carter Trust, and TAM 201317010 (also unfavorable).

Frank Aragona Trust v. Comm., 142 TC No. 9 (2014)

Topics:  Estate Planning, Trusts

Published In: Wills, Trusts, & Estate Planning Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Charles (Chuck) Rubin, Gutter Chaves Josepher Rubin Forman Fleisher P.A. | Attorney Advertising

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