Internal Revenue Bulletin 1996-7 (PDF rendition): IRS Notices

Preserve advance releases and the authoritative Internal Revenue Bulletin rendition; directory timestamps are file-publication metadata, not legal effective dates. HTML bulletins begin June 2003; earlier available issues require full PDF parsing. Whole bulletin rendition: numbered items are identified below; other legal material and publisher context remain included. This is not a new standalone advance release.

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Bulletin No. 1996–7
February 12, 1996
HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.
INCOME TAX
PS–2–95, page 50.
Proposed regulations under section 731 relating to the
treatment of a distribution of marketable securities by a
partnership. A public hearing will be held on April 3,
1996.
T.D. 8642, page 4.
Final regulations under sections 704 and 737 of the
Code relating to the recognition of gain or loss by
contributing partner on distribution of contributed
property or other property.
ESTATE TAX
T.D. 8644, page 16.
Final regulations relating to generation-skipping transfer
tax.
ADMINISTRATIVE
Del. Order 232 (Rev. 2), page 49.
The authority to modify or rescind a Taxpayer Assist-
ance Order (TAO) is limited only to the Commissioner,
Deputy Commissioner, or Taxpayer Ombudsman. Del.
Order 232 (Rev. 1) superseded.
Del. Order 239 (Rev. 1), page 49.
The Taxpayer Ombudsman is delegated the authority to
issue Taxpayer Assistance Orders (TAO) to intervene on
behalf of taxpayers that make a positive action with
respect to taxpayer cases; to prepare an annual report
of the most significant problems taxpayers face when
conducting business with IRS and suggest solutions
where applicable; and to establish a system to track the
Service’s response to changes suggested in the annual
report. Del. Order 239 amended.
Notice 96–10, page 47.
Books and records; imaging systems. This notice
provides a proposed revenue procedure regarding the
use by taxpayers of an imaging system to satisfy the
requirement of section 6001 of the Code to maintain
books and records.
Announcement 96–8, page 56.
Publication 595, Tax Guide for Commercial Fishermen,
is corrected.
Finding Lists begin on page 60.
Announcement of Disbarments and Suspensions begins on page 57.

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Mission of the Service
The purpose of the Internal Revenue Service is to
collect the proper amount of tax revenue at the least
cost; serve the public by continually improving the
quality of our products and services; and perform in a
manner warranting the highest degree of public
confidence in our integrity, efficiency and fairness.
Statement of Principles
of Internal Revenue
Tax Administration
The function of the Internal Revenue Service is to
administer the Internal Revenue Code. Tax policy
for raising revenue is determined by Congress.
With this in mind, it is the duty of the Service to
carry out that policy by correctly applying the laws
enacted by Congress; to determine the reasonable
meaning of various Code provisions in light of the
Congressional purpose in enacting them; and to
perform this work in a fair and impartial manner,
with neither a government nor a taxpayer point of
view.
At the heart of administration is interpretation of the
Code. It is the responsibility of each person in the
Service, charged with the duty of interpreting the
law, to try to find the true meaning of the statutory
provision and not to adopt a strained construction in
the belief that he or she is ‘‘protecting the revenue.’’
The revenue is properly protected only when we as-
certain and apply the true meaning of the statute.
The Service also has the responsibility of applying
and administering the law in a reasonable,
practical manner. Issues should only be raised by
examining officers when they have merit, never
arbitrarily or for trading purposes. At the same
time, the examining officer should never hesitate
to raise a meritorious issue. It is also important
that care be exercised not to raise an issue or to
ask a court to adopt a position inconsistent with
an established Service position.
Administration should be both reasonable and
vigorous. It should be conducted with as little
delay as possible and with great courtesy and
considerateness. It should never try to overreach,
and should be reasonable within the bounds of law
and sound administration. It should, however, be
vigorous in requiring compliance with law and it
should be relentless in its attack on unreal tax
devices and fraud.

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Introduction
The Internal Revenue Bulletin is the authoritative
instrument of the Commissioner of Internal Revenue for
announcing official rulings and procedures of the
Internal Revenue Service and for publishing Treasury
Decisions, Executive Orders, Tax Conventions, legisla-
tion, court decisions, and other items of general
interest. It is published weekly and may be obtained
from the Superintendent of Documents on a subscrip-
tion basis. Bulletin contents of a permanent nature are
consolidated semiannually into Cumulative Bulletins,
which are sold on a single-copy basis.
It is the policy of the Service to publish in the Bulletin
all substantive rulings necessary to promote a uniform
application of the tax laws, including all rulings that
supersede, revoke, modify, or amend any of those
previously published in the Bulletin. All published
rulings apply retroactively unless otherwise indicated.
Procedures relating solely to matters of internal
management are not published; however, statements of
internal practices and procedures that affect the rights
and duties of taxpayers are published.
Revenue rulings represent the conclusions of the
Service on the application of the law to the pivotal facts
stated in the revenue ruling. In those based on
positions taken in rulings to taxpayers or technical
advice to Service field offices, identifying details and
information of a confidential nature are deleted to
prevent unwarranted invasions of privacy and to comply
with statutory requirements.
Rulings and procedures reported in the Bulletin do not
have the force and effect of Treasury Department
Regulations, but they may be used as precedents.
Unpublished rulings will not be relied on, used, or cited
as precedents by Service personnel in the disposition of
other cases. In applying published rulings and proce-
dures, the effect of subsequent legislation, regulations,
court decisions, rulings, and procedures must be
considered, and Service personnel and others con-
cerned are cautioned against reaching the same
conclusions in other cases unless the facts and
circumstances are substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—1986 Code.
This part includes rulings and decisions based on
provisions of the Internal Revenue Code of 1986.
Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows:
Subpart A, Tax Conventions, and Subpart B, Legislation
and Related Committee Reports.
Part III.—Administrative, Procedural, and Miscellanous.
To the extent practicable, pertinent cross references to
these subjects are contained in the other Parts and
Subparts. Also included in this part are Bank Secrecy
Act Administrative Rulings. Bank Secrecy Act Admin-
istrative Rulings are issued by the Department of the
Treasury’s Office of the Assistant Secretary
(Enforcement).
Part IV.—Items of General Interest.
With the exception of the Notice of Proposed Rulemak-
ing and the disbarment and suspension list included in
this part, none of these announcements are consoli-
dated in the Cumulative Bulletins.
The first Bulletin for each month includes an index for
the matters published during the preceding month.
These monthly indexes are cumulated on a quarterly
and semiannual basis, and are published in the first
Bulletin of the succeeding quarterly and semi-annual
period, respectively.
The Bulletin Index-Digest System, a research and
reference service supplementing the Bulletin, may be
obtained from the Superintendent of Documents on a
subscription basis. It consists of four Services: Service
No. 1, Income Tax; Service No. 2, Estate and Gift
Taxes; Service No. 3, Employment Taxes; Service No.
4, Excise Taxes. Each Service consists of a basic
volume and a cumulative supplement that provides (1)
finding lists of items published in the Bulletin, (2)
digests of revenue rulings, revenue procedures, and
other published items, and (3) indexes of Public Laws,
Treasury Decisions, and Tax Conventions.
The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents U.S. Government Printing Office, Washington, D.C. 20402.

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Part I. Rulings and Decisions Under the Internal Revenue Code of 1986
Section 704.—Partner’s Distributive
Share
26 CFR 1.704–4: Distribution on contributed
property.
T.D. 8642
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
Recognition of Gain or Loss by
Contributing Partner on Distribution
of Contributed Property or Other
Property
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations relating to the recogni-
tion of gain or loss on certain distribu-
tions of contributed property by a
partnership under section 704(c)(1)(B)
of the Internal Revenue Code of 1986
(Code). This document also contains
final regulations relating to the recogni-
tion of gain on certain distributions to a
contributing partner under section 737.
The final regulations affect partnerships
and their partners and are necessary to
provide guidance for complying with
the applicable tax law.
EFFECTIVE DATE: January 9, 1995.
FOR FURTHER INFORMATION
CONTACT: Stephen J. Coleman, (202)
622-3060 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
The Revenue Reconciliation Act of
1989 added section 704(c)(1)(B) and
section 704(c)(2) to the Internal Reve-
nue Code. Section 704(c)(1)(B) pro-
vides that, in the case of a distribution
of contributed property to another
partner within five years of its contri-
bution, the contributing partner must
recognize gain or loss in an amount
equal to the gain or loss the partner
would have been allocated under sec-
tion 704(c)(1)(A) on a sale of the
property by the partnership at its fair
market value at the time of the distri-
bution. Section 704(c)(2) provides an
exception for distributions of certain
like-kind property.
The Energy Policy Act of 1992
added section 737 to the Code. Section
737 requires a partner who contributes
appreciated property to recognize gain
on a subsequent distribution of other
property to the contributing partner to
the extent of the lesser of (i) the net
precontribution gain on property con-
tributed by the partner, or (ii) the
excess of the value of the distributed
property over the adjusted basis of the
partner’s interest in the partnership.
On January 9, 1995, a notice of pro-
posed rulemaking (PS–76–92; PS–51–
93 [1995–1 C.B. 1001]) under section
704(c)(1)(B) and section 737 was pub-
lished in the Federal Register (60 FR
2352). Written comments responding to
this notice were received. No public
hearing was held because no hearing
was requested. After consideration of
all comments received, the proposed
regulations under section 704(c)(1)(B)
and section 737 are adopted as revised
by this Treasury decision.
Summary of Significant Comments
and Revisions
The significant comments on the
proposed regulations and the revisions
made in the final regulations are
discussed below.
A.Section 704(c)(1)(B)
Determination of Gain and Loss
The proposed regulations provide
that section 704(c)(1)(B) applies only
to a distribution that is properly charac-
terized as a distribution to a partner
acting in the capacity of a partner
within the meaning of section 731 and
section 737, and not to a transaction or
distribution that is subject to provisions
other than section 731(a) or section
737. Comments requested that the pro-
vision be clarified. The final regula-
tions clarify that section 704(c)(1)(B)
applies only to the extent that a trans-
action is a distribution under section
731. References to transactions and
distributions not subject to section
704(c)(1)(B) have been deleted.
One commentator suggested certain
clarifying revisions to the proposed
regulations’ definition of fair market
value. The definition in the proposed
regulations, however, is identical to the
definition of fair market value in the
704(b) regulations, and distributed
property should have the same fair
market value for purposes of determin-
ing gain and loss under section
704(c)(1)(B) and determining capital
account adjustments under section
704(b). The final regulations therefore
adopt the definition in the proposed
regulations without change.
The proposed regulations provide
that the amount of gain or loss
resulting from a distribution of part-
nership property is determined as if the
distributed property had been sold by
the partnership to the distributee part-
ner. As a result, if built-in loss property
is distributed to a partner that holds
more than a 50 percent interest in
partnership capital or profits, the built-
in loss that otherwise would be recog-
nized is disallowed under section
707(b)(1)(A). One commentator sug-
gested that section 704(c)(1)(B) was
intended to address disguised sales
between partners and that, therefore, a
loss should be disallowed on a distribu-
tion only if it would be disallowed on a
direct sale between the partners. Sec-
tion 704(c)(1)(B), however, respects the
form of the transaction as between the
partnership and a partner and does not
recast the transaction as a disguised
sale. See H.R. Rep. No. 247, 101st
Cong., 1st Sess. 406 (1989). The final
regulations therefore adopt the pro-
posed regulations without change.
Several of the provisions in the
proposed regulations refer to distribu-
tions that are part of ‘‘the same plan or
arrangement.’’ Commentators requested
clarification of this term. The reference
to distributions that are part of the
same plan or arrangement was intended
to reflect the fact that distributions of
multiple properties to one partner or
distributions of different properties to
more than one partner over a period of
time may be treated as part of the same
distribution under general principles of
taxation, such as the step transaction
doctrine. The final regulations remove
the reference to ‘‘same plan or arrange-
ment’’ and refers to distributions that
are part of the same distribution. This
change is made for simplification only

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and is not intended as a substantive
change to the scope of a distribution
for tax purposes. As under current law,
distributions do not need to be contem-
poraneous to be part of the same
distribution.
Several comments were received re-
garding the effect of a partnership
termination under section 708(b)(1)(B).
One comment suggested that it was not
clear whether property that had pre-
viously been contributed to the part-
nership (and was therefore already
subject to a five-year period) was
subject to a new five-year period after
the termination. The final regulations
clarify that a new five-year period does
not begin to the extent of any pre-
termination gain or loss that would
have been allocated to a contributing
partner under section 704(c)(1)(A) on a
sale of contributed property imme-
diately before the termination.
The legislative history of section
704(c)(1)(B) indicates that a con-
structive termination does not change
the application of section 704(c) to pre-
contribution gain or loss on property
contributed to the partnership before
termination. One comment read this
legislative history as possibly suggest-
ing that a pro rata distribution is
deemed to occur under section 708(b)-
(1)(B) for section 704(c)(1)(A) pur-
poses, but a different distribution is
deemed to occur for section 704(c)(1)-
(B) purposes. The comment expressed
concern about the complexity of such a
system. Section 704(c)(1)(B), however,
does not require or impose such a
‘‘hybrid system.’’ The amount of gain
or loss under section 704(c)(1)(B) is
determined by reference to the amount
of gain or loss that would have been
allocated to the partner under section
704(c)(1)(A) if the property had been
sold. Thus, property of a partnership
t h a t t e r m i n a t e s u n d e r s e c t i o n
708(b)(1)(B) is deemed to be dis-
tributed to the partners in the same
manner for both sections.
Another comment suggested it was
unclear whether section 704(c)(1)(B)
could apply to property that had not
been contributed by a partner to the
partnership prior to the termination.
The final regulations confirm that a
new five-year period begins for all
property that is deemed contributed to
the new partnership after the termina-
tion (which would include property not
actually contributed to the partnership),
except to the extent that such built-in
gain or loss would have been allocated
to the contributing partner under sec-
tion 704(c)(1)(A) on a sale of the
contributed property immediately be-
fore the termination.
Commentators also requested guid-
ance on the interaction of section
708(b)(1)(B) and section 704(c) in
general. The IRS and Treasury recog-
nize the need for additional guidance
on this issue, but such guidance is
beyond the scope of these regulations.
The IRS and Treasury are considering a
separate project involving the interac-
tion of section 704(c) and section
708(b)(1)(B) and invite additional com-
ments and suggestions regarding the
project.
Exceptions
The proposed regulations provide
that section 704(c)(1)(B) does not
apply to property contributed to the
partnership on or before October 3,
1989. One commentator requested an
exception for property required to be
contributed under a binding contract
entered into on or before October 3,
1989. The statutory effective date
provisions, however, do not contain a
binding contract exception. Accord-
ingly, the final regulations adopt the
proposed regulations without change.
One commentator suggested an addi-
tional exception for distributions of an
undivided interest in property. The
final regulations provide that section
704(c)(1)(B) does not apply to such a
distribution to the extent that the
distributed interest does not exceed the
undivided interest contributed by the
distributee partner.
One commentator also requested an
additional exception for distributions of
fungible property because the partners
may not be able to track the specific
contributed property. The final regula-
tions do not provide such an exception.
Contributed property may be fungible
from an economic perspective, but such
property is generally not fungible for
tax purposes because each contributed
property will have its own individual
tax basis.
The proposed regulations provide an
exception for distributions of section
704(c) property to a noncontributing
partner in liquidation of the partnership
if the contributing partner receives an
interest in the contributed property and
the built-in gain or loss in that property
is equal to or greater than the built-in
gain or loss that would have otherwise
been allocated to the contributing part-
ner. One commentator suggested that
the exception more clearly indicate the
amount of built-in gain or loss that
must be reflected in the property dis-
tributed to the contributing partner. The
final regulations clarify that the amount
of the built-in gain or loss must be
equal to the gain or loss that would
have been allocated to the contributing
partner under section 704(c)(1)(A) if
the contributed property had been sold
immediately before the distribution.
One commentator also suggested ex-
panding this exception to apply to the
extent of the built-in gain or loss in the
property distributed to the contributing
partner. This comment is not adopted
in the final regulations. The exception
was intended to apply only in the
limited situation in which a partnership
liquidates and the value of the contrib-
uted property exceeds the contributing
partner’s capital account. In that situa-
tion, the portion of the contributed
property in excess of the contributing
partner’s capital account would have to
be distributed to another partner,
thereby triggering section 704(c)(1)(B).
The exception allows a partner to avoid
section 704(c)(1)(B) in this situation,
so long as the built-in gain or loss in
the property distributed to the contrib-
uting partner is at least equal to the
gain or loss that would have been
allocated to the contributing partner
under section 704(c)(1)(A) if the con-
tributed property had been sold imme-
diately before the distribution.
Special Rules
The proposed regulations provide a
special rule under section 704(c)(2) for
situations in which the partnership
distributes like-kind property to a con-
tributing partner within a specified
period of the distribution of the prop-
erty contributed by that partner. Under
this rule, the gain or loss that otherwise
would have been recognized on the dis-
tribution of the contributed property is
reduced by the amount of the con-
tributing partner’s built-in gain or loss
in the distributed like-kind property.
One commentator criticized this rule as
i n c o n s i s t e n t w i t h t h e s t a t u t o r y
provision.
Section 704(c)(2) provides that
‘‘[u]nder regulations prescribed by the
Secretary, .. . to the extent of the value
of the [like-kind property distributed to
the contributing partner, the calculation

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of the contributing partner’s gain or
loss attributable to the distribution of
the contributed property] shall be [de-
termined] as if the contributing partner
had contributed to the partnership the
[like-kind] property.’’ This provision is
generally intended to treat the contrib-
uting partner as if the partner had
exchanged the contributed property for
like-kind property in a nontaxable
exchange outside of the partnership.
This allows the contributing partner to
avoid recognition of gain or loss under
section 704(c)(1)(B) on the distribution
of the contributed property to another
partner because the contributing partner
is treated as having contributed the
like-kind property, not the property that
is actually distributed to the other
partner.
If the contributing partner, however,
had engaged in a like-kind exchange
outside of the partnership, the partner’s
built-in gain or loss in the like-kind
property received would have been the
same as the property that was surren-
dered. The rule in the proposed regula-
tions reflects this result by limiting the
application of section 704(c)(2) to the
extent that the built-in gain or loss in
the contributed property is not pre-
served in the like-kind property dis-
tributed to the contributing partner. The
IRS and Treasury continue to believe
that the regulations properly implement
Congress’ objective with respect to this
provision. Therefore, the regulations
are finalized without change.
One commentator also suggested a
clarification of the interaction of the
like-kind exception and the disguised
sale rules of 707(a)(2)(B). The pro-
posed regulations provide that the like-
kind exception reduces any gain that
would have otherwise been recognized
under section 704(c)(1)(B). The pro-
posed regulations also provide that
section 704(c)(1)(B) applies only to a
distribution to a partner within the
meaning of section 731. There is no
suggestion in section 704(c)(2) or the
proposed regulations that the like-kind
exception was intended as an exception
to the disguised sale provisions. The
final regulations confirm that the dis-
guised sale provisions can apply to a
distribution, even if the distribution
would otherwise have qualified for the
section 704(c)(2) like-kind exception.
Anti-Abuse Rule
Commentators made several sugges-
tions for clarifying or modifying the
anti-abuse rule in the proposed regula-
tions. In particular, these commentators
requested clarification of the relation-
ship between this rule and the general
partnership anti-abuse rule in Treas.
Reg. section 1.701–2. The general anti-
abuse regulation is a rule of general
applicability that provides general prin-
ciples to be applied in interpreting and
applying all of the provisions of sub-
chapter K. In certain situations, how-
ever, more specific anti-abuse rules are
needed to carry out the purpose of a
particular provision. The final regula-
tions therefore adopt the rule in the
p r o p o s e d r e g u l a t i o n s w i t h o u t
modification.
B.Section 737
Determination of Gain
The final regulations are clarified to
provide that section 737 applies only to
the extent that a transaction is a
distribution under section 731. In ac-
cordance with section 737(d)(2), the
final regulations also provide that sec-
tion 737 does not apply to the extent
that section 751(b) applies to the
distribution.
Net Precontribution Gain
The proposed regulations provide
that a distributee partner’s net pre-
contribution gain is determined without
regard to the like-kind exception of
section 704(c)(2) in situations in which
the contributed property is not actually
distributed to another partner. One
commentator suggested deleting this
provision as superfluous. The final
regulations adopt the proposed regula-
tions without change. This provision
clarifies that section 737 does not
contain a like-kind exception similar to
the exception in section 704(c)(2).
Section 737 applies even if the prop-
erty received by the partner is of a
like-kind with the contributed property.
Character of Gain
One commentator suggested that the
proposed regulations fail to clarify
whether there are two groups (ordinary
and capital) for purposes of determin-
ing the character of a partner’s net
precontribution gain or whether there
may be an additional section 1231
group or section 1245 and section 1250
groups. The final regulations adopt the
proposed regulations without change.
The proposed regulations provide
that character for purposes of a part-
ner’s net precontribution gain is deter-
mined as if the contributed property
were sold to an unrelated third party.
As a result, all of the provisions that
are relevant in determining the charac-
ter of gain or loss on a sale are
relevant in determining the character of
the net precontribution gain. For exam-
ple, if the sale of property would have
resulted in part capital gain and part
ordinary income, the character of the
net precontribution gain for that prop-
erty is part ordinary and part capital.
The same approach applies in deter-
mining the allocation of any adjustment
to the partnership’s basis in partnership
property as a result of gain recognized
by the distributee partner. A basis
adjustment attributable to gain treated
as capital gain under section 1231
would be allocated to the property that
entered into the calculation of the
amount of section 1231 gain.
One commentator also suggested that
the proposed regulations do not clarify
whether character is determined at the
partnership or the partner level. This
determination may be important in
situations such as section 1231 where
the character of the gain or loss may
depend on the partner’s particular tax
circumstances. The final regulations
clarify that the character of the gain or
loss is determined at the partnership
level for this purpose.
Exceptions
One commentator suggested adding
an exception for certain divisive trans-
actions in which the contributing part-
ner continued to own an indirect
interest in the contributed property. The
final regulations add a new exception
under which section 737 does not apply
to a transfer of contributed property by
a transferor partnership to a transferee
partnership, followed by a distribution
of an interest in the transferee part-
nership (and no other property) to the
contributing partner in complete liqui-
dation of the partner’s interest.
This exception is added because the
distributee partner has simply converted
an interest in the transferor partnership
into an interest in a transferee part-
nership that holds the same contributed
section 704(c) property. The limitations
on this exception ensure that the
partner’s basis in the transferee part-
nership attributable to the contributed

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property is the same as the partner’s
basis in the transferor partnership at-
tributable to that property. This allows
a partnership to engage in a divisive
split-up transaction, while preventing
any avoidance of section 737 that
might occur as a result of the basis
allocation rules for non-liquidating
distributions.
The proposed regulations provide
that section 737 does not apply to an
incorporation of a partnership other
than an incorporation involving an
actual distribution of partnership prop-
erty to the partners. One commentator
suggested that this distinction between
methods of incorporation creates an
unnecessary trap for the unwary and
may have a chilling effect on the
conversion of partnerships into S cor-
porations. The final regulations adopt
the proposed regulations without
change. The form of incorporation
chosen by the partners is respected for
Federal tax purposes and, as a result,
the distribution of property in connec-
tion with the incorporation is treated as
a distribution for purposes of section
737.
One commentator suggested an addi-
tional exception for distributions of an
undivided interest in property similar to
that described with respect to the
regulations under section 704(c)(1)(B).
The final regulations provide a compar-
able rule under section 737.
Anti-Abuse Rule
Commentators made several sugges-
tions regarding the anti-abuse rule in
the proposed regulations. These sugges-
tions are essentially the same as the
comments regarding the anti-abuse rule
in the section 704(c)(1)(B) regulations,
and thus the comments are discussed
above.
Effective Date
These regulations are effective for
distributions by a partnership to a
partner on or after January 9, 1995.
Special Analyses
It has been determined that this
Treasury decision is not a significant
regulatory action as defined in EO
12866. Therefore, a regulatory assess-
ment is not required. It has also been
determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C.
chapter 5) and the Regulatory Flex-
ibility Act (5 U.S.C. chapter 6) do not
apply to these regulations and, there-
fore, a Regulatory Flexibility Analysis
is not required. Pursuant to section
7805(f) of the Internal Revenue Code,
the notice of proposed rulemaking
preceding these regulations was submit-
ted to the Chief Counsel for Advocacy
of the Small Business Administration
for comment on its impact on small
business.
Drafting Information
Several persons from the Office of
Chief Counsel and the Treasury De-
partment participated in the develop-
ment of these regulations.
******
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is
amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation
for part 1 is amended by adding the
following citation:
Authority: 26 U.S.C. 7805 * * *
Section 1.704–4 also issued under 26
U.S.C. 704(c) * * *
Par. 2. Section 1.704–4 is added to
read as follows:
§1.704–4 Distribution of contributed
property.
(a)Determination of gain and loss—
(1) In general. A partner that contrib-
utes section 704(c) property to a
partnership must recognize gain or loss
under section 704(c)(1)(B) and this
section on the distribution of such
property to another partner within five
years of its contribution to the part-
nership in an amount equal to the gain
or loss that would have been allocated
t o s u c h p a r t n e r u n d e r s e c t i o n
704(c)(1)(A) and §1.704–3 if the dis-
tributed property had been sold by the
partnership to the distributee partner for
its fair market value at the time of the
distribution. See §1.704–3(a)(3)(i) for a
definition of section 704(c) property.
(2)Transactions to which section
704(c)(1)(B) applies. Section 704(c)-
(1)(B) and this section apply only to
the extent that a distribution by a
partnership is a distribution to a partner
acting in the capacity of a partner
within the meaning of section 731.
(3)Fair market value of property.
The fair market value of the distributed
section 704(c) property is the price at
which the property would change hands
between a willing buyer and a willing
seller at the time of the distribution,
neither being under any compulsion to
buy or sell and both having reasonable
knowledge of the relevant facts. The
fair market value that a partnership
assigns to distributed section 704(c)
property will be regarded as correct,
provided that the value is reasonably
agreed to among the partners in an
arm’s-length negotiation and the part-
ners have sufficiently adverse interests.
( 4 )D e t e r m i n a t i o n o f f i v e - y e a r
period—(i) General rule. The five-year
period specified in paragraph (a)(1) of
this section begins on and includes the
date of contribution.
(ii)Section 708(b)(1)(B) termina-
tions. A termination of the partnership
under section 708(b)(1)(B) begins a
new five-year period for each partner
with respect to the built-in gain and
built-in loss property that the partner is
deemed to recontribute to a new
partnership following the termination,
but only to the extent that the pre-
termination built-in gain or loss, if any,
on such property would not have been
allocated to the contributing partner
under section 704(c)(1)(A) and §1.704–
3 on a sale of the contributed property
to an unrelated party immediately
before the termination. See §1.704–
3(a)(3)(ii) for the definitions of built-in
gain and built-in loss on section 704(c)
property.
(5)Examples. The following exam-
ples illustrate the rules of this para-
graph (a). Unless otherwise specified,
partnership income equals partnership
expenses (other than depreciation de-
ductions for contributed property) for
each year of the partnership, the fair
market value of partnership property
does not change, all distributions by
the partnership are subject to section
704(c)(1)(B), and all partners are
unrelated.
Example 1. Recognition of gain. (i) On
January 1, 1995, A, B, and C form partnership
ABC as equal partners. A contributes $10,000
cash and Property A, nondepreciable real prop-
erty with a fair market value of $10,000 and an
adjusted tax basis of $4,000. Thus, there is a
built-in gain of $6,000 on Property A at the time
of contribution. B contributes $10,000 cash and
Property B, nondepreciable real property with a

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fair market value and adjusted tax basis of
$10,000. C contributes $20,000 cash.
(ii)On December 31, 1998, Property A and
Property B are distributed to C in complete
liquidation of C’s interest in the partnership.
(iii)A would have recognized $6,000 of gain
under section 704(c)(1)(A) and §1.704–3 on the
sale of Property A at the time of the distribution
($10,000 fair market value less $4,000 adjusted
tax basis). As a result, A must recognize $6,000
of gain on the distribution of Property A to C. B
would not have recognized any gain or loss
under section 704(c)(1)(A) and §1.704–3 on the
sale of Property B at the time of distribution
because Property B was not section 704(c)
property. As a result, B does not recognize any
gain or loss on the distribution of Property B.
Example 2. Effect of post-contribution de-
preciation deductions. (i) On January 1, 1995, A,
B, and C form partnership ABC as equal
partners. A contributes Property A, depreciable
property with a fair market value of $30,000 and
an adjusted tax basis of $20,000. Therefore, there
is a built-in gain of $10,000 on Property A. B
and C each contribute $30,000 cash. ABC uses
the traditional method of making section 704(c)
allocations described in §1.704–3(b) with respect
to Property A.
(ii)Property A is depreciated using the
straight-line method over its remaining 10-year
recovery period. The partnership has book
depreciation of $3,000 per year (10 percent of
the $30,000 book basis), and each partner is
allocated $1,000 of book depreciation per year
(one-third of the total annual book depreciation
of $3,000). The partnership has a tax deprecia-
tion deduction of $2,000 per year (10 percent of
the $20,000 tax basis in Property A). This $2,000
tax depreciation deduction is allocated equally
between B and C, the noncontributing partners
with respect to Property A.
(iii)At the end of the third year, the book
value of Property A is $21,000 ($30,000 initial
book value less $9,000 aggregate book deprecia-
tion) and the adjusted tax basis is $14,000
($20,000 initial tax basis less $6,000 aggregate
tax depreciation). A’s remaining section
704(c)(1)(A) built-in gain with respect to Prop-
erty A is $7,000 ($21,000 book value less
$14,000 adjusted tax basis).
(iv)On December 31, 1997, Property A is
distributed to B in complete liquidation of B’s
interest in the partnership. If Property A had
been sold for its fair market value at the time of
the distribution, A would have recognized $7,000
of gain under section 704(c)(1)(A) and §1.704–
3(b). Therefore, A recognizes $7,000 of gain on
the distribution of Property A to B.
Example 3. Effect of remedial method. (i) On
January 1, 1995, A, B, and C form partnership
ABC as equal partners. A contributes Property
A1, nondepreciable real property with a fair
market value of $10,000 and an adjusted tax
basis of $5,000, and Property A2, nondepreciable
real property with a fair market value and
adjusted tax basis of $10,000. B and C each
contribute $20,000 cash. ABC uses the remedial
method of making section 704(c) allocations
described in §1.704–3(d) with respect to Property
A1.
(ii)On December 31, 1998, when the fair
market value of Property A1 has decreased to
$7,000, Property A1 is distributed to C in a
current distribution. If Property A1 had been sold
by the partnership at the time of the distribution,
ABC would have recognized the $2,000 of
r e m a i n i n g b u i l t - i n g a i n u n d e r s e c t i o n
704(c)(1)(A) on the sale (fair market value of
$7,000 less $5,000 adjusted tax basis). All of this
gain would have been allocated to A. ABC
would also have recognized a book loss of
$3,000 ($10,000 original book value less $7,000
current fair market value of the property). Book
loss in the amount of $2,000 would have been
allocated equally between B and C. Under the
remedial method, $2,000 of tax loss would also
have been allocated equally to B and C to match
their share of the book loss. As a result, $2,000
of gain would also have been allocated to A as
an offsetting remedial allocation. A would have
recognized $4,000 of total gain under section
704(c)(1)(A) on the sale of Property A1 ($2,000
of section 704(c) recognized gain plus $2,000
remedial gain). Therefore, A recognizes $4,000
of gain on the distribution of Property A1 to C
under this section.
(b)Character of gain or loss—(1)
General rule. Gain or loss recognized
by the contributing partner under sec-
tion 704(c)(1)(B) and this section has
the same character as the gain or loss
that would have resulted if the dis-
tributed property had been sold by the
partnership to the distributee partner at
the time of the distribution.
(2)Example. The following example
illustrates the rule of this paragraph (b).
Unless otherwise specified, partnership
income equals partnership expenses
(other than depreciation deductions for
contributed property) for each year of
the partnership, the fair market value of
partnership property does not change,
all distributions by the partnership are
subject to section 704(c)(1)(B), and all
partners are unrelated.
Example. Character of gain. (i) On January 1,
1995, A and B form partnership AB. A
contributes $10,000 and Property A, nondepre-
ciable real property with a fair market value of
$10,000 and an adjusted tax basis of $4,000, in
exchange for a 25 percent interest in partnership
capital and profits. B contributes $60,000 cash
for a 75 percent interest in partnership capital
and profits.
(ii)On December 31, 1998, Property A is
distributed to B in a current distribution.
Property A is used in a trade or business of B.
(iii)A would have recognized $6,000 of gain
under section 704(c)(1)(A) on a sale of Property
A at the time of the distribution (the difference
between the fair market value ($10,000) and the
adjusted tax basis ($4,000) of the property at that
time). Because Property A is not a capital asset
in the hands of Partner B and B holds more than
50 percent of partnership capital and profits, the
character of the gain on a sale of Property A to
B would have been ordinary income under
section 707(b)(2). Therefore, the character of the
gain to A on the distribution of Property A to B
is ordinary income.
(c)Exceptions—(1) Property con-
tributed on or before October 3, 1989.
Section 704(c)(1)(B) and this section
do not apply to property contributed to
the partnership on or before October 3,
1989.
(2)Certain liquidations. Section
704(c)(1)(B) and this section do not
apply to a distribution of an interest in
section 704(c) property to a partner
other than the contributing partner in a
liquidation of the partnership if—
(i)The contributing partner receives
an interest in the section 704(c) prop-
erty contributed by that partner (and no
other property); and
(ii)The built-in gain or loss in the
interest distributed to the contributing
partner, determined immediately after
the distribution, is equal to or greater
than the built-in gain or loss on the
property that would have been allo-
cated to the contributing partner under
section 704(c)(1)(A) and §1.704–3 on a
sale of the contributed property to an
unrelated party immediately before the
distribution.
(3)Section 708(b)(1)(B) termination.
Section 704(c)(1)(B) and this section
do not apply to a deemed distribution
of property caused by a termination of
the partnership under section 708(b)(1)-
(B). See paragraph (a)(4)(ii) of this
section for a special rule regarding a
new five-year period for certain prop-
erty deemed contributed to a new
partnership following a termination of
t h e p a r t n e r s h i p u n d e r s e c t i o n
708(b)(1)(B). See also §1.737–2(a) for
a similar rule in the context of section
737.
(4)Complete transfer to another
partnership. Section 704(c)(1)(B) and
this section do not apply to a transfer
by a partnership (transferor partnership)
of all of its assets and liabilities to a
second partnership (transferee part-
nership) in an exchange described in
section 721, followed by a distribution
of the interest in the transferee part-
nership in liquidation of the transferor
partnership as part of the same plan or
arrangement. A subsequent distribution
of section 704(c) property by the
transferee partnership to a partner of
the transferee partnership is subject to
section 704(c)(1)(B) to the same extent
that a distribution by the transferor
partnership would have been subject to
section 704(c)(1)(B). See §1.737–2(b)
for a similar rule in the context of
section 737.
(5)Incorporation of a partnership.
Section 704(c)(1)(B) and this section
do not apply to an incorporation of a
partnership by any method of incor-

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poration (other than a method involving
an actual distribution of partnership
property to the partners followed by a
contribution of that property to a
corporation), provided that the part-
nership is liquidated as part of the
incorporation transaction. See §1.737–
2(c) for a similar rule in the context of
section 737.
(6)Undivided interests. Section
704(c)(1)(B) and this section do not
apply to a distribution of an undivided
interest in property to the extent that
the undivided interest does not exceed
the undivided interest, if any, contrib-
uted by the distributee partner in the
same property. See §1.737–2(d)(4) for
the application of section 737 in a
similar context. The portion of the
undivided interest in property retained
by the partnership after the distribution,
if any, that is treated as contributed by
the distributee partner, is reduced to the
extent of the undivided interest dis-
tributed to the distributee partner.
(7)Example. The following example
illustrates the rule of paragraph (c)(2)
of this section. Unless otherwise spec-
ified, partnership income equals part-
nership expenses (other than deprecia-
t i o n d e d u c t i o n s f o r c o n t r i b u t e d
property) for each year of the part-
nership, the fair market value of
partnership property does not change,
all distributions by the partnership are
subject to section 704(c)(1)(B), and all
partners are unrelated.
Example. (i) On January 1, 1995, A and B
form partnership AB, as equal partners. A
contributes Property A, nondepreciable real
property with a fair market value and adjusted
tax basis of $20,000. B contributes Property B,
nondepreciable real property with a fair market
value of $20,000 and an adjusted tax basis of
$10,000. Property B therefore has a built-in gain
of $10,000 at the time of contribution.
(ii)On December 31, 1998, the partnership
liquidates when the fair market value of Property
A has not changed, but the fair market value of
Property B has increased to $40,000.
(iii)In the liquidation, A receives Property A
and a 25 percent interest in Property B. This
interest in Property B has a fair market value of
$10,000 to A, reflecting the fact that A was
entitled to 50 percent of the $20,000 post-
contribution appreciation in Property B. The
partnership distributes to B a 75 percent interest
in Property B with a fair market value of
$30,000. B’s basis in this portion of Property B
is $10,000 under section 732(b). As a result, B
has a built-in gain of $20,000 in this portion of
Property B immediately after the distribution
($30,000 fair market value less $10,000 adjusted
tax basis). This built-in gain is greater than the
$10,000 of built-in gain in Property B at the time
of contribution to the partnership. B therefore
does not recognize any gain on the distribution
of a portion of Property B to A under this
section.
(d)Special rules—(1) Nonrecogni-
tion transactions. Property received by
the partnership in exchange for section
704(c) property in a nonrecognition
transaction is treated as the section
704(c) property for purposes of section
704(c)(1)(B) and this section to the
extent that the property received is
treated as section 704(c) property under
§1.704–3(a)(8). See §1.737–2(d)(3) for
a similar rule in the context of section
737.
(2)Transfers of a partnership inter-
est. The transferee of all or a portion of
the partnership interest of a contribut-
ing partner is treated as the contribut-
ing partner for purposes of section
704(c)(1)(B) and this section to the
extent of the share of built-in gain or
loss allocated to the transferee partner.
See §1.704–3(a)(7).
(3)Distributions of like-kind prop-
erty. If section 704(c) property is
distributed to a partner other than the
contributing partner and like-kind prop-
erty (within the meaning of section
1031) is distributed to the contributing
partner no later than the earlier of (i)
180 days following the date of the
distribution to the non-contributing
partner, or (ii) the due date (determined
with regard to extensions) of the
contributing partner’s income tax return
for the taxable year of the distribution
to the noncontributing partner, the
amount of gain or loss, if any, that the
contributing partner would otherwise
have recognized under section 704(c)-
(1)(B) and this section is reduced by
the amount of built-in gain or loss in
the distributed like-kind property in the
hands of the contributing partner imme-
diately after the distribution. The con-
tributing partner’s basis in the dis-
t r i b u t e d l i k e - k i n d p r o p e r t y i s
determined as if the like-kind property
were distributed in an unrelated dis-
tribution prior to the distribution of any
other property distributed as part of the
same distribution and is determined
without regard to the increase in the
contributing partner’s adjusted tax basis
in the partnership interest under section
704(c)(1)(B) and this section. See
§1.707–3 for provisions treating the
distribution of the like-kind property to
the contributing partner as a disguised
sale in certain situations.
(4)Example. The following example
illustrates the rules of this paragraph
(d). Unless otherwise specified, part-
nership income equals partnership ex-
penses (other than depreciation deduc-
tions for contributed property) for each
year of the partnership, the fair market
value of partnership property does not
change, all distributions by the part-
n e r s h i p a r e s u b j e c t t o s e c t i o n
704(c)(1)(B), and all partners are
unrelated.
Example. Distribution of like-kind property. (i)
On January 1, 1995, A, B, and C form
partnership ABC as equal partners. A contributes
Property A, nondepreciable real property with a
fair market value of $20,000 and an adjusted tax
basis of $10,000. B and C each contribute
$20,000 cash. The partnership subsequently buys
Property X, nondepreciable real property of a
like-kind to Property A with a fair market value
and adjusted tax basis of $8,000. The fair market
value of Property X subsequently increases to
$10,000.
(ii)On December 31, 1998, Property A is
distributed to B in a current distribution. At the
same time, Property X is distributed to A in a
current distribution. The distribution of Property
X does not result in the contribution of Property
A being properly characterized as a disguised
sale to the partnership under §1.707–3. A’s basis
in Property X is $8,000 under section 732(a)(1).
A therefore has $2,000 of built-in gain in
Property X ($10,000 fair market value less
$8,000 adjusted tax basis).
(iii)A would generally recognize $10,000 of
gain under section 704(c)(1)(B) on the distribu-
tion of Property A, the difference between the
fair market value ($20,000) of the property and
its adjusted tax basis ($10,000). This gain is
reduced, however, by the amount of the built-in
gain of Property X in the hands of A. As a
result, A recognizes only $8,000 of gain on the
distribution of Property A to B under section
704(c)(1)(B) and this section.
(e)Basis adjustments—(1) Contrib-
uting partner’s basis in the partnership
interest. The basis of the contributing
partner’s interest in the partnership is
increased by the amount of the gain, or
decreased by the amount of the loss,
recognized by the partner under section
704(c)(1)(B) and this section. This
increase or decrease is taken into
account in determining (i) the contrib-
uting partner’s adjusted tax basis under
section 732 for any property distributed
to the partner in a distribution that is
part of the same distribution as the
distribution of the contributed property,
other than like-kind property described
in paragraph (d)(3) of this section
(pertaining to the special rule for
distributions of like-kind property), and
(ii) the amount of the gain recognized
by the contributing partner under sec-
tion 731 or section 737, if any, on a
distribution of money or property to the
contributing partner that is part of the
same distribution as the distribution of
the contributed property. For a deter-
mination of basis in a distribution
subject to section 737, see §1.737–3(a).

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(2)Partnership’s basis in part-
nership property. The partnership’s
adjusted tax basis in the distributed
section 704(c) property is increased or
decreased immediately before the dis-
tribution by the amount of gain or loss
recognized by the contributing partner
under section 704(c)(1)(B) and this
section. Any increase or decrease in
basis is therefore taken into account in
determining the distributee partner’s
adjusted tax basis in the distributed
property under section 732. For a
determination of basis in a distribution
subject to section 737, see §1.737–3(b).
(3)Section 754 adjustments. The
basis adjustments to partnership prop-
erty made pursuant to paragraph (e)(2)
of this section are not elective and
must be made regardless of whether the
partnership has an election in effect
under section 754. Any adjustments to
the bases of partnership property (in-
cluding the distributed section 704(c)
property) under section 734(b) pursuant
to a section 754 election must be made
after (and must take into account) the
adjustments to basis made under para-
graph (e)(2) of this section. See
§1.737–3(c)(4) for a similar rule in the
context of section 737.
(4)Example. The following example
illustrates the rules of this paragraph
(e). Unless otherwise specified, part-
nership income equals partnership ex-
penses (other than depreciation deduc-
tions for contributed property) for each
year of the partnership, the fair market
value of partnership property does not
change, all distributions by the part-
nership are subject to section 704(c)-
(1)(B), and all partners are unrelated.
Example. Basis adjustment. (i) On January 1,
1995, A, B, and C form partnership ABC as
equal partners. A contributes $10,000 cash and
Property A, nondepreciable real property with a
fair market value of $10,000 and an adjusted tax
basis of $4,000. B and C each contribute $20,000
cash.
(ii)On December 31, 1998, Property A is
distributed to B in a current distribution.
(iii)Under paragraph (a) of this section, A
recognizes $6,000 of gain on the distribution of
Property A because that is the amount of gain
that would have been allocated to A under
section 704(c)(1)(A) and §1.704–3 on a sale of
Property A for its fair market value at the time
of the distribution (fair market value of Property
A ($10,000) less its adjusted tax basis at the time
of distribution ($4,000)). The adjusted tax basis
of A’s partnership interest is increased from
$14,000 to $20,000 to reflect this gain. The
partnership’s adjusted tax basis in Property A is
increased from $4,000 to $10,000 immediately
prior to its distribution to B. B’s adjusted tax
basis in Property A is therefore $10,000 under
section 732(a)(1).
(f)Anti-abuse rule—(1) In general.
The rules of section 704(c)(1)(B) and
this section must be applied in a
manner consistent with the purpose of
section 704(c)(1)(B). Accordingly, if a
principal purpose of a transaction is to
achieve a tax result that is inconsistent
with the purpose of section 704(c)(1)-
(B), the Commissioner can recast the
transaction for federal tax purposes as
appropriate to achieve tax results that
are consistent with the purpose of
section 704(c)(1)(B) and this section.
Whether a tax result is inconsistent
with the purpose of section 704(c)-
(1)(B) and this section must be deter-
mined based on all the facts and
circumstances. See §1.737–4 for an
anti-abuse rule and examples in the
context of section 737.
(2)Examples. The following exam-
ples illustrate the anti-abuse rule of this
paragraph (f). The examples set forth
below do not delineate the boundaries
of either permissible or impermissible
types of transactions. Further, the addi-
tion of any facts or circumstances that
are not specifically set forth in an
example (or the deletion of any facts or
circumstances) may alter the outcome
of the transaction described in the
example. Unless otherwise specified,
partnership income equals partnership
expenses (other than depreciation de-
ductions for contributed property) for
each year of the partnership, the fair
market value of partnership property
does not change, all distributions by
the partnership are subject to section
704(c)(1)(B), and all partners are un-
related.
Example 1. Distribution in substance made
within five-year period; results inconsistent with
the purpose of section 704(c)(1)(B). (i) On
January 1, 1995, A, B, and C form partnership
ABC as equal partners. A contributes Property
A, nondepreciable real property with a fair
market value of $10,000 and an adjusted tax
basis of $1,000. B and C each contributes
$10,000 cash.
(ii)On December 31, 1998, the partners desire
to distribute Property A to B in complete
liquidation of B’s interest in the partnership. If
Property A were distributed at that time,
however, A would recognize $9,000 of gain
under section 704(c)(1)(B), the difference be-
tween the $10,000 fair market value and the
$1,000 adjusted tax basis of Property A, because
Property A was contributed to the partnership
less than five years before December 31, 1998.
On becoming aware of this potential gain
recognition, and with a principal purpose of
avoiding such gain, the partners amend the
partnership agreement on December 31, 1998,
and take any other steps necessary to provide
that substantially all of the economic risks and
benefits of Property A are borne by B as of
December 31, 1998, and that substantially all of
the economic risks and benefits of all other
partnership property are borne by A and C. The
partnership holds Property A until January 5,
2000, at which time it is distributed to B in
complete liquidation of B’s interest in the
partnership.
(iii)The actual distribution of Property A
occurred more than five years after the contribu-
tion of the property to the partnership. The steps
taken by the partnership on December 31, 1998,
however, are the functional equivalent of an
actual distribution of Property A to B in
complete liquidation of B’s interest in the
partnership as of that date. Section 704(c)(1)(B)
requires recognition of gain when contributed
section 704(c) property is in substance dis-
tributed to another partner within five years of its
contribution to the partnership. Allowing a
contributing partner to avoid section 704(c)(1)(B)
through arrangements such as those in this
Example 1 that have the effect of a distribution
of property within five years of the date of its
contribution to the partnership would effectively
undermine the purpose of section 704(c)(1)(B)
and this section. As a result, the steps taken by
the partnership on December 31, 1998, are
treated as causing a distribution of Property A to
B for purposes of section 704(c)(1)(B) on that
date, and A recognizes gain of $9,000 under
section 704(c)(1)(B) and this section at that time.
(iv)Alternatively, if on becoming aware of
the potential gain recognition to A on a
distribution of Property A on December 31,
1998, the partners had instead agreed that B
would continue as a partner with no changes to
the partnership agreement or to B’s economic
interest in partnership operations, the distribution
of Property A to B on January 5, 2000, would
not have been inconsistent with the purpose of
section 704(c)(1)(B) and this section. In that
situation, Property A would not have been dis-
tributed until after the expiration of the five-year
period specified in section 704(c)(1)(B) and this
section. Deferring the distribution of Property A
until the end of the five-year period for a
principal purpose of avoiding the recognition of
gain under section 704(c)(1)(B) and this section
is not inconsistent with the purpose of section
704(c)(1)(B). Therefore, A would not have
recognized gain on the distribution of Property A
in that case.
Example 2. Suspension of five-year period in
manner consistent with the purpose of section
704(c)(1)(B). (i) A, B, and C form partnership
ABC on January 1, 1995, to conduct bona fide
business activities. A contributes Property A,
nondepreciable real property with a fair market
value of $10,000 and an adjusted tax basis of
$1,000, in exchange for a 49.5 percent interest in
partnership capital and profits. B contributes
$10,000 in cash for a 49.5 percent interest in
partnership capital and profits. C contributes cash
for a 1 percent interest in partnership capital and
profits. A and B are wholly owned subsidiaries
of the same affiliated group and continue to
control the management of Property A by virtue
of their controlling interests in the partnership.
The partnership is formed pursuant to a plan a
principal purpose of which is to minimize the
period of time that A would have to remain a
partner with a potential acquiror of Property A.
(ii)On December 31, 1997, D is admitted as a
partner to the partnership in exchange for
$10,000 cash.
(iii)On January 5, 2000, Property A is
distributed to D in complete liquidation of D’s
interest in the partnership.

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(iv)The distribution of Property A to D
occurred more than five years after the contribu-
tion of the property to the partnership. On these
facts, however, a principal purpose of the
transaction was to minimize the period of time
that A would have to remain partners with a
potential acquiror of Property A, and treating the
five-year period of section 704(c)(1)(B) as
running during a time when Property A was still
effectively owned through the partnership by
members of the contributing affiliated group of
which A is a member is inconsistent with the
purpose of section 704(c)(1)(B). Prior to the
admission of D as a partner, the pooling of assets
between A and B, on the one hand, and C, on
the other hand, although sufficient to constitute
ABC as a valid partnership for federal income
tax purposes, is not a sufficient pooling of assets
for purposes of running the five-year period with
respect to the distribution of Property A to D.
Allowing a contributing partner to avoid section
704(c)(1)(B) through arrangements such as those
in this Example 2 would have the effect of
substantially nullifying the five-year requirement
of section 704(c)(1)(B) and this section and
elevating the form of the transaction over its
substance. As a result, with respect to the
distribution of Property A to D, the five-year
period of section 704(c)(1)(B) is tolled until the
admission of D as a partner on December 31,
1997. Therefore, the distribution of Property A
occurred before the end of the five-year period
of section 704(c)(1)(B), and A recognizes gain of
$9,000 under section 704(c)(1)(B) on the
distribution.
(g)Effective date. This section ap-
plies to distributions by a partnership to
a partner on or after January 9, 1995.
Par. 3. Sections 1.737–1, 1.737–2,
1.737–3, 1.737–4, and 1.737–5 are
added to read as follows:
§1.737–1 Recognition of
precontribution gain.
(a)Determination of gain—(1) In
general. A partner that receives a
distribution of property (other than
money) must recognize gain under
section 737 and this section in an
amount equal to the lesser of the
excess distribution (as defined in para-
graph (b) of this section) or the
partner’s net precontribution gain (as
defined in paragraph (c) of this sec-
tion). Gain recognized under section
737 and this section is in addition to
any gain recognized under section 731.
(2)Transactions to which section
737 applies. Section 737 and this
section apply only to the extent that a
distribution by a partnership is a
distribution to a partner acting in the
capacity of a partner within the mean-
ing of section 731, except that section
737 and this section do not apply to the
extent that section 751(b) applies to the
distribution.
(b)Excess distribution—(1) Defini-
tion. The excess distribution is the
amount (if any) by which the fair
market value of the distributed property
(other than money) exceeds the dis-
tributee partner’s adjusted tax basis in
the partner’s partnership interest.
(2)Fair market value of property.
The fair market value of the distributed
property is the price at which the
property would change hands between
a willing buyer and a willing seller at
the time of the distribution, neither
being under any compulsion to buy or
sell and both having reasonable knowl-
edge of the relevant facts. The fair
market value that a partnership assigns
to distributed property will be regarded
as correct, provided that the value is
reasonably agreed to among the part-
ners in an arm’s-length negotiation and
the partners have sufficiently adverse
interests.
(3)Distributee partner’s adjusted
tax basis—(i) General rule. In deter-
mining the amount of the excess
distribution, the distributee partner’s
adjusted tax basis in the partnership
interest includes any basis adjustment
resulting from the distribution that is
subject to section 737 (for example,
adjustments required under section 752)
and from any other distribution or
transaction that is part of the same
distribution, except for—
(A)The increase required under sec-
tion 737(c)(1) for the gain recognized
by the partner under section 737; and
(B)The decrease required under sec-
tion 733(2) for any property distributed
to the partner other than property
previously contributed to the part-
nership by the distributee partner. See
§1.704–4(e)(1) for a rule in the context
of section 704(c)(1)(B). See also
§1.737–3(b)(2) for a special rule for
determining a partner’s adjusted tax
basis in distributed property previously
contributed by the partner to the
partnership.
(ii)Advances or drawings. The dis-
tributee partner’s adjusted tax basis in
the partnership interest is determined as
of the last day of the partnership’s
taxable year if the distribution to which
section 737 applies is properly charac-
terized as an advance or drawing
against the partner’s distributive share
of income. See §1.731–1(a)(1)(ii).
(c)Net precontribution gain—(1)
General rule. The distributee partner’s
net precontribution gain is the net gain
(if any) that would have been recog-
nized by the distributee partner under
section 704(c)(1)(B) and §1.704–4 if
all property that had been contributed
to the partnership by the distributee
partner within five years of the dis-
tribution and is held by the partnership
immediately before the distribution had
been distributed by the partnership to
another partner other than a partner
who owns, directly or indirectly, more
than 50 percent of the capital or profits
interest in the partnership. See §1.704–
4 for provisions determining a contrib-
uting partner’s gain or loss under
section 704(c)(1)(B) on an actual dis-
tribution of contributed section 704(c)
property to another partner.
(2)Special rules—(i) Property con-
tributed on or before October 3, 1989.
Property contributed to the partnership
on or before October 3, 1989, is not
taken into account in determining a
partner’s net precontribution gain. See
§1.704–4(c)(1) for a similar rule in the
context of section 704(c)(1)(B).
(ii)Section 734(b)(1)(A) adjust-
ments. For distributions to a distributee
partner of money by a partnership with
a section 754 election in effect that are
part of the same distribution as the
distribution of property subject to sec-
tion 737, for purposes of paragraph (a)
and (c)(1) of this section the distributee
partner’s net precontribution gain is
reduced by the basis adjustments (if
any) made to section 704(c) property
contributed by the distributee partner
under section 734(b)(1)(A). See
§1.737–3(c)(4) for rules regarding basis
adjustments for partnerships with a
section 754 election in effect.
(iii)Transfers of a partnership inter-
est. The transferee of all or a portion of
a contributing partner’s partnership in-
terest succeeds to the transferor’s net
precontribution gain, if any, in an
amount proportionate to the interest
transferred. See §1.704–3(a)(7) and
§1.704–4(d)(2) for similar provisions in
the context of section 704(c)(1)(A) and
section 704(c)(1)(B).
(iv)Section 704(c)(1)(B) gain recog-
nized in related distribution. A dis-
tributee partner’s net precontribution
gain is determined after taking into
account any gain or loss recognized by
the partner under section 704(c)(1)(B)
and §1.704–4 (or that would have been
recognized by the partner except for
the like-kind exception in section
704(c)(2) and §1.704–4(d)(3)) on an
actual distribution to another partner of
section 704(c) property contributed by

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the distributee partner that is part of the
same distribution as the distribution to
the distributee partner.
(v)Section 704(c)(2) disregarded. A
distributee partner’s net precontribution
gain is determined without regard to
the provisions of section 704(c)(2) and
§1.704–4(d)(3) in situations in which
the property contributed by the dis-
tributee partner is not actually dis-
tributed to another partner in a distribu-
tion related to the section 737
distribution.
(d)Character of gain. The character
of the gain recognized by the dis-
tributee partner under section 737 and
this section is determined by, and is
proportionate to, the character of the
partner’s net precontribution gain. For
this purpose, all gains and losses on
section 704(c) property taken into
account in determining the partner’s net
precontribution gain are netted accord-
ing to their character. Character is
determined at the partnership level for
this purpose, and any character with a
net negative amount is disregarded. The
character of the partner’s gain under
section 737 is the same as, and in
proportion to, any character with a net
positive amount. Character for this
purpose is determined as if the section
704(c) property had been sold by the
partnership to an unrelated third party
at the time of the distribution and
includes any item that would have been
taken into account separately by the
contributing partner under section
702(a) and §1.702–1(a).
(e)Examples. The following exam-
ples illustrate the provisions of this
section. Unless otherwise specified,
partnership income equals partnership
expenses (other than depreciation de-
ductions for contributed property) for
each year of the partnership, the fair
market value of partnership property
does not change, all distributions by
the partnership are subject to section
737, and all partners are unrelated.
Example 1. Calculation of excess distribution
and net precontribution gain. (i) On January 1,
1995, A, B, and C form partnership ABC as
equal partners. A contributes Property A, depre-
ciable real property with a fair market value of
$30,000 and an adjusted tax basis of $20,000. B
contributes Property B, nondepreciable real prop-
erty with a fair market value and adjusted tax
basis of $30,000. C contributes $30,000 cash.
(ii)Property A has 10 years remaining on its
cost recovery schedule and is depreciated using
the straight-line method. The partnership uses the
traditional method for allocating items under
section 704(c) described in §1.704–3(b)(1) for
Property A. The partnership has book deprecia-
tion of $3,000 per year (10 percent of the
$30,000 book basis in Property A) and each
partner is allocated $1,000 of book depreciation
per year (one-third of the total annual book
depreciation of $3,000). The partnership also has
tax depreciation of $2,000 per year (10 percent
of the $20,000 adjusted tax basis in Property A).
This $2,000 tax depreciation is allocated equally
between B and C, the noncontributing partners
with respect to Property A.
(iii)At the end of 1997, the book value of
Property A is $21,000 ($30,000 initial book
value less $9,000 aggregate book depreciation)
and its adjusted tax basis is $14,000 ($20,000
initial tax basis less $6,000 aggregate tax
depreciation).
(iv)On December 31, 1997, Property B is
distributed to A in complete liquidation of A’s
partnership interest. The adjusted tax basis of
A’s partnership interest at that time is $20,000.
The amount of the excess distribution is $10,000,
the difference between the fair market value of
the distributed Property B ($30,000) and A’s
adjusted tax basis in A’s partnership interest
($20,000). A’s net precontribution gain is $7,000,
the difference between the book value of
Property A ($21,000) and its adjusted tax basis at
the time of the distribution ($14,000). A
recognizes gain of $7,000 on the distribution, the
lesser of the excess distribution and the net
precontribution gain.
Example 2. Determination of distributee part-
ner’s basis. (i) On January 1, 1995, A, B, and C
form general partnership ABC as equal partners.
A contributes Property A, nondepreciable real
property with a fair market value of $10,000 and
an adjusted tax basis of $4,000. B and C each
contributes $10,000 cash.
(ii)The partnership purchases Property B,
nondepreciable real property with a fair market
value of $9,000, subject to a $9,000 nonrecourse
liability. This nonrecourse liability is allocated
equally among the partners under section 752,
increasing A’s adjusted tax basis in A’s part-
nership interest from $4,000 to $7,000.
(iii)On December 31, 1998, A receives
$2,000 cash and Property B, subject to the
$9,000 liability, in a current distribution.
(iv)In determining the amount of the excess
distribution, the adjusted tax basis of A’s
partnership interest is adjusted to take into
account the distribution of money and the shift in
liabilities. A’s adjusted tax basis is therefore
increased to $11,000 for this purpose ($7,000
initial adjusted tax basis, less $2,000 distribution
of money, less $3,000 (decrease in A’s share of
the $9,000 partnership liability), plus $9,000
(increase in A’s individual liabilities)). As a
result of this basis adjustment, the adjusted tax
basis of A’s partnership interest ($11,000) is
greater than the fair market value of the
distributed property ($9,000) and therefore, there
is no excess distribution. A recognizes no gain
under section 737.
Example 3. Net precontribution gain reduced
for gain recognized under section 704(c)(1)(B).
(i) On January 1, 1995, A, B, and C form
partnership ABC as equal partners. A contributes
Properties A1 and A2, nondepreciable real
properties located in the United States each with
a fair market value of $10,000 and an adjusted
tax basis of $6,000. B contributes Property B,
nondepreciable real property located outside the
United States, with a fair market value and
adjusted tax basis of $20,000. C contributes
$20,000 cash.
(ii)On December 31, 1998, Property B is
distributed to A in complete liquidation of A’s
interest and, as part of the same distribution,
Property A1 is distributed to B in a current
distribution.
(iii)A’s net precontribution gain before the
distribution is $8,000 ($20,000 fair market value
of Properties A1 and A2 less $12,000 adjusted
tax basis of such properties). A recognizes
$4,000 of gain under section 704(c)(1)(B) and
§1.704–4 on the distribution of Property A1 to B
($10,000 fair market value of Property A1 less
$6,000 adjusted tax basis of Property A1). This
gain is taken into account in determining A’s
excess distribution and net precontribution gain.
As a result, A’s net precontribution gain is
reduced from $8,000 to $4,000, and the adjusted
tax basis in A’s partnership interest is increased
by $4,000 to $16,000.
(iv)A recognizes gain of $4,000 on the
receipt of Property B under section 737, an
amount equal to the lesser of the excess
distribution of $4,000 ($20,000 fair market value
of Property B less $16,000 adjusted tax basis of
A’s interest in the partnership) and A’s remain-
ing net precontribution gain of $4,000.
Example 4. Character of gain. (i) On January
1, 1995, A, B, and C form partnership ABC as
equal partners. A contributes the following
nondepreciable property to the partnership:
Fair Market
Value
Adjusted Tax
Basis
Property A1$30,000$20,000
Property A230,00038,000
Property A310,0009,000
(ii)The character of gain or loss on Property
A1 and Property A2 is long-term, U.S.-source
capital gain or loss. The character of gain on
Property A3 is long-term, foreign-source capital
gain. B contributes Property B, nondepreciable
real property with a fair market value and
adjusted tax basis of $70,000. C contributes
$70,000 cash.
(iii)On December 31, 1998, Property B is
distributed to A in complete liquidation of A’s
interest in the partnership. A recognizes $3,000
of gain under section 737, an amount equal to
the excess distribution of $3,000 ($70,000 fair
market value of Property B less $67,000 adjusted
tax basis in A’s partnership interest) and A’s net
precontribution gain of $3,000 ($70,000 aggre-
gate fair market value of properties contributed
by A less $67,000 aggregate adjusted tax basis of
such properties).
(iv)In determining the character of A’s gain,
all gains and losses on property taken into
account in determining A’s net precontribution
gain are netted according to their character and
allocated to A’s recognized gain under section
737 based on the relative proportions of the net
positive amounts. U.S.-source and foreign-source
gains must be netted separately because A would
have been required to take such gains into
account separately under section 702. As a result,
A’s net precontribution gain of $3,000 consists
of $2,000 of net long-term, U.S.-source capital
gain ($10,000 gain on Property A1 and $8,000
loss on Property A2) and $1,000 of net long-
term, foreign-source capital gain ($1,000 gain on
Property A3).
(v)The character of A’s gain under paragraph
(d) of this section is therefore $2,000 long-term,
U.S.-source capital gain ($3,000 gain recognized
under section 737 3 $2,000 net long-term, U.S.-

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source capital gain/$3,000 total net precontribu-
tion gain) and $1,000 long-term, foreign-source
capital gain ($3,000 gain recognized under
section 737 3 $1,000 net long-term, foreign-
source capital gain/$3,000 total net precontribu-
tion gain).
§1.737–2 Exceptions and special
rules.
(a)Section 708(b)(1)(B) termina-
tions. Section 737 and this section do
not apply to a deemed distribution of
property caused by a termination of the
partnership under section 708(b)(1)(B).
See §1.704–4(c)(3) for a similar rule in
the context of section 704(c)(1)(B).
(b)Transfers to another partner-
ship—(1) Complete transfer. Section
737 and this section do not apply to a
transfer by a partnership (transferor
partnership) of all of its assets and
liabilities to a second partnership
(transferee partnership) in an exchange
described in section 721, followed by a
distribution of the interest in the
transferee partnership in liquidation of
the transferor partnership as part of the
same plan or arrangement. See §1.704–
4(c)(4) for a similar rule in the context
of section 704(c)(1)(B).
(2)Certain divisive transactions.
Section 737 and this section do not
apply to a transfer by a partnership
(transferor partnership) of all of the
section 704(c) property contributed by
a partner to a second partnership
(transferee partnership) in an exchange
described in section 721, followed by a
distribution as part of the same plan or
arrangement of an interest in the
transferee partnership (and no other
property) in complete liquidation of the
interest of the partner that originally
contributed the section 704(c) property
to the transferor partnership.
(3)Subsequent distributions. A sub-
sequent distribution of property by the
transferee partnership to a partner of
the transferee partnership that was
formerly a partner of the transferor
partnership is subject to section 737 to
the same extent that a distribution from
the transferor partnership would have
been subject to section 737.
(c)Incorporation of a partnership.
Section 737 and this section do not
apply to an incorporation of a part-
nership by any method of incorporation
(other than a method involving an
actual distribution of partnership prop-
erty to the partners followed by a
contribution of that property to a
corporation), provided that the part-
nership is liquidated as part of the
incorporation transaction. See §1.704–
4(c)(5) for a similar rule in the context
of section 704(c)(1)(B).
(d)Distribution of previously con-
tributed property—(1) General rule.
Any portion of the distributed property
that consists of property previously
contributed by the distributee partner
(including property treated as contrib-
uted by the partner in connection with
a termination of the partnership under
section 708(b)(1)(B)) (previously con-
tributed property) is not taken into
account in determining the amount of
the excess distribution or the partner’s
net precontribution gain. See §1.737–
3(b)(2) for a special rule for determin-
ing the basis of previously contributed
property in the hands of a distributee
partner who contributed the property to
the partnership.
(2)Limitation for distribution of
previously contributed interest in an
entity. An interest in an entity pre-
viously contributed to the partnership is
not treated as previously contributed
property to the extent that the value of
the interest is attributable to property
contributed to the entity after the
interest was contributed to the part-
nership. The preceding sentence does
not apply to the extent that the property
contributed to the entity was contrib-
uted to the partnership by the partner
that also contributed the interest in the
entity to the partnership.
(3)Nonrecognition transactions.
Property received by the partnership in
exchange for contributed section 704(c)
property in a nonrecognition transaction
is treated as the contributed property
with regard to the contributing partner
for purposes of section 737 to the
extent that the property received is
treated as section 704(c) property under
§1.704–3(a)(8). See §1.704–4(d)(1) for
a similar rule in the context of section
704(c)(1)(B).
(4)Undivided interests. The distribu-
tion of an undivided interest in prop-
erty is treated as the distribution of
previously contributed property to the
extent that the undivided interest does
not exceed the undivided interest, if
any, contributed by the distributee
partner in the same property. See
§1.704–4(c)(6) for the application of
section 704(c)(1)(B) in a similar con-
text. The portion of the undivided
interest in property retained by the
partnership after the distribution, if
any, that is treated as contributed by
the distributee partner, is reduced to the
extent of the undivided interest dis-
tributed to the distributee partner.
(e)Examples. The following exam-
ples illustrate the rules of this section.
Unless otherwise specified, partnership
income equals partnership expenses
(other than depreciation deductions for
contributed property) for each year of
the partnership, the fair market value of
partnership property does not change,
all distributions by the partnership are
subject to section 737, and all partners
are unrelated.
Example 1. Distribution of previously contrib-
uted property. (i) On January 1, 1995, A, B, and
C form partnership ABC as equal partners. A
contributes the following nondepreciable real
property to the partnership:
Fair Market
Value
Adjusted Tax
Basis
Property A1$20,000$10,000
Property A210,0006,000
(ii)A’s total net precontribution gain on the
contributed property is $14,000 ($10,000 on
Property A1 plus $4,000 on Property A2). B
contributes $10,000 cash and Property B, non-
depreciable real property with a fair market value
and adjusted tax basis of $20,000. C contributes
$30,000 cash.
(iii)On December 31, 1998, Property A2 and
Property B are distributed to A in complete
liquidation of A’s interest in the partnership.
Property A2 was previously contributed by A
and is therefore not taken into account in
determining the amount of the excess distribution
or A’s net precontribution gain. The adjusted tax
basis of Property A2 in the hands of A is also
determined under section 732 as if that property
were the only property distributed to A.
(iv)As a result of excluding Property A2 from
these determinations, the amount of the excess
distribution is $10,000 ($20,000 fair market
value of distributed Property B less $10,000
adjusted tax basis in A’s partnership interest).
A’s net precontribution gain is also $10,000
($14,000 total net precontribution gain less
$4,000 gain with respect to previously contrib-
uted Property A2). A therefore recognizes
$10,000 of gain on the distribution, the lesser of
the excess distribution and the net precontribu-
tion gain.
Example 2. Distribution of a previously con-
tributed interest in an entity. (i) On January 1,
1995, A, B, and C form partnership ABC as
equal partners. A contributes Property A, non-
depreciable real property with a fair market value
of $10,000 and an adjusted tax basis of $5,000,
and all of the stock of Corporation X with a fair
market value and adjusted tax basis of $500. B
contributes $500 cash and Property B, nondepre-
ciable real property with a fair market value and
adjusted tax basis of $10,000. Partner C contrib-
utes $10,500 cash. On December 31, 1996, ABC
contributes Property B to Corporation X in a
nonrecognition transaction under section 351.
(ii)On December 31, 1998, all of the stock of
Corporation X is distributed to A in complete
liquidation of A’s interest in the partnership. The
stock is treated as previously contributed prop-
erty with respect to A only to the extent of the

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$500 fair market value of the Corporation X
stock contributed by A. The fair market value of
the distributed stock for purposes of determining
the amount of the excess distribution is therefore
$10,000 ($10,500 total fair market value of
Corporation X stock less $500 portion treated as
previously contributed property). The $500 fair
market value and adjusted tax basis of the
Corporation X stock is also not taken into
account in determining the amount of the excess
distribution and the net precontribution gain.
(iii)A recognizes $5,000 of gain under section
737, the amount of the excess distribution
($10,000 fair market value of distributed prop-
erty less $5,000 adjusted tax basis in A’s
partnership interest) and A’s net precontribution
gain ($10,000 fair market value of Property A
less $5,000 adjusted tax basis in Property A).
Example 3. Distribution of undivided interest
in property. (i) On January 1, 1995, A and B
form partnership AB as equal partners. A
contributes $500 cash and an undivided one-half
interest in Property X. B contributes $500 cash
and an undivided one-half interest in Property X.
(ii)On December 31, 1998, an undivided one-
half interest in Property X is distributed to A in
a current distribution. The distribution of the
undivided one-half interest in Property X is
treated as a distribution of previously contributed
property because A contributed an undivided
one-half interest in Property X. As a result, A
does not recognize any gain under section 737 on
the distribution.
§1.737–3 Basis adjustments; Recovery
rules.
(a)Distributee partner’s adjusted
tax basis in the partnership interest.
The distributee partner’s adjusted tax
basis in the partnership interest is
increased by the amount of gain
recognized by the distributee partner
under section 737 and this section. This
increase is not taken into account in
determining the amount of gain recog-
nized by the partner under section
737(a)(1) and this section or in deter-
mining the amount of gain recognized
by the partner under section 731(a) on
the distribution of money in the same
distribution or any related distribution.
See §1.704–4(e)(1) for a determination
of the distributee partner’s adjusted tax
basis in a distribution subject to section
704(c)(1)(B).
(b)Distributee partner’s adjusted
tax basis in distributed property—(1)
In general. The distributee partner’s
adjusted tax basis in the distributed
property is determined under section
732(a) or (b) as applicable. The in-
crease in the distributee partner’s ad-
justed tax basis in the partnership
interest under paragraph (a) of this
section is taken into account in deter-
mining the distributee partner’s ad-
justed tax basis in the distributed
property other than property previously
contributed by the partner. See §1.704–
4(e)(2) for a determination of basis in a
d i s t r i b u t i o n s u b j e c t t o s e c t i o n
704(c)(1)(B).
(2)Previously contributed property.
The distributee partner’s adjusted tax
basis in distributed property that the
partner previously contributed to the
partnership is determined as if it were
distributed in a separate and independ-
ent distribution prior to the distribution
that is subject to section 737 and
§1.737–1.
(c)Partnership’s adjusted tax basis
in partnership property—(1) Increase in
basis. The partnership’s adjusted tax
basis in eligible property is increased by
the amount of gain recognized by the
distributee partner under section 737.
(2)Eligible property. Eligible prop-
erty is property that—
(i)Entered into the calculation of
the distributee partner’s net pre-
contribution gain;
(ii)Has an adjusted tax basis to the
partnership less than the property’s fair
market value at the time of the
distribution;
(iii)Would have the same character
of gain on a sale by the partnership to
an unrelated party as the character of
any of the gain recognized by the dis-
tributee partner under section 737; and
(iv)Was not distributed to another
partner in a distribution subject to
section 704(c)(1)(B) and §1.704–4 that
was part of the same distribution as the
distribution subject to section 737.
(3)Method of adjustment. For the
purpose of allocating the basis increase
under paragraph (c)(2) of this section
among the eligible property, all eligible
property of the same character is
treated as a single group. Character for
this purpose is determined in the same
manner as the character of the recog-
nized gain is determined under §1.737–
1(d). The basis increase is allocated
among the separate groups of eligible
property in proportion to the character
of the gain recognized under section
737. The basis increase is then allo-
cated among property within each
group in the order in which the
property was contributed to the part-
nership by the partner, starting with the
property contributed first, in an amount
equal to the difference between the
property’s fair market value and its
adjusted tax basis to the partnership at
the time of the distribution. For prop-
erty that has the same character and
was contributed in the same (or a
related) transaction, the basis increase
is allocated based on the respective
amounts of unrealized appreciation in
such properties at the time of the
distribution.
(4)Section 754 adjustments. The
basis adjustments to partnership prop-
erty made pursuant to paragraph (c)(1)
of this section are not elective and
must be made regardless of whether the
partnership has an election in effect
under section 754. Any adjustments to
the bases of partnership property (in-
cluding eligible property as defined in
paragraph (c)(2) of this section) under
section 734(b) pursuant to a section
754 election (other than basis adjust-
ments under section 734(b)(1)(A) de-
scribed in the following sentence) must
be made after (and must take into
account) the adjustments to basis made
under paragraph (a) and paragraph
(c)(1) of this section. Basis adjustments
under section 734(b)(1)(A) that are
attributable to distributions of money to
the distributee partner that are part of
the same distribution as the distribution
of property subject to section 737 are
made before the adjustments to basis
under paragraph (a) and paragraph
(c)(1) of this section. See §1.737–
1(c)(2)(ii) for the effect, if any, of basis
adjustments under section 734(b)(1)(A)
on a partner’s net precontribution gain.
See also §1.704–4(e)(3) for a similar
rule regarding basis adjustments pur-
suant to a section 754 election in the
context of section 704(c)(1)(B).
(d)Recovery of increase to adjusted
tax basis. Any increase to the adjusted
tax basis of partnership property under
paragraph (c)(1) of this section is
recovered using any applicable recov-
ery period and depreciation (or other
cost recovery) method (including first-
year conventions) available to the
partnership for newly purchased prop-
erty (of the type adjusted) placed in
service at the time of the distribution.
(e)Examples. The following exam-
ples illustrate the rules of this section.
Unless otherwise specified, partnership
income equals partnership expenses
(other than depreciation deductions for
contributed property) for each year of
the partnership, the fair market value of
partnership property does not change,
all distributions by the partnership are
subject to section 737, and all partners
are unrelated.
Example 1. Partner’s basis in distributed
property. (i) On January 1, 1995, A, B, and C

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form partnership ABC as equal partners. A
contributes Property A, nondepreciable real
property with a fair market value of $10,000 and
an adjusted tax basis of $5,000. B contributes
Property B, nondepreciable real property with a
fair market value and adjusted tax basis of
$10,000. C contributes $10,000 cash.
(ii)On December 31, 1998, Property B is
distributed to A in complete liquidation of A’s
interest in the partnership. A recognizes $5,000
of gain under section 737, an amount equal to
the excess distribution of $5,000 ($10,000 fair
market value of Property B less $5,000 adjusted
tax basis in A’s partnership interest) and A’s net
precontribution gain of $5,000 ($10,000 fair
market value of Property A less $5,000 adjusted
tax basis of such property).
(iii)A’s adjusted tax basis in A’s partnership
interest is increased by the $5,000 of gain
recognized under section 737. This increase is
taken into account in determining A’s basis in
the distributed property. Therefore, A’s adjusted
tax basis in distributed Property B is $10,000
under section 732(b).
Example 2. Partner’s basis in distributed
property in connection with gain recognized
under section 704(c)(1)(B). (i) On January 1,
1995, A, B, and C form partnership ABC as
equal partners. A contributes the following
nondepreciable real property to the partnership:
Fair Market
Value
Adjusted Tax
Basis
Property A1$10,000$5,000
Property A210,0002,000
(ii)B contributes $10,000 cash and Property
B, nondepreciable real property, with a fair
market value and adjusted tax basis of $10,000.
C contributes $20,000 cash.
(iii) On December 31, 1998, Property B is
distributed to A in a current distribution and
Property A1 is distributed to B in a current
distribution. A recognizes $5,000 of gain under
section 704(c)(1)(B) and §1.704–4 on the dis-
tribution of Property A1 to B, the difference
between the fair market value of such property
($10,000) and the adjusted tax basis in dis-
tributed Property A1 ($5,000). The adjusted tax
basis of A’s partnership interest is increased by
this $5,000 of gain under section 704(c)(1)(B)
and §1.704–4(e)(1).
(iv)The increase in the adjusted tax basis of
A’s partnership interest is taken into account in
determining the amount of the excess distribu-
tion. As a result, there is no excess distribution
because the fair market value of Property B
($10,000) is less than the adjusted tax basis of
A’s interest in the partnership at the time of
distribution ($12,000). A therefore recognizes no
gain under section 737 on the receipt of Property
B. A’s adjusted tax basis in Property B is
$10,000 under section 732(a)(1). The adjusted
tax basis of A’s partnership interest is reduced
from $12,000 to $2,000 under section 733. See
Example 3 of §1.737–1(e).
Example 3. Partnership’s basis in partnership
property after a distribution with section 737
gain. (i) On January 31, 1995, A, B, and C form
partnership ABC as equal partners. A contributes
the following nondepreciable property to the
partnership:
Fair Market
Value
Adjusted Tax
Basis
Property A1$1,000$ 500
Property A24,0001,500
Property A34,0006,000
Property A46,0004,000
(ii)The character of gain or loss on Properties
A1, A2, and A3 is long-term, U.S.-source capital
gain or loss. The character of gain on Property
A4 is long-term, foreign-source capital gain. B
contributes Property B, nondepreciable real prop-
erty with a fair market value and adjusted tax
basis of $15,000. C contributes $15,000 cash.
(iii)On December 31, 1998, Property B is
distributed to A in complete liquidation of A’s
interest in the partnership. A recognizes gain of
$3,000 under section 737, an amount equal to the
excess distribution of $3,000 ($15,000 fair
market value of Property B less $12,000 adjusted
tax basis in A’s partnership interest) and A’s net
precontribution gain of $3,000 ($15,000 aggre-
gate fair market value of the property contributed
by A less $12,000 aggregate adjusted tax basis of
such property).
(iv)$2,000 of A’s gain is long-term, foreign-
source capital gain ($3,000 total gain under
section 737 3 $2,000 net long-term, foreign-
source capital gain/$3,000 total net precontribu-
tion gain). $1,000 of A’s gain is long-term, U.S.-
source capital gain ($3,000 total gain under
section 737 3 $1,000 net long-term, U.S.-source
capital gain/$3,000 total net precontribution
gain).
(v)The partnership must increase the adjusted
tax basis of the property contributed by A by
$3,000. All property contributed by A is eligible
property. Properties A1, A2, and A3 have the
same character and are grouped into a single
group for purposes of allocating this basis
increase. Property A4 is in a separate character
group.
(vi)$2,000 of the basis increase must be
allocated to long-term, foreign-source capital
assets because $2,000 of the gain recognized by
A was long-term, foreign-source capital gain.
The adjusted tax basis of Property A4 is
therefore increased from $4,000 to $6,000.
$1,000 of the increase must be allocated to
Properties A1 and A2 because $1,000 of the gain
recognized by A is long-term, U.S.-source capital
gain. No basis increase is allocated to Property
A3 because its fair market value is less than its
adjusted tax basis. The $1,000 basis increase is
allocated between Properties A1 and A2 based
on the unrealized appreciation in each asset
before such basis adjustment. As a result, the
adjusted tax basis of Property A1 is increased by
$167 ($1,000 3 $500/$3,000) and the adjusted
tax basis of Property A2 is increased by $833
($1,000 3 $2,500/3,000).
§1.737–4 Anti-abuse rule.
(a)In general. The rules of section
737 and §§1.737–1, 1.737–2, and
1.737–3 must be applied in a manner
consistent with the purpose of section
737. Accordingly, if a principal pur-
pose of a transaction is to achieve a tax
result that is inconsistent with the
purpose of section 737, the Commis-
sioner can recast the transaction for
federal tax purposes as appropriate to
achieve tax results that are consistent
with the purpose of section 737.
Whether a tax result is inconsistent
with the purpose of section 737 must
be determined based on all the facts
and circumstances. See §1.704–4(f) for
an anti-abuse rule and examples in the
context of section 704(c)(1)(B). The
anti-abuse rule and examples under
section 704(c)(1)(B) and §1.704–4(f)
are relevant to section 737 and
§§1.737–1, 1.737–2, and 1.737–3 to the
extent that the net precontribution gain
for purposes of section 737 is deter-
m i n e d b y r e f e r e n c e t o s e c t i o n
704(c)(1)(B).
(b)Examples. The following exam-
ples illustrate the rules of this section.
The examples set forth below do not
delineate the boundaries of either per-
missible or impermissible types of
transactions. Further, the addition of
any facts or circumstances that are not
specifically set forth in an example (or
the deletion of any facts or circum-
stances) may alter the outcome of the
transaction described in the example.
Unless otherwise specified, partnership
income equals partnership expenses
(other than depreciation deductions for
contributed property) for each year of
the partnership, the fair market value of
partnership property does not change,
all distributions by the partnership are
subject to section 737, and all partners
are unrelated.
Example 1. Increase in distributee partner’s
basis by temporary contribution; results incon-
sistent with the purpose of section 737. (i) On
January 1, 1995, A, B, and C form partnership
ABC as equal partners. A contributes Property
A1, nondepreciable real property with a fair
market value of $10,000 and an adjusted tax
basis of $1,000. B contributes Property B,
nondepreciable real property with a fair market
value of $10,000 and an adjusted tax basis of
$10,000. C contributes $10,000 cash.
(ii)On January 1, 1999, pursuant to a plan a
principal purpose of which is to avoid gain under
section 737, A transfers to the partnership
Property A2, nondepreciable real property with a
fair market value and adjusted tax basis of
$9,000. A treats the transfer as a contribution to
the partnership pursuant to section 721 and
increases the adjusted tax basis of A’s part-
nership interest from $1,000 to $10,000. On
January 1, 1999, the partnership agreement is
amended and all other necessary steps are taken
so that substantially all of the economic risks and
benefits of Property A2 are retained by A. On
February 1, 1999, Property B is distributed to A
in a current distribution. If the contribution of
Property A2 is treated as a contribution to the
partnership for purposes of section 737, there is
no excess distribution because the fair market
value of distributed Property B ($10,000) does
not exceed the adjusted tax basis of A’s interest
in the partnership ($10,000), and therefore

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section 737 does not apply. A’s adjusted tax
basis in distributed Property B is $10,000 under
section 732(a)(1) and the adjusted tax basis of
A’s partnership interest is reduced to zero under
section 733.
(iii)On March 1, 2000, A receives Property
A2 from the partnership in complete liquidation
of A’s interest in the partnership. A recognizes
no gain on the distribution of Property A2
because the property was previously contributed
property. See §1.737–2(d).
(iv)Although A has treated the transfer of
Property A2 as a contribution to the partnership
that increased the adjusted tax basis of A’s
interest in the partnership, it would be inconsist-
ent with the purpose of section 737 to recognize
the transfer as a contribution to the partnership.
Section 737 requires recognition of gain when
the value of distributed property exceeds the
distributee partner’s adjusted tax basis in the
partnership interest. Section 737 assumes that
any contribution or other transaction that affects
a partner’s adjusted tax basis in the partnership
interest is a contribution or transaction in
substance and is not engaged in with a principal
purpose of avoiding recognition of gain under
section 737. Because the transfer of Property A2
to the partnership was not a contribution in
substance and was made with a principal purpose
of avoiding recognition of gain under section
737, the Commissioner can disregard the contri-
bution of Property A2 for this purpose. As a
result, A recognizes gain of $9,000 under section
737 on the receipt of Property B, an amount
equal to the lesser of the excess distribution of
$9,000 ($10,000 fair market value of distributed
Property B less the $1,000 adjusted tax basis of
A’s partnership interest, determined without
regard to the transitory contribution of Property
A2) or A’s net precontribution gain of $9,000 on
Property A1.
Example 2. Increase in distributee partner’s
basis; section 752 liability shift; results consistent
with the purpose of section 737. (i) On January 1,
1995, A and B form general partnership AB as
equal partners. A contributes Property A, non-
depreciable real property with a fair market value
of $10,000 and an adjusted tax basis of $1,000. B
contributes Property B, nondepreciable real prop-
erty with a fair market value and adjusted tax
basis of $10,000. The partnership also borrows
$10,000 on a recourse basis and purchases
Property C. The $10,000 liability is allocated
equally between A and B under section 752,
thereby increasing the adjusted tax basis in A’s
partnership interest to $6,000.
(ii)On December 31, 1998, the partners agree
that A is to receive Property B in a current
distribution. If A were to receive Property B at
that time, A would recognize $4,000 of gain
under section 737, an amount equal to the lesser
of the excess distribution of $4,000 ($10,000 fair
market value of Property B less $6,000 adjusted
tax basis in A’s partnership interest) or A’s net
precontribution gain of $9,000 ($10,000 fair
market value of Property A less $1,000 adjusted
tax basis of Property A).
(iii)With a principal purpose of avoiding such
gain, A and B agree that A will be solely liable
for the repayment of the $10,000 partnership
liability and take the steps necessary so that the
entire amount of the liability is allocated to A
under section 752. The adjusted tax basis in A’s
partnership interest is thereby increased from
$6,000 to $11,000 to reflect A’s share of the
$5,000 of liability previously allocated to B. As
a result of this increase in A’s adjusted tax basis,
there is no excess distribution because the fair
market value of distributed Property B ($10,000)
is less than the adjusted tax basis of A’s
partnership interest. Recognizing A’s increased
adjusted tax basis as a result of the shift in
liabilities is consistent with the purpose of
section 737 and this section. Section 737 requires
recognition of gain only when the value of the
distributed property exceeds the distributee part-
ner’s adjusted tax basis in the partnership
interest. The $10,000 recourse liability is a bona
fide liability of the partnership that was under-
taken for a substantial business purpose and A’s
and B’s agreement that A will assume respon-
sibility for repayment of that debt has substance.
Therefore, the increase in A’s adjusted tax basis
in A’s interest in the partnership due to the shift
in partnership liabilities under section 752 is
respected, and A recognizes no gain under
section 737.
§1.737–5 Effective date.
Sections 1.737–1, 1.737–2, 1.737–3,
and 1.737–4 apply to distributions by a
partnership to a partner on or after
January 9, 1995.
Dated December 13, 1995.
Margaret Milner Richardson,
Commissioner of
Internal Revenue.
Approved:
Leslie Samuels,
Assistant Secretary of
the Treasury.
(Filed by the Office of the Federal Register on
December 22, 1995, 8:45 a.m., and published
in the issue of the Federal Register for
December 26, 1995, 60 F.R. 66727)
Section 2601.—Tax Imposed
26 CFR 26.2601–1: Effective dates.
T.D. 8644
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 26, 301 and 602
Generation-Skipping Transfer Tax
AGENCY: Internal Revenue Service,
Treasury
A C T I O N : F i n a l a n d t e m p o r a r y
regulations
SUMMARY: This document contains
final generation-skipping transfer
(GST) tax regulations under chapter 13
of the Internal Revenue Code (Code),
as added by section 1431 of the Tax
Reform Act of 1986. Changes to the
applicable law were made by the Tax
Reform Act of 1986, the Technical and
Miscellaneous Revenue Act of 1988,
and the Revenue Reconciliation Act of
1989. The regulations are necessary to
provide guidance to taxpayers so that
they may comply with chapter 13 of
the Code.
DATES: These regulations are effective
December 27, 1995.
FOR FURTHER INFORMATION
CONTACT: James F. Hogan, (202)
622-3090 (not a toll free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information re-
quirements contained in these final
regulations have been reviewed and
approved by the Office of Management
and Budget in accordance with the
Paperwork Reduction Act (44 U.S.C.
3507) under control numbers 1545–
0985 (relating to §§26.2601–1 and
26.2662–2) and 1545–1358 (relating to
§§26.2632–1, 26.2642–1, 26.2642–2,
26.2642–3, 26.2642–4 and 26.2652–2).
All of these paperwork requirements
will be consolidated under control
number 1545–0985. Responses to this
collection of information are required
to ensure the proper collection of the
generation-skipping transfer tax.
An agency may not conduct or
sponsor, and a person is not required to
respond to, a collection unless the
collection of information displays a
valid control number.
The estimated burden per respondent is
1 hour under control number 1545–0985.
The time estimates for the reporting and
recordkeeping requirements under control
number 1545–1358 are included in the
estimates of burden applicable to Forms
706, 706NA, 706GS(T), 706GS(D),
706GS(D–1), and 709.
Comments concerning the accuracy
of this burden estimate and suggestions
for reducing this burden should be
directed to the Internal Revenue Serv-
ice, Attn: IRS Reports Clearance Of-
ficer T:FP, Washington, DC 20224, and
to the Office of Management and
Budget, Attn: Desk Officer for the
Department of Treasury, Office of
Information and Regulatory Affairs,
Washington, DC 20503.

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Books or records relating to this
collection of information must be re-
tained as long as their contents may
become material in the administration
of any internal revenue law. Generally,
tax returns and tax return information
are confidential, as required by 26
U.S.C. 6103.
Background
On March 15, 1988, the IRS pub-
lished in the Federal Register a notice
of proposed rulemaking (53 FR 8469)
by cross reference to Temporary Reg-
ulations published on the same date in
the Federal Register (53 FR 8441)
under §§2601 and 2662. Subsequently,
on December 24, 1992, the IRS pub-
lished a second notice of proposed
rulemaking (57 FR 61353) amending
the prior notice. Also, on December 24,
1992, the IRS published a notice of
proposed rulemaking in the Federal
Register (57 FR 61356) containing
proposed regulations under §§2611,
2612, 2613, 2632, 2641, 2642, 2652,
2653, 2654, and 2663. The IRS re-
ceived written and oral comments on
the proposed regulations and, on April
21, 1993, a public hearing was held.
These documents adopt final regula-
tions with respect to these notices of
proposed rulemaking.
The following is a discussion of the
more significant revisions that were
made.
Section 2601—Transitional Rules
Transfers after September 25, 1985
and before October 23, 1986
Section 26.2601–1(a)(2)(i), relating
to inter vivos transfers made after
September 25, 1985, and before Octo-
ber 23, 1986, clarifies that chapter 13
applies to inter vivos transfers that are
subject to chapter 12 even though a gift
tax is not actually paid because of, for
example, the marital deduction or the
unified credit.
Section 26.2601–1(a)(2)(ii) (which
treats inter vivos transfers made after
September 25, 1985, and before Octo-
ber 23, 1986, as if made on October
23, 1986) clarifies that the value of the
transferred property for purposes of
chapter 13 is determined as of the
actual transfer date rather than as of the
deemed transfer date of October 23,
1986.
Section 26.2601–1(a)(4) adds an ex-
ample illustrating that §26.2601–1(a)(2)
does not apply to transfers made under
a revocable trust that becomes irrevoca-
ble by reason of the grantor’s death
after September 25, 1985, but before
October 23, 1986. Those transfers are
not subject to chapter 13 because they
are in the nature of testamentary
transfers that occurred prior to October
23, 1986.
Section 26.2601–1(b)(1)(ii)(C) clar-
ifies that incidents of ownership in an
insurance policy that are relinquished
before September 25, 1985, are not to
be taken into account in determining
whether a trust is irrevocable for
purposes of §26.2601–1(b)(1), which
exempts trusts that were irrevocable on
September 25, 1985, from the provi-
sions of chapter 13.
Under §26.2601–1(b)(1)(iii)(A), a
qualified terminable interest property
(QTIP) trust that is grandfathered under
§26.2601–1(b)(1) is treated as if the
reverse QTIP election had been made
under section 2652(a)(3). Example 1 in
§26.2601–1(b)(1)(iii)(B) has been re-
vised to illustrate that the initial QTIP
election under section 2523(f) need not
be made before September 25, 1985,
provided that the trust was irrevocable
on that date. Further, §26.2601–1(b)(1)-
(v)(C) has been revised to provide that
in the case of a trust with respect to
which a reverse QTIP election is
deemed to have been made, the failure
to exercise the right of reimbursement
under section 2207A will not be treated
as a constructive addition to the trust.
This conforms the treatment of trusts
that are irrevocable on September 25,
1985, with the rule provided in
§26.2652–1(a)(3) which applies to
trusts created after September 25, 1985.
In §26.2601–1(b)(2)(iv)(B), the
phrase ‘‘or to a generation-skipping
trust’’ has been added to eliminate any
implication that the provision is limited
to situations involving direct skips. The
provision applies to all generation-
skipping transfers.
Section 26.2601–1(b)(3)(iii) applies
the transitional rules where the dece-
dent was under a mental disability but
had not been adjudged a mental incom-
petent. This section has been clarified
to provide that any evidence submitted
to establish the decedent’s state of
incompetency is not conclusive and is
subject to examination. In addition, an
example has been added to illustrate
the transitional rules applicable in the
case of mental incompetency.
Uniform statutory rule against
perpetuities
The notice of proposed rulemaking
published on December 24, 1992, (57
FR 61353) contained a proposed modi-
fication to §26.2601–1(b)(1)(v)(B)(2).
S e c t i o n 2 6 . 2 6 0 1 – 1 ( b ) ( 1 ) ( v ) ( B ) (2)
provided that the exercise of a non-
general power of appointment will not
be treated as an addition to a grand-
fathered GST trust if the power is
exercised in a manner that may not
postpone or suspend the vesting, abso-
lute ownership, or power of alienation
of a interest in property for a period,
measured from the date of creation of
the trust, extending beyond any life in
being at the date of creation of the trust
plus a period of 21 years (perpetuities
period).
The proposed modification to
§26.2601–1(b)(1)(v)(B)(2), which is fi-
nalized in this document, provides that
the exercise of a nongeneral power of
appointment that validly postpones or
suspends the vesting, absolute owner-
ship, or power of alienation of an
interest in property for a term of years
that will not exceed 90 years (measured
from the date of creation of the trust)
will not be considered an exercise that
postpones vesting, etc., beyond the
perpetuities period. The modification
takes into account the fact that many
states have adopted the Uniform Statu-
t o r y R u l e A g a i n s t P e r p e t u i t i e s
(USRAP) which allows either a 90 year
perpetuities period or the common law
perpetuities period. Under §26.2601–
1(b)(1)(v)(B)(2), as modified, the non-
general power may not be exercised in
a manner that postpones vesting, etc.,
for the longer of 90 years or the
common law period (lives in being plus
21 years).
The discussion in the preamble pub-
lished on December 24, 1992, indicates
that USRAP has a ‘‘wait and see’’
aspect that is not appropriate for GST
purposes because it will be necessary
to determine the GST tax consequences
of distributions and terminations at the
time they occur. Thus, the preamble
stated that, in order to comply with the
regulation and avoid a constructive
addition, it must be clear at the time
the nongeneral power is exercised that
the exercise may not postpone or
suspend vesting, etc., beyond either
lives in being plus 21 years or 90 years
(but not the longer of the two periods).
A commentator has pointed out that the
USRAP invalidates any attempt to

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exercise a power for the longer of the
two periods. Under the USRAP, it will
be clear at the time the nongeneral
power is exercised that the exercise
may not postpone or suspend vesting,
etc., beyond one of the two periods
(but not both). Under the USRAP, the
common law period (lives in being plus
21 years) is imposed in the event that
the power holder exercises the power
in a manner that attempts to suspend or
postpone vesting, etc., for the longer of
the two periods. Although the preamble
published on December 24, 1992, may
have been misleading in referring to a
‘‘wait and see’’ aspect of USRAP, the
modification to §26.2601–1(b)(1)(v)-
(B)(2) is not affected.
Section 2611 et. seq.—GST
substantive rules
Definition of generation-skipping
transfers
Section 26.2611–1 has been revised
to clarify that, in determining whether
an event is subject to the GST tax,
reference must be made to the most
recent transfer that was subject to
Federal estate or gift tax. This is
because the most recent transfer that
was subject to estate or gift tax
establishes the identity of the trans-
feror, which in turn determines the
identity of the skip persons and non-
skip persons.
Definitions
Section 26.2612–1(a)(2)(i) of the
proposed regulations provides generally
that, for purposes of determining
whether a transfer constitutes a direct
skip, the generation assignment of a
person who would otherwise be a skip
person is redetermined by disregarding
the intervening generation, if certain
individuals have died prior to the
transfer (e.g., a predeceased child of
the transferor). The section has been
modified to provide that, if an individ-
ual who is a member of the intervening
generation dies no later than 90 days
after the transfer, the deceased individ-
ual is treated as having predeceased the
transferor, if the governing instrument
or applicable state law provides for
such treatment.
Section 26.2612–1(a)(2)(ii) has been
added to provide that, if a transferor
makes an addition to an existing trust
after the death of an individual de-
scribed in paragraph (a)(2)(i) of that
section (i.e., an individual in the
intervening generation), the additional
property is treated as being held in a
separate trust for purposes of chapter
13.
Section 2612(a)(1) defines the term
taxable termination to mean the termi-
nation of an interest in property held in
trust unless, among other things, at no
time after such termination may a dis-
tribution (including distributions on
termination) be made from the trust to
a skip person. Section 26.2612–1(b)(1)-
(iii), as proposed, has been revised to
provide that, for purposes of applying
this rule, potential distributions to skip
persons are to be disregarded if the
probability of occurrence is so remote
as to be negligible. A similar rule has
been applied to §26.2612–1(d)(2), re-
garding when a trust is considered a
skip person. The probability that a
distribution will occur is so remote as
to be negligible only if it can be
ascertained by actuarial standards that
there is less than a 5 percent proba-
bility that the distribution will occur.
Section 26.2612–1(c)(2) has been
added to clarify that the look-through
rule in section 2651(e)(2) does not
apply for purposes of determining
whether a transfer from one trust to
another trust is a taxable distribution.
Thus, the transfer is treated as having
been made to the recipient trust rather
than to the beneficiaries of that trust.
Accordingly, a transfer is a taxable
distribution only if the recipient trust
itself is a skip person.
Section 26.2612–1(e)(3) has been
added to provide that, in determining
whether a trust is a skip person, trust
interests disclaimed pursuant to a
qualified disclaimer described in sec-
tion 2518 are not taken into account.
Example 3 has been added to
§26.2612–1(f) to illustrate that a trans-
fer to a trust pursuant to which a
beneficiary who is a skip person has a
withdrawal power is not a direct skip
unless the trust is a skip person.
Example 9 has been added to
§26.2612–1(f) to illustrate that a tax-
able termination may occur upon the
distribution of the entire trust property
(less amounts retained to pay a result-
ing GST tax and administration
expenses).
Example 14 contained in §26.2612–
1(f) of the proposed regulations illus-
trates that an individual is not treated
as having an interest in a trust for
purposes of Chapter 13, if the individ-
ual’s support obligation could be satis-
fied at the discretion of the trustee.
This example has been renumbered as
Example 15 and has been clarified to
provide that an individual will have an
interest in the trust if the trustee is
required to make distributions for the
beneficiary’s support, in satisfaction of
the individual’s support obligation.
Allocation of GST exemption
Under §26.2632–1(b)(2)(ii)(A) of the
proposed regulations, a late allocation
of GST exemption is effective on the
date the Form 709 reporting the alloca-
tion is filed, and is deemed to precede
in point of time any taxable event
occurring on that date. This section has
been revised to specify that the Form
709 is treated as filed on the date it is
mailed to the appropriate IRS Service
Center. Further, the late allocation may
be made on a timely filed Form 709
reporting another transfer.
Section 26.2632–1(b)(2)(ii)(B) has
been added to clarify how the GST
exemption allocated on a Federal gift
tax return (Form 709) is to be appor-
tioned in the event that the amount
allocated on the return exceeds the
value of the transfers reported on the
return.
Example 4 of §26.2632–1(b)(2)(iii)
of the proposed regulations has been
revised to better illustrate the effective
date of a late allocation of GST
exemption.
Example 5 of §26.2632–1(b)(2)(iii)
has been added to illustrate the auto-
matic allocation of GST exemption to
inter vivos direct skips in situations
where split gift treatment is elected on
an initial gift tax return filed after its
due date.
Section 26.2632–1(d)(1) has been re-
vised to provide that a late allocation
of GST exemption made by an execu-
tor with respect to an inter vivos
transfer not included in the gross
estate, is effective as of the date the
allocation is filed. This rule does not
apply to any automatic allocation under
section 2632(b)(1). This revision con-
forms the regulation to section
2642(b)(3).
Estate tax inclusion period
As proposed, §26.2632–1(c)(2)(ii)
provided that an estate tax inclusion
period (ETIP) exists during the period

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in which the transferred property would
have been includible in the transferor’s
gross estate had the transferor retained
an interest held by the transferor’s
spouse, but only to the extent the
spouse acquired the interest from the
transferor in an inter vivos transfer that
was not included in the transferor’s
taxable gifts or for which a deduction
was allowed under section 2523. Com-
mentators stated that there was no
support in the statute for this spousal
rule, and any such rule would require a
legislative change. The final regulations
eliminate this spousal rule and Example
5 of §26.2632–1(c)(5).
Section 26.2632–1(c)(2)(ii)(A) has
been added to provide that the ETIP
rules do not apply when the possibility
that the property will be included in the
gross estate of the transferor (or the
transferor’s spouse) is so remote as to
be negligible. Further, §26.2632–1(c)-
(2)(ii)(B) has been added to provide
that transferred property will not be
treated as being subject to inclusion in
the transferor’s spouse’s gross estate,
and thus, subject to an ETIP, where the
only power possessed by the spouse is
a right to withdraw no more than the
greater of 5 percent or $5,000 of the
trust’s corpus and the withdrawal right
terminates within 60 days of the
transfer to the trust.
Section 26.2632–1(c)(5) Example 3,
of the proposed regulations illustrates
that if a transferor’s spouse elects gift-
splitting treatment with respect to the
transferor’s gift that is subject to an
ETIP, the spouse is treated as the
transferor of one-half of the gift. The
example has been expanded to illustrate
that, since the spouse’s deemed transfer
is subject to an ETIP, if the spouse dies
prior to the termination of the trust, the
spouse’s executor may allocate GST
exemption to the trust. However, the
allocation will not be effective until the
ETIP terminates on the transferor’s
death.
Erroneous allocations
Under the proposed regulations, al-
locations in excess of the amount of
the property transferred are void. This
treatment has been expanded under the
final regulations. Thus, any allocation
to a trust that has no GST potential at
the time of the allocation, with respect
to the transferor for whom the alloca-
tion is made, is also void. This pro-
vision is intended to prevent the
wasting of GST exemption because of
an erroneous allocation with respect to
a testamentary or inter vivos transfer.
A trust will have no GST potential only
if there is no possibility that a GST
will be made from the trust with
respect to the transferor.
Determination of applicable fraction
Section 26.2642–1(b)(2) of the pro-
posed regulations provided rules for
determining the inclusion ratio with
respect to a trust subject to an ETIP
where GSTs are made from the trust
during the ETIP. Comments were re-
ceived that the rules were unclear
regarding whether an ineffective alloca-
tion, i.e., an allocation made prior to
any distributions or terminations, would
apply in determining the amount of the
transferor’s unused GST exemption, or
whether such an allocation could be
modified prior to an ETIP termination.
I n r e s p o n s e t o t h e c o m m e n t s ,
§26.2632–1(c)(1) (providing rules for
the allocation of exemption with re-
spect to a trust subject to an ETIP) and
§26.2642–1(b)(2) clarify that an alloca-
tion made to a trust subject to an ETIP
prior to any distribution or termination
is not subject to modification or
revocation. However, the allocation
will not be effective, i.e., the allocation
does not operate to fix the inclusion
ratio of the trust, at the time it is made.
Rather, the allocation becomes effec-
tive as of the date of a subsequent
distribution or termination. Section
26.2632–1(c)(5) Example 2, illustrates
this point.
Section 26.2642–2 of the proposed
regulations provides valuation rules for
determining the denominator of the
applicable fraction under section 2642.
Section 26.2642–2(a)(1) of the final
regulations specifies that, in the case of
a timely allocation of GST exemption
with respect to an inter vivos transfer,
the denominator of the applicable frac-
tion is the fair market value of the
transferred property, as finally deter-
mined for gift tax purposes.
Section 26.2642–2(b)(1) of the pro-
posed regulations provides special rules
for determining the denominator of the
applicable fraction in situations involv-
ing property subject to the special
valuation rules contained in section
2032A. Under the proposed regulations,
the special use value of the property
could only be used in determining the
applicable fraction if the property was
transferred in a direct skip. Thus, a
generation-skipping trust to which sec-
tion 2032A property was transferred in
a transfer that was not a direct skip
would not receive the benefit of the
favorable valuation rules of section
2032A in determining the applicable
fraction with respect to the trust.
Comments stated that the proposed
regulation was inconsistent with section
2642(b), which provides that the chap-
ter 11 value must be used to determine
the applicable fraction in the case of a
testamentary transfer. Under the final
regulations, the section 2032A value of
property is to be used to determine the
applicable fraction for a direct skip
transfer and for a generation-skipping
trust created in a transfer other than a
direct skip.
In the event that additional estate tax
is imposed under section 2032A(c)
with respect to the property, then the
applicable fraction is redetermined as
of the transferor’s date of death. Thus,
the GST tax liability with respect to
any direct skip, taxable termination, or
taxable distribution occurring prior to
the recapture event would be recom-
puted based on the redetermined appli-
cable fraction, and an additional GST
tax would be due. The taxation of any
future GST transfers would also be
based on the redetermined applicable
fraction.
Sections 26.2642–2(b)(2) and (3) of
the proposed regulations contain special
rules for determining the denominator
of the applicable fraction in situations
involving residuary and pecuniary pay-
ments. Generally, in the case of a
residual GST after the payment of a
pecuniary amount, the denominator of
the applicable fraction will be the
estate tax value of the total assets
available to satisfy the pecuniary pay-
ment less the amount of the pecuniary
payment, provided the pecuniary pay-
ment carries ‘‘appropriate interest’’ as
defined in §26.2642–2(b)(4). Under
§26.2642–2(b)(4)(ii), the payment need
not carry appropriate interest if, inter
alia, the payment is irrevocably ‘‘set
aside’’ within 15 months of the trans-
feror’s death. The final regulations
clarify that this exception to the appro-
priate interest requirement applies only
if the entire payment is set aside.
Further, the payment is treated as set
aside if the amount is segregated and
held in a separate account pending
distribution. Finally, under the pro-
posed regulation, the appropriate inter-

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est requirement can be satisfied if a pro
rata share of estate income is allocated
to the pecuniary bequest. The final
regulations clarify that the payment of
income may be allocated pursuant to
the terms of the governing instrument
or applicable local law.
Section 26.2642–4(a)(3) of the pro-
posed regulations addresses a situation
where a lifetime allocation is made
with respect to a trust when the trust
was not subject to an ETIP, and the
trust is subsequently included in the
transferor’s gross estate. The regulation
has been revised to provide that, if
additional GST exemption is allocated
to the trust, the nontax portion of the
trust is determined immediately after
the date of the transferor’s death. Also,
if additional GST exemption is not
allocated to the trust by the transferor’s
executor, the applicable fraction does
not change, if the trust was not
otherwise subject to an ETIP at the
time the previous allocation of GST
exemption was made. Further, where
such property is included in the gross
estate, the denominator of the applica-
ble fraction is reduced to reflect any
federal or state estate or inheritance tax
paid by the trust.
Definition of transferor
Section 26.2652–1(a)(1) of the pro-
posed regulations, defining transferor,
has been revised to specify that a
surviving spouse is treated as the
transferor of a qualified domestic trust
(QDOT) described in section 2056A
that is included in the surviving
spouse’s gross estate for federal estate
tax purposes, assuming the trust is not
subject to a reverse QTIP election
under section 2652(a)(3). The surviving
spouse is also the transferor of any
QDOT created by the surviving spouse
under section 2056(d)(2)(B).
Section 26.2652–1(a)(4), as pro-
posed, provided that the creator of a
special power of appointment will be
treated as making a transfer subject to
estate or gift tax (and thus be consid-
ered a transferor) if the holder of the
power exercised the power in a manner
that may postpone vesting, etc., of the
property subject to the power beyond
the permissible perpetuities period.
This result is inconsistent with section
2041(a)(3), which treats the holder of
the power as making a transfer under
these circumstances. Accordingly, the
regulation has been revised to provide
that the holder of the power will be
treated as making a taxable transfer, if
the holder exercises the power in the
manner prescribed.
Section 26.2652–1(a)(5) has been
added to specify that where a donor’s
spouse consents to have the donor’s
gift treated as made one-half by the
spouse, then for purposes of chapter
13, the spouse is treated as the
transferor of one-half of the property
transferred by the donor. Thus, if a
donor transfers property to a trust and
retains a qualified interest as defined in
section 2702(b), with the remainder to
a grandchild, a consenting spouse
would be treated as the transferor of
one-half the entire property. It was
suggested that the spouse should only
be treated as the transferor of that
portion of the trust corresponding to
one-half of the actuarial value of the
interest passing to the grandchild, since
under section 2513, only one-half the
gift to the grandchild may be treated as
made by the consenting spouse. How-
ever, treating the consenting spouse as
the transferor of one-half of the entire
trust is consistent with the general
treatment accorded other split-interest
transfers. For example, if a transferor
transferred property in trust retaining
an interest that qualified under section
2702(b), with the remainder to the
transferor’s grandchild, the transferor
would be considered the transferor of
the entire trust for purposes of chapter
13, notwithstanding that, from a techni-
cal standpoint, only the actuarial value
of the gift to the grandchild is subject
to gift tax at the time of the transfer.
Example 8 in §26.2652–1(a)(6) has
been added illustrating that a surviving
spouse will not be treated as making a
contribution to a QTIP trust that is
included in the spouse’s gross estate
and is subject to a reverse QTIP
election, where the spouse directs in
the will that the estate tax generated by
the inclusion of the trust is to be paid
from the spouse’s probate estate.
Separate shares treated as separate
trusts
Section 26.2654–1 of the proposed
regulations provides rules under which
‘‘separate shares’’ of a single trust that
satisfy the requirements of the regula-
tions will be recognized as separate
trusts for GST purposes.
Under the proposed regulations, a
mandatory payment of a pecuniary
amount is treated as a separate share of
a trust (and thus, a separate trust for
GST purposes) if certain conditions are
satisfied. The section is clarified to
specify that a mandatory payment is a
payment that is nondiscretionary and
noncontingent; i.e., the payment must
be made in all events.
A sentence was added to Example 3,
now contained in §26.2654–1(a)(5), to
clarify that, where a decedent’s probate
estate pours over to a revocable trust,
and then amounts are distributed pur-
suant to the terms of the trust, the
distributions will be treated as separate
shares for purposes of chapter 13.
Example 4, now contained in
§26.2654–1(a)(5), has been revised to
specify that the bequest of a pecuniary
amount payable in kind is not treated
as a separate share of the trust, since,
under the facts presented, neither the
trust nor local law requires that the
assets distributed in satisfaction of the
bequest fairly reflect net appreciation
and depreciation. This is the result
regardless of whether the assets are
distributed within 15 months of the
transferor’s death.
Comments received suggested that
the regulations should allow separate
trust treatment whenever a single inter
vivos trust was recognized as separate
trusts under local law. For example, an
inter vivos trust provides income to
child for life, but when each grandchild
reaches age 35, a separate trust is to be
established for the child, the grand-
child, and the grandchild’s issue. Com-
ments suggested that the Service should
recognize each trust established when a
grandchild reaches age 35 as a separate
trust, and allow a late allocation of
GST exemption specifically to that
trust when severance occurs.
This suggestion was rejected. Gener-
ally, the adoption of this approach
would effectively allow the allocation
of GST exemption to specific distribu-
tions from a GST trust, rather than to
the entire trust. This result would be
contrary to the clear language of the
statute. See, e.g., sections 2642(a)(1)-
(A) and (a)(2).
Division of a single trust into
separate trusts
Under §26.2654–1(c) of the proposed
regulations, a testamentary trust could
be severed into several parts, provided
the severance was commenced prior to
the filing of the estate tax return.

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Further, the new trusts created pursuant
to the severance had to be identical to
the old trusts. For example, a testamen-
tary trust providing for income to
spouse, remainder to be divided equally
between child and grandchild could
only be severed into two trusts both
providing income to spouse with the
remainder to be divided between child
and grandchild. Finally, an inter vivos
trust could not be severed unless it
consisted of separate shares, or dif-
ferent transferors had contributed to the
trust.
The regulation has been clarified to
specify that the division of a single
trust that is included in the transferor’s
gross estate will be recognized if
either: (1) the single trust consists of
separate shares and is thus, treated as
separate trusts; or (2) the single trust,
although not consisting of separate
shares, is severed into separate trusts
pursuant to a direction in the governing
instrument providing that the trust is to
be divided into separate trusts on the
transferor’s death; or (3) the governing
instrument does not require or direct
severance but the trust is severed
pursuant to the discretionary authority
of the trustee granted under the govern-
ing instrument or local law.
The final regulations provide that the
trusts resulting from the severance of a
single testamentary trust need not be
identical. Thus, if the trust provides
income to spouse, remainder to child
and grandchild, the trust may be
severed to create two trusts, one with
income to spouse, remainder to child
and a second with income to spouse
remainder to grandchild. This result
could be achieved through proper estate
planning in any event. However, the
regulations make it clear that the
resulting trusts must provide for the
same succession of interests as
provided for under the original trusts.
Thus, a trust providing for an income
interest to a child, with remainder to a
grandchild, could not be divided into
one trust for the child (equal in value
to the child’s income interest) and
another for the grandchild.
The proposed regulations provided
that the new trusts must be funded with
a fractional share of each and every
asset held by the original single trust.
The provision has been revised to
provide that the new trusts may also be
funded on a nonpro rata basis, based on
the fair market value of the assets
selected on the date of severance. Thus,
the executor or trustee may select the
assets with which to fund each trust,
and need not fractionalize each asset.
An example has been added to illu-
strate that, if a revocable trust included
in the transferor’s gross estate is, under
the terms of the trust, divided into
multiple trusts on the transferor’s
death, then each trust established will
be treated as a separate trust for GST
purposes.
Due date of return
New §26.2662–1(d)(2) has been
added to provide that the due date of
the return with respect to a taxable
termination subject to an election under
section 2624(c) (relating to alternate
valuation in accordance with section
2032) is April 15th of the following
year in which the taxable termination
occurred or on or before the 15th day
of the tenth month following the month
in which the death that resulted in the
taxable termination occurred, which-
ever is later.
Application of chapter 13 to
nonresident aliens
Section 2663(2) requires that the
Commissioner prescribe regulations,
consistent with the provisions of chap-
ters 11 and 12, providing for the
application of the GST tax to a
nonresident alien (NRA). In general,
under §26.2663–2(b) as proposed, the
GST tax applied to inter vivos and
testamentary direct skip transfers by a
NRA, to the extent that the transferred
property was U.S. situs property such
that the transfer was subject to a gift
tax (in the case of inter vivos transfers)
or an estate tax (in the case of testa-
mentary transfers). Similarly, in the
case of transfers in trust, chapter 13
applied to taxable terminations and
distributions to the extent the initial
transfer to the trust (whether inter vivos
or testamentary) consisted of U.S. situs
property, such that the initial transfer
was subject to the gift or estate tax.
This was the case regardless of the
situs of the property at the time of the
actual distribution or termination and
regardless of the residency or citizen-
ship of the skip person receiving the
beneficial interest or property.
Under §26.2663–2(c) as proposed, if
the property involved in a generation-
skipping transfer was not situated in
the U.S. at the time of the initial
transfer, the generation-skipping trans-
fer was still subject to the GST tax if:
(1) at the time of the direct skip,
taxable termination or distribution, the
property passes to a skip person who is
a U.S. resident or citizen; and (2) at the
time of the initial transfer to the skip
person or trust, a lineal descendant of
the transferor, who is a lineal ancestor
of the skip person, was a resident or
citizen of the U.S. This rule applied
regardless of the situs of the property
at the time of the actual distribution or
termination. Section 26.2663–2(f) of
the proposed regulations provided for
the automatic allocation of a NRA’s
$1,000,000 GST exemption regardless
of whether the transfer was a direct
skip.
Thus, the proposed regulations sub-
jected non-U.S. situs property to the
GST tax based on the status of the skip
person/recipient of the property at the
time the property was received, and the
status of the generation that was
skipped at the time of the initial
transfer to the trust or skip person.
Many comments were critical of this
approach. In general, these comments
emphasized that the estate and gift tax
provisions subject transfers by NRAs to
transfer tax based on the situs of the
property, not the status of the recipient.
Therefore, the proposed regulations
conflict with section 2663, which
provides that the regulations should be
consistent with the principles of chap-
ters 11 and 12 of the Internal Revenue
Code (Code). Further, the commenta-
tors argued that treating a NRA who
transfers non-U.S. situs property as a
transferor for GST tax purposes would
conflict with the definition of trans-
feror under section 2652, since the
transfer would not be subject to estate
or gift tax. Under section 2652, an
individual is a transferor only to the
extent the transfer is subject to U.S.
gift tax or estate tax.
The proposed regulations have been
revised to address these concerns.
Thus, the rules in the proposed regula-
tions applying chapter 13 to transfers
of property that were not subject to
estate or gift tax have been eliminated.
Under the final regulations, the applica-
tion of the GST tax will be limited to
situations where an estate or gift tax is
imposed on the property. Thus, the
GST tax will apply to inter vivos and
testamentary direct skip transfers by a
NRA transferor to the extent a gift tax
is imposed on the transfer (in the case
of an inter vivos transfer) or the
transferred property is included in the

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transferor’s gross estate (in the case of
a testamentary direct skip). In the case
of taxable terminations and taxable
distributions, chapter 13 will apply to
the extent a gift tax was imposed on
the initial transfer to the trust, or the
property was included in the trans-
feror’s gross estate. Accordingly, under
the final regulations (in the absence of
a situation involving an ETIP), the
application of Chapter 13 is generally
dependent on the situs of the property
at the time of the initial transfer. The
regulations contain special rules for
determining the applicable fraction and
inclusion ratio where a trust is funded
with both U.S. and foreign situs
property.
In general, the rules of §26.2632–1
apply with respect to the allocation of
the exemption. However, the ETIP rule
provided in §26.2632–1(c) applies only
if the property transferred by the NRA
is subsequently included in the trans-
feror’s gross estate. The final regula-
tions provide transitional relief with
respect to NRA’s who made GST
transfers and relied on the automatic
allocation rules in the proposed
regulations.
Special Analyses
It has been determined that this
Treasury decision is not a significant
regulatory action as defined in EO
12866. Therefore, a regulatory assess-
ment is not required. It has also been
determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C.
chapter 5) and the Regulatory Flex-
ibility Act (5 U.S.C. chapter 6) do not
apply to these regulations, and there-
fore, a Regulatory Flexibility Analysis
is not required. Pursuant to section
7805(f) of the Internal Revenue Code,
the notice of proposed rulemaking
preceding these regulations was submit-
ted to the Small Business Administra-
tion for comment on its impact on
small business.
Drafting Information
The principal author of these regula-
tions is James F. Hogan, Office of the
Chief Counsel, IRS. Other personnel
from the IRS and Treasury Department
participated in their development.
******
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 26, 301,
and 602 are amended as follows:
Paragraph 1. Part 26 is revised to
read as follows:
PART 26—GENERATION-SKIPPING
TRANSFER TAX REGULATIONS
UNDER THE TAX REFORM ACT
OF 1986
26.2600–1 Table of contents.
26.2601–1 Effective dates.
26.2611–1 Generation-skipping transfer
defined.
26.2612–1 Definitions.
26.2613–1 Skip person.
2 6 . 2 6 3 2 – 1 A l l o c a t i o n o f G S T
exemption.
26.2641–1 Applicable rate of tax.
26.2642–1 Inclusion ratio.
26.2642–2 Valuation.
26.2642–3 Special rule for charitable
lead annuity trusts.
26.2642–4 Redetermination of applica-
ble fraction.
26.2642–5 Finality of inclusion ratio.
26.2652–1 Transferor defined; other
definitions.
2 6 . 2 6 5 2 – 2 S p e c i a l e l e c t i o n f o r
qualified terminable interest property.
26.2653–1 Taxation of multiple skips.
26.2654–1 Certain trusts treated as
separate trusts.
26.2662–1 Generation-skipping transfer
tax return requirements.
26.2663–1 Recapture tax under section
2032A.
26.2663–2 Application of chapter 13 to
transfers by nonresidents not citizens of
the United States.
Authority: 26 U.S.C. 7805 and 26
U.S.C. 2663.
Section 26.2632–1 also issued under 26
U.S.C. 2632 and 2663.
Section 26.2642–4 also issued under 26
U.S.C. 2632 and 2663.
Section 26.2662–1 also issued under 26
U.S.C. 2662.
Section 26.2663–2 also issued under 26
U.S.C. 2632 and 2663.
§26.2600–1 Table of contents.
§26.2601–1 Effective dates.
(a)Transfers subject to the
generation-skipping transfer
tax.
(1)In general.
(2)Certain transfers treated as
if made after October 22,
1986.
(3)Certain trust events treated
as if occurring after Octo-
ber 22, 1986.
(4)Example.
(b)Exceptions.
(1)Irrevocable trusts.
(2)Transition rule for wills or
revocable trusts executed
before October 22, 1986.
(3)Transition rule in the case
of mental incompetency.
(4) Exceptions to additions
rule.
(c)Additional effective dates.
§26.2611–1 Generation-skipping
transfer defined.
§26.2612–1 Definitions.
(a)Direct skip.
(1)In general.
(2)Special rule for certain lin-
eal descendants.
(b)Taxable termination.
(1)In general.
(2)Partial termination.
(c)Taxable distribution.
(1)In general.
(2)Look-through rule not to
apply.
(d)Skip person.
(e)Interest in trust.
(1)In general.
(2)Exceptions.
(f)Examples.
§26.2613–1 Skip person.
§26.2632–1 Allocation of GST
exemption.
(a)General rule.
(b)Lifetime allocations.
(1)Automatic allocation to di-
rect skips.
(2) A l l o c a t i o n t o o t h e r
transfers.
(c)Special rules during an estate
tax inclusion period.
(1)In general.
(2)Estate tax inclusion period
defined.
(3)Termination of an ETIP.
(4)Treatment of direct skips.

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(5)Examples.
(d)Allocations after the trans-
feror’s death.
(1)Allocation by executor.
(2)Automatic allocation after
death.
§26.2641–1 Applicable rate of tax.
§26.2642–1 Inclusion ratio.
(a)In general.
(b)Numerator of applicable
fraction.
(1)In general.
(2)GSTs occurring during an
ETIP.
(c)Denominator of applicable
fraction.
(1)In general.
(2)Zero denominator.
(3)Nontaxable gifts.
(d)Examples.
§26.2642–2 Valuation.
(a)Lifetime transfers.
(1)In general.
(2)Special rule for late alloca-
tions during life.
(b)Transfers at death.
(1)In general.
(2)Special rule for pecuniary
payments.
(3)Special rule for residual
transfers after payment of a
pecuniary payment.
(4)Appropriate interest.
(c)Examples.
§26.2642–3 Special rule for
charitable lead annuity trusts.
(a)In general.
(b)Adjusted GST exemption
defined.
(c)Example.
§26.2642–4 Redetermination of
applicable fraction.
(a)In general.
(1)Multiple transfers to a sin-
gle trust.
(2)Consolidation of separate
trusts.
(3)Property included in trans-
feror’s gross estate.
(4)Imposition of recapture tax
under section 2032A.
(b)Examples.
§26.2642–5 Finality of inclusion
ratio.
(a)Direct skips.
(b)Other GSTs.
§26.2652–1 Transferor defined; other
definitions.
(a)Transferor defined.
(1)In general.
(2)Transfers subject to Federal
estate or gift tax.
(3) Special rule for certain
QTIP trusts.
(4)Exercise of certain non-
general powers of appoint-
ment.
(5)Split-gift transfers.
(6)Examples.
(b)Trust defined.
(1)In general.
(2)Examples.
(c)Trustee defined.
(d)Executor defined.
(e)Interest in trust.
§26.2652–2 Special election for
qualified terminable interest property.
(a)In general.
(b)Time and manner of making
election.
(c)Transitional rule.
(d)Examples.
§26.2653–1 Taxation of multiple
skips.
(a)General rule.
(b)Examples.
§26.2654–1 Certain trusts treated as
separate trusts.
(a)Single trust treated as separate
trusts.
(1)Substantially separate and
independent shares.
(2) Multiple transferors with
respect to a single trust.
(3)Severance of a single trust.
(4)Allocation of exemption.
(5)Examples.
(b)Division of a trust included in
the gross estate.
(1)In general.
(2)Special rule.
(3)Allocation of exemption.
(4)Example.
§26.2662–1 Generation-skipping
transfer tax return requirements.
(a)In general.
(b)Form of return.
(1)Taxable distributions.
(2)Taxable terminations.
(3)Direct skip.
(c)Person liable for tax and re-
quired to make return.
(1)In general.
(2)Special rule for direct skips
occurring at death with re-
spect to property held in
trust arrangements.
(3)Limitation on personal lia-
bility of trustee.
(4)Exceptions.
(d)Time and manner of filing
return.
(1)In general.
(2)Exceptions.
(e)Place for filing returns.
(f)Lien on property.
§26.2663–1 Recapture tax under
section 2032A.
§26.2663–2 Application of chapter 13
to transfers by nonresidents not
citizens of the United States.
(a)In general.
(b)Transfers subject to Chapter
13.
(1)Direct skips.
(2)Taxable distributions and
taxable terminations.
(c)Trusts funded in part with
property subject to Chapter 13
and in part with property not
subject to Chapter 13.
(1)In general.
(2)Nontax portion of the trust.
(3)Special rule with respect to
estate tax inclusion period.
(d)Examples.
(e)Transitional rule for allocations
for transfers made before De-
cember 27, 1995.
26.2601–1 Effective dates.
( a )T r a n s f e r s s u b j e c t t o t h e
generation-skipping transfer tax—(1)
In general. Except as otherwise pro-
vided in this section, the provisions of
chapter 13 of the Internal Revenue
Code of 1986 (Code) apply to any
generation-skipping transfer (as defined
in section 2611) made after October 22,
1986.
(2)Certain transfers treated as if
made after October 22, 1986. Solely

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for purposes of chapter 13, an inter
vivos transfer is treated as if it were
made on October 23, 1986, if it was—
(i)Subject to chapter 12 (regardless
of whether a tax was actually incurred
or paid); and
(ii)Made after September 25, 1985,
but before October 23, 1986. For
purposes of this paragraph, the value of
the property transferred shall be the
value of the property on the date the
property was transferred.
(3)Certain trust events treated as if
occurring after October 22, 1986. For
purposes of chapter 13, if an inter
vivos transfer is made to a trust after
September 25, 1985, but before Octo-
ber 23, 1986, any subsequent distribu-
tion from the trust or termination of an
interest in the trust that occurred before
October 23, 1986, is treated as occur-
ring immediately after the deemed
transfer on October 23, 1986. If more
than one distribution or termination
occurs with respect to a trust, the
events are treated as if they occurred
on October 23, 1986, in the same order
as they occurred. See paragraph (b)(1)-
(iv)(B) of this section for rules deter-
mining the portion of distributions and
terminations subject to tax under chap-
ter 13. This paragraph (a)(3) does not
apply to transfers to trusts not subject
to chapter 13 by reason of the transi-
tion rules in paragraphs (b)(2) and (3)
of this section. The provisions of this
paragraph (a)(3) do not apply in
determining the value of the property
under chapter 13.
(4)Example. The following example
illustrates the principle that paragraph
(a)(2) of this section is not applicable
to transfers under a revocable trust that
became irrevocable by reason of the
transferor’s death after September 25,
1985, but before October 23, 1986:
Example. T created a revocable trust on
September 30, 1985, that became irrevocable
when T died on October 10, 1986. Although the
trust terminated in favor of a grandchild of T, the
transfer to the grandchild is not treated as
occurring on October 23, 1986, pursuant to
paragraph (a)(2) of this section because it is not
an inter vivos transfer subject to chapter 12. The
transfer is not subject to chapter 13 because it is
in the nature of a testamentary transfer that
occurred prior to October 23, 1986.
( b )E x c e p t i o n s— ( 1 ) I r r e v o c a b l e
trusts—(i) In general. The provisions
of chapter 13 do not apply to any
generation-skipping transfer under a
trust (as defined in section 2652(b))
that was irrevocable on September 25,
1985. The rule of the preceding sen-
tence does not apply to a pro rata
portion of any generation-skipping
transfer under an irrevocable trust if
additions are made to the trust after
September 25, 1985. See paragraph (b)-
(1)(iv) of this section for rules for
determining the portion of the trust that
is subject to the provisions of chapter
13.
(ii)Irrevocable trust defined—(A) In
general. Unless otherwise provided in
either paragraph (b)(1)(ii)(B) or (C) of
this section, any trust (as defined in
section 2652(b)) in existence on Sep-
tember 25, 1985, is considered an
irrevocable trust.
(B)Property includible in the gross
estate under section 2038. For purposes
of this chapter a trust is not an ir-
revocable trust to the extent that, on
September 25, 1985, the settlor held a
power with respect to such trust that
would have caused the value of the
trust to be included in the settlor’s
gross estate for Federal estate tax
purposes by reason of section 2038
(without regard to powers relinquished
before September 25, 1985) if the
settlor had died on September 25,
1985. A trust is considered subject to a
power on September 25, 1985, even
though the exercise of the power was
subject to the precedent giving of
notice, or even though the exercise
could take effect only on the expiration
of a stated period, whether or not on or
before September 25, 1985, notice had
been given or the power had been
exercised. A trust is not considered
subject to a power if the power is, by
its terms, exercisable only on the
occurrence of an event or contingency
not subject to the settlor’s control
(other than the death of the settlor) and
if the event or contingency had not in
fact taken place on September 25,
1985.
(C)Property includible in the gross
estate under section 2042. A policy of
insurance on an individual’s life that is
treated as a trust under section 2652(b)
is not considered an irrevocable trust to
the extent that, on September 25, 1985,
the insured possessed any incident of
ownership (as defined in §20.2042–1(c)
of this chapter, and without regard to
any incidents of ownership relinquished
before September 25, 1985), that would
have caused the value of the trust, (i.e.,
the insurance proceeds) to be included
in the insured’s gross estate for Federal
estate tax purposes by reason of section
2042, if the insured had died on
September 25, 1985.
(D)Examples. The following exam-
ples illustrate the application of this
paragraph (b)(1):
Example 1. Section 2038 applicable. On
September 25, 1985, T, the settlor of a trust that
was created before September 25, 1985, held a
testamentary power to add new beneficiaries to
the trust. T held no other powers over any
portion of the trust. The testamentary power held
by T would have caused the trust to be included
in T’s gross estate under section 2038 if T had
died on September 25, 1985. Therefore, the trust
is not an irrevocable trust for purposes of this
section.
Example 2. Section 2038 not applicable when
power held by a person other than settlor. On
September 25, 1985, S, the spouse of the settlor
of a trust in existence on that date, had an annual
right to withdraw a portion of the principal of
the trust. The trust was otherwise irrevocable on
that date. Because the power was not held by the
settlor of the trust, it is not a power described in
section 2038. Thus, the trust is considered an
irrevocable trust for purposes of this section.
Example 3. Section 2038 not applicable. In
1984, T created a trust and retained the right to
expand the class of remaindermen to include any
of T’s afterborn grandchildren. As of September
25, 1985, all of T’s grandchildren were named
remaindermen of the trust. Since the exercise of
T’s power was dependent on there being
afterborn grandchildren who were not members
of the class of remaindermen, a contingency that
did not exist on September 25, 1985, the trust is
not considered subject to the power on Septem-
ber 25, 1985, and is an irrevocable trust for
purposes of this section. The result is not
changed even if grandchildren are born after
September 25, 1985, whether or not T exercises
the power to expand the class of remaindermen.
Example 4. Section 2042 applicable. On
September 25, 1985, T purchased an insurance
policy on T’s own life and designated child, C,
and grandchild, GC, as the beneficiaries. T
retained the power to obtain from the insurer a
loan against the surrender value of the policy.
T’s insurance policy is a trust (as defined in
section 2652(b)) for chapter 13 purposes. The
trust is not considered an irrevocable trust
because, on September 25, 1985, T possessed an
incident of ownership that would have caused the
value of the policy to be included in T’s gross
estate under section 2042 if T had died on that
date.
Example 5. Trust partially irrevocable. In
1984, T created a trust naming T’s grandchildren
as the income and remainder beneficiaries. T
retained the power to revoke the trust as to one-
half of the principal at any time prior to T’s
death. T retained no other powers over the trust
principal. T did not die before September 25,
1985, and did not exercise or release the power
before that date. The half of the trust not subject
to T’s power to revoke is an irrevocable trust for
purposes of this section.
(iii)Trust containing qualified termi-
nable interest property—(A) In gen-
eral. For purposes of chapter 13, a trust
described in paragraph (b)(1)(ii) of this
section that holds qualified terminable
interest property by reason of an
election under section 2056(b)(7) or

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section 2523(f) (made either on, before
or after September 25, 1985) is treated
in the same manner as if the decedent
spouse or the donor spouse (as the case
may be) had made an election under
section 2652(a)(3). Thus, transfers from
such trusts are not subject to chapter
13, and the decedent spouse or the
donor spouse (as the case may be) is
treated as the transferor of such prop-
erty. The rule of this paragraph
(b)(1)(iii) does not apply to that portion
of the trust that is subject to chapter 13
by reason of an addition to the trust
occurring after September 25, 1985.
See §26.2652–2(a) for rules where an
election under section 2652(a)(3) is
made. See §26.2652–2(c) for rules
where a portion of a trust is subject to
an election under section 2652(a)(3).
(B)Examples. The following exam-
ples illustrate the application of this
paragraph (b)(1)(iii):
Example 1. QTIP election made after Septem-
ber 25, 1985. On March 28, 1985, T established
a trust. The trust instrument provided that the
trustee must distribute all income annually to T’s
spouse, S, during S’s life. Upon S’s death, the
remainder is to be distributed to GC, the
grandchild of T and S. On April 15, 1986, T
elected under section 2523(f) to treat the
property in the trust as qualified terminable
interest property. On December 1, 1987, S died
and soon thereafter the trust assets were dis-
tributed to GC. Because the trust was irrevocable
on September 25, 1985, the transfer to GC is not
subject to tax under chapter 13. T is treated as
the transferor with respect to the transfer of the
trust assets to GC in the same manner as if T
had made an election under section 2652(a)(3) to
reverse the effect of the section 2523(f) election
for chapter 13 purposes.
Example 2. Section 2652(a)(3) election deemed
to have been made. Assume the same facts as in
Example 1, except the trust instrument provides
that after S’s death all income is to be paid
annually to C, the child of T and S. Upon C’s
death, the remainder is to be distributed to GC.
C died on October 1, 1992, and soon thereafter
the trust assets are distributed to GC. Because
the trust was irrevocable on September 25, 1985,
the termination of C’s interest is not subject to
chapter 13.
(iv)Additions to irrevocable trusts—
(A) In general. If an addition is made
after September 25, 1985, to an irrevo-
cable trust which is excluded from
chapter 13 by reason of paragraph
(b)(1) of this section, a pro rata portion
of subsequent distributions from (and
terminations of interests in property
held in) the trust is subject to the
provisions of chapter 13. If an addition
is made, the trust is thereafter deemed
to consist of two portions, a portion not
subject to chapter 13 (the non-chapter
13 portion) and a portion subject to
chapter 13 (the chapter 13 portion),
each with a separate inclusion ratio (as
defined in section 2642(a)). The non-
chapter 13 portion represents the value
of the assets of the trust as it existed
on September 25, 1985. The applicable
fraction (as defined in section
2642(a)(2)) for the non-chapter 13
portion is deemed to be 1 and the
inclusion ratio for such portion is 0.
The chapter 13 portion of the trust
represents the value of all additions
made to the trust after September 25,
1985. The inclusion ratio for the
chapter 13 portion is determined under
section 2642. This paragraph (b)(1)(iv)-
(A) requires separate portions of one
trust only for purposes of determining
inclusion ratios. For purposes of chap-
ter 13, a constructive addition under
paragraph (b)(1)(v) of this section is
treated as an addition. See paragraph
(b)(4) of this section for exceptions to
the additions rule of this paragraph
(b)(1)(iv). See §26.2654–1(a)(2) for
rules treating additions to a trust by an
individual other than the initial trans-
feror as a separate trust for purposes of
chapter 13.
(B)Terminations of interests in and
distributions from trusts. Where a
termination or distribution described in
section 2612 occurs with respect to a
trust to which an addition has been
made, the portion of such termination
or distribution allocable to the chapter
13 portion is determined by reference
to the allocation fraction, as defined in
paragraph (b)(1)(iv)(C) of this section.
In the case of a termination described
in section 2612(a) with respect to a
trust, the portion of such termination
that is subject to chapter 13 is the
product of the allocation fraction and
the value of the trust (to the extent of
the terminated interest therein). In the
case of a distribution described in
section 2612(b) from a trust, the
portion of such distribution that is
subject to chapter 13 is the product of
the allocation fraction and the value of
the property distributed.
(C)Allocation fraction—(1) In gen-
eral. The allocation fraction allocates
appreciation and accumulated income
between the chapter 13 and non-chapter
13 portions of a trust. The numerator of
the allocation fraction is the amount of
the addition (valued as of the date the
addition is made), determined without
regard to whether any part of the
transfer is subject to tax under chapter
11 or chapter 12, but reduced by the
amount of any Federal or state estate or
gift tax imposed and subsequently paid
by the recipient trust with respect to
the addition. The denominator of the
allocation fraction is the total value of
the entire trust immediately after the
addition. For purposes of this para-
graph (b)(1)(iv)(C), the total value of
the entire trust is the fair market value
of the property held in trust (deter-
mined under the rules of section 2031),
reduced by any amount attributable to
or paid by the trust and attributable to
the transfer to the trust that is similar
to an amount that would be allowable
as a deduction under section 2053 if
the addition had occurred at the death
of the transferor, and further reduced
by the same amount that the numerator
was reduced to reflect Federal or state
estate or gift tax incurred by and
subsequently paid by the recipient trust
with respect to the addition. Where
there is more than one addition to
principal after September 25, 1985, the
portion of the trust subject to chapter
13 after each such addition is deter-
mined pursuant to a revised fraction. In
each case, the numerator of the revised
fraction is the sum of the value of the
chapter 13 portion of the trust imme-
diately before the latest addition, and
the amount of the latest addition. The
denominator of the revised fraction is
the total value of the entire trust
immediately after the addition. If the
transfer to the trust is a generation-
skipping transfer, the numerator and
denominator are reduced by the amount
of the generation-skipping transfer tax,
if any, that is imposed by chapter 13
on the transfer and actually recovered
from the trust. The allocation fraction
is rounded off to five decimal places
(.00001).
(2)Examples. The following exam-
ples illustrate the application of para-
graph (b)(1)(iv) of this section. In each
of the examples, assume that the
recipient trust does not pay any Federal
or state transfer tax by reason of the
addition.
Example 1. Post September 25, 1985, addition
to trust. (i) On August 16, 1980, T established an
irrevocable trust. Under the trust instrument, the
trustee is required to distribute the entire income
annually to T’s child, C, for life, then to T’s
grandchild, GC, for life. Upon GC’s death, the
remainder is to be paid to GC’s issue. On
October 1, 1986, when the total value of the
entire trust is $400,000, T transfers $100,000 to
the trust. The allocation fraction is computed as
follows:

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Value of addition
=
$100,000
=.2
Total value of trust
$400,000 + $100,000
(ii)Thus, immediately after the transfer, 20
percent of the value of future generation-skipping
transfers under the trust will be subject to
chapter 13.
Example 2. Effect of expenses. Assume the
same facts as in Example 1, except immediately
prior to the transfer on October 1, 1986, the fair
market value of the individual assets in the trust
totaled $400,000. Also, assume that the trust had
accrued and unpaid debts, expenses, and taxes
totaling $300,000. Assume further that the entire
$300,000 represented amounts that would be
deductible under section 2053 if the trust were
includible in the transferor’s gross estate. The
numerator of the allocation fraction is $100,000
and the denominator of the allocation fraction is
$200,000 (($400,000 – $300,000) + $100,000).
T h u s , t h e a l l o c a t i o n f r a c t i o n i s . 5
($100,000/$200,000) and 50 percent of the value
of future generation-skipping transfers will be
subject to chapter 13.
Example 3. Multiple additions. (i) Assume the
same facts as in Example 1, except on January
30, 1988, when the total value of the entire trust
is $600,000, T transfers an additional $40,000 to
the trust. Before the transfer, the value of the
portion of the trust that was attributable to the
prior addition was $120,000 ($600,000 3 .2).
The new allocation fraction is computed as
follows:
Total value of additions
=
Total value of trust
$120,000 + $40,000
=
$160,000
=.25
$600,000 + $40,000
$640,000
(ii)Thus, immediately after the transfer, 25
percent of the value of future generation-skipping
transfers under the trust will be subject to
chapter 13.
Example 4. Allocation fraction at time of
generation-skipping transfer. Assume the same
facts as in Example 3, except on March 1, 1989,
when the value of the trust is $800,000, C dies.
A generation-skipping transfer occurs at C’s
death because of the termination of C’s life
estate. Therefore, $200,000 ($800,000 3 .25) is
subject to tax under chapter 13.
( v )C o n s t r u c t i v e a d d i t i o n s— ( A )
Powers of Appointment. Except as
provided in paragraph (b)(1)(v)(B) of
this section, where any portion of a
trust remains in the trust after the post-
September 25, 1985, release, exercise,
or lapse of a power of appointment
over that portion of the trust, and the
release, exercise, or lapse is treated to
any extent as a taxable transfer under
chapter 11 or chapter 12, the value of
the entire portion of the trust subject to
the power that was released, exercised,
or lapsed is treated as if that portion
had been withdrawn and immediately
retransferred to the trust at the time of
the release, exercise, or lapse. The
creator of the power will be considered
the transferor of the addition except to
the extent that the release, exercise, or
lapse of the power is treated as a
taxable transfer under chapter 11 or
chapter 12. See §26.2652–1 for rules
for determining the identity of the
transferor of property for purposes of
chapter 13.
(B)Special rule for certain powers
of appointment. The release, exercise,
or lapse of a power of appointment
(other than a general power of appoint-
ment as defined in §2041(b)) is not
treated as an addition to a trust if—
(1) Such power of appointment was
created in an irrevocable trust that is
not subject to chapter 13 under para-
graph (b)(1) of this section; and
(2) In the case of an exercise, the
power of appointment is not exercised
in a manner that may postpone or
suspend the vesting, absolute owner-
ship or power of alienation of an
interest in property for a period,
measured from the date of creation of
the trust, extending beyond any life in
being at the date of creation of the trust
plus a period of 21 years plus, if
necessary, a reasonable period of gesta-
tion (the perpetuities period). For pur-
poses of this paragraph (b)(1)(v)(B)(2),
the exercise of a power of appointment
that validly postpones or suspends the
vesting, absolute ownership or power
of alienation of an interest in property
for a term of years that will not exceed
90 years (measured from the date of
creation of the trust) will not be
considered an exercise that postpones
or suspends vesting, absolute owner-
ship or the power of alienation beyond
the perpetuities period. If a power is
exercised by creating another power, it
is deemed to be exercised to whatever
extent the second power may be
exercised.
(C)Constructive addition if liability
is not paid out of trust principal.
Where a trust described in paragraph
(b)(1) of this section is relieved of any
liability properly payable out of the
assets of such trust, the person or entity
who actually satisfies the liability is
considered to have made a constructive
addition to the trust in an amount equal
to the liability. The constructive addi-
tion occurs when the trust is relieved of
liability (e.g., when the right of recov-
ery is no longer enforceable). But see
§26.2652–1(a)(3) for rules involving
the application of section 2207A in the
case of an election under section
2652(a)(3).
(D)Examples. The following exam-
ples illustrate the application of this
paragraph (b)(1)(v):
Example 1. Lapse of a power of appointment.
On June 19, 1980, T established an irrevocable
trust with a corpus of $500,000. The trust
instrument provides that the trustee shall dis-
tribute the entire income from the trust annually
to T’s spouse, S, during S’s life. At S’s death,
the remainder is to be distributed to T and S’s
grandchild, GC. T also gave S a general power
of appointment over one-half of the trust assets.
On December 21, 1989, when the value of the
trust corpus is $1,500,000, S died without having
exercised the general power of appointment. The
value of one-half of the trust corpus, $750,000
($1,500,000 3 .5) is included in S’s gross estate
under section 2041(a) and is subject to tax under
Chapter 11. Because the value of one-half of the
trust corpus is subject to tax under Chapter 11
with respect to S’s estate, S is treated as the
transferor of that property for purposes of
Chapter 13 (see section 2652(a)(1)(A)). For
purposes of the generation-skipping transfer tax,
the lapse of S’s power of appointment is treated
as if $750,000 ($1,500,000 3 .5) had been
distributed to S and then transferred back to the
trust. Thus, S is considered to have added
$750,000 ($1,500,000 3 .5) to the trust at the
date of S’s death. Because this constructive
addition occurred after September 25, 1985, 50
percent of the corpus of the trust became subject
to Chapter 13 at S’s death.
Example 2. Multiple actual additions. On June
19, 1980, T established an irrevocable trust with
a principal of $500,000. The trust instrument
provides that the trustee shall distribute the entire
income from the trust annually to T’s spouse, S,
during S’s life. At S’s death, the remainder is to
be distributed to GC, the grandchild of T and S.
On October 1, 1985, when the trust assets were
valued at $800,000, T added $200,000 to the
trust. After the transfer on October 1, 1985, the
allocation fraction was .2 ($200,000/$1,000,000).
On December 21, 1989, when the value of the
trust principal is $1,000,000, T adds $1,000,000
to the trust. After this addition, the new alloca-
tion fraction is 0.6 ($1,200,000/$2,000,000). The
numerator of the fraction is the value of that
portion of trust assets that were subject to
chapter 13 immediately prior to the addition (by
reason of the first addition), $200,000 (.2 3
$1,000,000), plus the value of the second
transfer, $1,000,000, which equals $1,200,000.
The denominator of the fraction, $2,000,000, is
the total value of the trust assets immediately
after the second transfer. Thus, 60 percent of the
principal of the trust becomes subject to chapter
13.

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Example 3. Entire portion of trust subject to
lapsed power is treated as an addition. On
September 25, 1985, B possessed a general
power of appointment over the assets of an
irrevocable trust that had been created by T in
1980. Under the terms of the trust, B’s power
lapsed on July 20, 1987. For Federal gift tax
purposes, B is treated as making a gift of ninety-
five percent (100% – 5%) of the value of the
principal (see section 2514). However, because
the entire trust was subject to the power of
appointment, 100 percent (that portion of the
trust subject to the power) of the assets of the
trust are treated as a constructive addition. Thus,
the entire amount of all generation-skipping
transfers occurring pursuant to the trust instru-
ment after July 20, 1987, are subject to chapter
13.
Example 4. Exercise of power of appointment
in favor of another trust. On March 1, 1985, T
established an irrevocable trust as defined in
paragraph (b)(1)(ii) of this section. Under the
terms of the trust instrument, the trustee is
required to distribute the entire income annually
to T’s child, C, for life, then to T’s grandchild,
GC, for life. GC has the power to appoint any or
all of the trust assets to Trust 2 which is an
irrevocable trust (as defined in paragraph (b)(1)-
(ii) of this section) that was established on
August 1, 1985. The terms of Trust 2’s govern-
ing instrument provide that the trustee shall pay
income to T’s great grandchild, GGC, for life.
Upon GGC’s death the remainder is to be paid to
GGC’s issue. GGC was alive on March 1, 1985,
when Trust 1 was created. C died on April 1,
1986. On July 1, 1987, GC exercised the power
of appointment. The exercise of GC’s power
does not subject future transfers from Trust 2 to
tax under chapter 13 because the exercise of the
power in favor of Trust 2 does not suspend the
vesting, absolute ownership, or power of aliena-
tion of an interest in property for a period,
measured from the date of creation of Trust 1,
extending beyond the life of GGC (a beneficiary
under Trust 2 who was in being at the date of
creation of Trust 1) plus a period of 21 years.
The result would be the same if Trust 2 had been
created after the effective date of chapter 13.
Example 5. Exercise of power of appointment
in favor of another trust. Assume the same facts
as in Example 3, except that GGC was born on
March 28, 1986. The valid exercise of GC’s
power in favor of Trust 2 causes the principal of
Trust 1 to be subject to chapter 13, because GGC
was not born until after the creation of Trust 1.
Thus, such exercise may suspend the vesting,
absolute ownership, or power of alienation of an
interest in the trust principal for a period,
measured from the date of creation of Trust 1,
extending beyond the life of GGC (a beneficiary
under Trust 2 who was not a life in being at the
date of creation of Trust 1).
Example 6. Extension for the longer of two
periods. Prior to the effective date of chapter 13,
GP established an irrevocable trust under which
the trust income was to be paid to GP’s child, C,
for life. C was given a testamentary power to
appoint the remainder in further trust for the
benefit of C’s issue. In default of C’s exercise of
the power, the remainder was to pass to charity.
C died on February 3, 1995, survived by a child
who was alive when GP established the trust. C
exercised the power in a manner that validly
extends the trust in favor of C’s issue until the
later of May 15, 2064 (80 years from the date
the trust was created), or the death of C’s child
plus 21 years. C’s exercise of the power is a
constructive addition to the trust because the
exercise may extend the trust for a period longer
than the permissible periods of either the life of
C’s child (a life in being at the creation of the
trust) plus 21 years or a term not more than 90
years measured from the creation of the trust. On
the other hand, if C’s exercise of the power
could extend the trust based only on the life of
C’s child plus 21 years or only for a term of 80
years from the creation of the trust (but not the
later of the two periods) then the exercise of the
power would not have been a constructive
addition to the trust.
Example 7. Extension for the longer of two
periods. The facts are the same as in Example 6
except local law provides that the effect of C’s
exercise is to extend the term of the trust until
May 15, 2064, whether or not C’s child pre-
deceases that date by more than 21 years. C’s
exercise is not a constructive addition to the trust
because C exercised the power in a manner that
cannot postpone or suspend vesting, absolute
ownership, or power of alienation for a term of
years that will exceed 90 years. The result would
be the same if the effect of C’s exercise is either
to extend the term of the trust until 21 years
after the death of C’s child or to extend the term
of the trust until the first to occur of May 15,
2064 or 21 years after the death of C’s child.
(vi)Appreciation and income. Ex-
cept to the extent that the provisions of
paragraphs (b)(1)(iv) and (v) of this
section allocate subsequent appreciation
and accumulated income between the
original trust and additions thereto,
appreciation in the value of the trust
and undistributed income added thereto
are not considered an addition to the
principal of a trust.
(2)Transition rule for wills or revo-
cable trusts executed before October
22, 1986—(i) In general. The provi-
sions of chapter 13 do not apply to any
generation-skipping transfer under a
will or revocable trust executed before
October 22, 1986, provided that—
(A)The document in existence on
October 21, 1986, is not amended at
any time after October 21, 1986, in any
respect which results in the creation of,
or an increase in the amount of, a
generation-skipping transfer;
(B)In the case of a revocable trust,
no addition is made to the revocable
trust after October 21, 1986, that
results in the creation of, or an increase
in the amount of, a generation-skipping
transfer; and
(C)The decedent dies before Janu-
ary 1, 1987.
(ii)Revocable trust defined. For pur-
poses of this section, the term revoca-
ble trust means any trust (as defined in
section 2652(b)) except to the extent
that, on October 22, 1986, the trust—
(A)Was an irrevocable trust de-
scribed in paragraph (b)(1) of this
section; or
(B)Would have been an irrevocable
trust described in paragraph (b)(1) of
this section had it not been created or
become irrevocable after September 25,
1985, and before October 22, 1986.
(iii)Will or revocable trust contain-
ing qualified terminable interest prop-
erty. The rules contained in paragraph
(b)(1)(iii) of this section apply to any
will or revocable trust within the scope
of the transition rule of this paragraph
(b)(2).
(iv)Amendments to will or revoca-
ble trust. For purposes of this para-
graph (b)(2), an amendment to a will or
a revocable trust in existence on
October 21, 1986, is not considered to
result in the creation of, or an increase
in the amount of, a generation-skipping
transfer where the amendment is—
(A)Basically administrative or clar-
ifying in nature and only incidentally
increases the amount transferred; or
(B)Designed to ensure that an exist-
ing bequest or transfer qualifies for the
applicable marital or charitable deduc-
tion for estate, gift, or generation-
skipping transfer tax purposes and only
incidentally increases the amount trans-
ferred to a skip person or to a
generation-skipping trust.
(v)Creation of, or increase in the
amount of, a GST. In determining
whether a particular amendment to a
will or revocable trust creates, or
increases the amount of, a generation-
skipping transfer for purposes of this
paragraph (b)(2), the effect of the
instrument(s) in existence on October
21, 1986, is measured against the effect
of the instrument(s) in existence on the
date of death of the decedent or on the
date of any prior generation-skipping
transfer. If the effect of an amendment
cannot be immediately determined, it is
deemed to create, or increase the
amount of, a generation-skipping trans-
fer until a determination can be made.
(vi)Additions to revocable trusts.
Any addition made after October 21,
1986, but before the death of the
settlor, to a revocable trust subjects all
subsequent generation-skipping trans-
fers under the trust to the provisions of
chapter 13. Any addition made to a
revocable trust after the death of the
settlor (if the settlor dies before Janu-
ary 1, 1987) is treated as an addition to
an irrevocable trust. See paragraph
(b)(1)(v) of this section for rules
involving constructive additions to
trusts. See paragraph (b)(1)(v)(B) of
this section for rules providing that

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certain transfers to trusts are not treated
as additions for purposes of this
section.
(vii)Examples. The following exam-
ples illustrate the application of para-
graph (b)(2)(iv) of this section:
(A)Facts applicable to Examples 1 through 5.
In each of Examples 1 through 5 assume that T
executed a will prior to October 22, 1986, and
that T dies on December 31, 1986.
Example 1. Administrative change. On Novem-
ber 1, 1986, T executes a codicil to T’s will
removing one of the co-executors named in the
will. Although the codicil may have the effect of
lowering administrative costs and thus increasing
the amount transferred, it is considered admin-
istrative in nature and thus does not cause
generation-skipping transfers under the will to be
subject to chapter 13.
Example 2. Effect of amendment not imme-
diately determinable. On November 1, 1986, T
executes a codicil to T’s will revoking a bequest
of $100,000 to C, a non-skip person (as defined
under section 2613(b)) and causing that amount
to be added to a residuary trust held for a skip
person. The amendment is deemed to increase
the amount of a generation-skipping transfer and
prevents any transfers under the will from
qualifying under paragraph (b)(2)(i) of this
section. If, however, C dies before T and under
local law the property would have been added to
the residue in any event because the bequest
would have lapsed, the codicil is not considered
an amendment that increases the amount of a
generation-skipping transfer.
Example 3. Refund of tax paid because of
amendment. T’s will provided that an amount
equal to the maximum allowable marital deduc-
tion would pass to T’s spouse with the residue of
the estate passing to a trust established for the
benefit of skip persons. On October 23, 1986, the
will is amended to provide that the marital share
passing to T’s spouse shall be the lesser of the
maximum allowable marital deduction or the
minimum amount that will result in no estate tax
liability for T’s estate. The amendment may
increase the amount of a generation-skipping
transfer. Therefore, any generation-skipping
transfers under the will are subject to tax under
chapter 13. If it becomes apparent that the
amendment does not increase the amount of a
generation-skipping transfer, a claim for refund
may be filed with respect to any generation-
skipping transfer tax that was paid within the
period set forth in section 6511. For example, it
would become apparent that the amendment did
not result in an increase in the residue if it is
subsequently determined that the maximum
marital deduction and the minimum amount that
will result in no estate tax liability are equal in
amount.
Example 4. An amendment that increases a
generation-skipping transfer causes complete
loss of exempt status. T’s will provided for the
creation of two trusts for the benefit of skip
persons. On November 1, 1986, T executed a
codicil to the will specifically increasing the
amount of a generation-skipping transfer under
the will. All transfers made pursuant to the will
or either of the trusts created thereunder are
precluded from qualifying under the transition
rule of paragraph (b)(2)(i) of this section and are
subject to tax under chapter 13.
Example 5. Corrective action effective. As-
sume that T in Example 4 later executes a second
codicil deleting the increase to the generation-
skipping transfer. Because the provision increas-
ing a generation-skipping transfer does not
become effective, it is not considered an
amendment to a will in existence on October 22,
1986.
(B)Facts applicable to Examples 6 through 9.
T created a trust on September 30, 1985, in
which T retained the power to revoke the
transfer at any time prior to T’s death. The trust
provided that, upon the death of T, the income
was to be paid to T’s spouse, W, for life and
then to A, B, and C, the children of T’s sibling,
S, in equal shares for life, with one-third of the
principal to be distributed per stirpes to each
child’s surviving issue upon the death of the
child. The trustee has the power to make
discretionary distributions of trust principal to
T’s sibling, S.
Example 6. Amendment that affects only a
person who is not a skip person. A became
disabled, and T modified the trust on December
1, 1986, to increase A’s share of the income.
Since the amendment does not result in the
creation of, or increase in the amount of, a
generation-skipping transfer, transfers pursuant to
the trust are not subject to chapter 13.
Example 7. Amendment increasing skip per-
son’s share. Assume that A, B, and C are the
grandchildren of S rather than the children (and
thus are skip persons as defined in section 2613).
T’s amendment of the trust increasing A’s share
of the income subjects the trust to the provisions
of chapter 13 because the amendment increases
the amount of the generation-skipping transfers
to be made to A.
Example 8. Amendment that adds a skip
person. Assume that T amends the trust to add
T’s grandchild, D, as an income beneficiary. The
trust will be subject to the provisions of chapter
13 because the amendment creates a generation-
skipping transfer.
Example 9. Refund of tax paid during interim
period when effect of amendment is not deter-
minable. Assume that T amends the trust to
provide that the issue of S are to take a one-
fourth share of the principal per stirpes upon S’s
death. Because the distribution to be made upon
S’s death may involve skip persons, the amend-
ment is considered an amendment that creates or
increases the amount of a generation-skipping
transfer until a determination can be made.
Accordingly, any distributions from (or termina-
tions of interests in) such trust are subject to
chapter 13 until it is determined that no skip
person has been added to the trust. At that time,
a claim for refund may be filed within the period
set forth in section 6511 with respect to any
generation-skipping transfer tax that was paid.
(3)Transition rule in the case of
mental incompetency—(i) In general. If
an individual was under a mental
disability to change the disposition of
his or her property continuously from
October 22, 1986, until the date of his
or her death, the provisions of chapter
13 do not apply to any generation-
skipping transfer—
(A)Under a trust (as defined in
section 2652(b)) to the extent such trust
consists of property, or the proceeds of
property, the value of which was
included in the gross estate of the
individual (other than property trans-
ferred by or on behalf of the individual
during the individual’s life after Octo-
ber 22, 1986); or
(B)Which is a direct skip (other
than a direct skip from a trust) that
occurs by reason of the death of the
individual.
(ii)Mental disability defined. For
purposes of this paragraph (b)(2), the
term mental disability means mental
incompetence to execute an instrument
governing the disposition of the indi-
vidual’s property, whether or not there
was an adjudication of incompetence
and regardless of whether there has
been an appointment of a guardian,
fiduciary, or other person charged with
either the care of the individual or the
care of the individual’s property.
(iii)Decedent who has not been
adjudged mentally incompetent. If there
has not been a court adjudication that
the decedent was mentally incompetent
on or before October 22, 1986, the
executor must file, with Form 706,
either—
(A)A certification from a qualified
physician stating that the decedent
was—
(1) mentally incompetent at all times
on and after October 22, 1986; and
(2) did not regain competence to
modify or revoke the terms of the trust
or will prior to his or her death; or
(B)Sufficient other evidence demon-
strating that the decedent was mentally
incompetent at all times on and after
October 22, 1986, as well as a
statement explaining why no certifica-
tion is available from a physician; and
(C)Any judgement or decree relat-
ing to the decedent’s incompetency that
was made after October 22, 1986.
Such items will be considered relevant,
but not determinative, in establishing
the decedent’s state of competency.
(iv)Decedent who has been ad-
judged mentally incompetent. If the
decedent has been adjudged mentally
incompetent on or before October 22,
1986, a copy of the judgment or
decree, and any modification thereof,
must be filed with the Form 706.
(v)Rule applies even if another
person has power to change trust
terms. In the case of a transfer from a
trust, this paragraph (b)(3) applies even
though a person charged with the care
of the decedent or the decedent’s
property has the power to revoke or
modify the terms of the trust, provided

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that the power is not exercised after
October 22, 1986, in a manner that
creates, or increases the amount of, a
generation-skipping transfer. See para-
graph (b)(2)(iv) of this section for rules
concerning amendments that create or
increase the amount of a generation-
skipping transfer.
(vi)Example. The following exam-
ple illustrates the application of para-
graph (b)(3)(v) of this section:
Example. T was mentally incompetent on
October 22, 1986, and remained so until death in
1993. Prior to becoming incompetent, T created
a revocable generation-skipping trust that was
includible in T’s gross estate. Prior to October
22, 1986, the appropriate court issued an order
under which P, who was thereby charged with
the care of T’s property, had the power to
modify or revoke the revocable trust. Although P
exercised the power after October 22, 1986, and
while T was incompetent, the power was not
exercised in a manner that created, or increased
the amount of, a generation-skipping transfer.
Thus, the existence and exercise of P’s power
did not cause the trust to lose its exempt status
under paragraph (b)(3) of this section. The result
would be the same if the court order was issued
after October 22, 1986.
(4)Exceptions to additions rule—(i)
In general. Any addition to a trust
made pursuant to an instrument or
arrangement covered by the transition
rules in paragraph (b)(2) or (3) of this
section is not treated as an addition for
purposes of this section. Moreover, any
property transferred inter vivos to a
trust is not treated as an addition if the
same property would have been added
to the trust pursuant to an instrument
covered by the transition rules in
paragraph (b)(2) or (3) of this section.
(ii)Examples. The following exam-
ples illustrate the application of para-
graph (b)(4)(i) of this section:
Example 1. Addition pursuant to terms of
exempt instrument. On December 31, 1980, T
created an irrevocable trust having a principal of
$100,000. Under the terms of the trust, the
principal was to be held for the benefit of T’s
grandchild, GC. Pursuant to the terms of T’s
will, a document entitled to relief under the
transition rule of paragraph (b)(2) of this section,
the residue of the estate was paid to the trust.
Because the addition to the trust was paid
pursuant to the terms of an instrument (T’s will)
that is not subject to the provisions of chapter 13
because of paragraph (b)(2) of this section, the
payment to the trust is not considered an addition
to the principal of the trust. Thus, distributions to
or for the benefit of GC, are not subject to the
provisions of chapter 13.
Example 2. Property transferred inter vivos
that would have been transferred to the same
trust by the transferor’s will. T is the grantor of
a trust that was irrevocable on September 25,
1985. T’s will, which was executed before
October 22, 1986, and not amended thereafter,
provides that, upon T’s death, the entire estate
will pour over into T’s trust. On October 1,
1985, T transfers $100,000 to the trust. While
T’s will otherwise qualifies for relief under the
transition rule in paragraph (b)(2) of this section,
the transition rule is not applicable unless T dies
prior to January 1, 1987. Thus, if T dies after
December 31, 1986, the transfer is treated as an
addition to the trust for purposes of any
distribution made from the trust after the transfer
to the trust on October 1, 1985. If T dies before
January 1, 1987, the entire trust (as well as any
distributions from or terminations of interests in
the trust prior to T’s death) is exempt, under
paragraph (b)(2) of this section, from chapter 13
because the $100,000 would have been added to
the trust under a will that would have qualified
under paragraph (b)(2) of this section. In either
case, for any generation-skipping transfers made
after the transfer to the trust on October 1, 1985,
but before T’s death, the $100,000 is treated as
an addition to the trust and a proportionate
amount of the trust is subject to chapter 13.
Example 3. Pour over to a revocable trust. T
and S are the settlors of separate revocable trusts
with equal values. Both trusts were established
for the benefit of skip persons (as defined in
section 2613). S dies on December 1, 1985, and
under the provisions of S’s trust, the principal
pours over into T’s trust. If T dies before
January 1, 1987, the entire trust is excluded
under paragraph (b)(2) of this section from the
operation of chapter 13. If T dies after December
31, 1986, the entire trust is subject to the
generation-skipping transfer tax provisions be-
cause T’s trust is not a trust described in
paragraph (b)(1) or (2) of this section. In the
latter case, the fact that S died before January 1,
1987, is irrelevant because the principal of S’s
trust was added to a trust that never qualified
under the transition rules of paragraph (b)(1) or
(2) of this section.
Example 4. Pour over to exempt trust. Assume
the same facts as in Example 3, except upon the
death of S on December 1, 1985, S’s trust
continues as an irrevocable trust and that the
principal of T’s trust is to be paid over upon T’s
death to S’s trust. Again, if T dies before
January 1, 1987, S’s entire trust falls within the
provisions of paragraph (b)(2) of this section.
However, if T dies after December 31, 1986, the
pour-over is considered an addition to the trust.
Therefore, S’s trust is not a trust excluded under
paragraph (b)(2) of this section because an
addition is made to the trust.
Example 5. Lapse of a general power of
appointment. S, the spouse of the settlor of an
irrevocable trust that was created in 1980, had,
on September 25, 1985, a general power of
appointment over the trust assets. The trust
provides that should S fail to exercise the power
of appointment the property is to remain in the
trust. On October 21, 1986, S executed a will
under which S failed to exercise the power of
appointment. If S dies before January 1, 1987,
without having exercised the power in a manner
which results in the creation of, or increase in
the amount of, a generation-skipping transfer (or
amended the will in a manner that results in the
creation of, or increase in the amount of, a
generation-skipping transfer), transfers pursuant
to the trust or the will are not subject to chapter
13 because the trust is an irrevocable trust and
the will qualifies under paragraph (b)(2) of this
section.
Example 6. Lapse of general power of
appointment held by intestate decedent. Assume
the same facts as in Example 5, except on
October 22, 1986, S did not have a will and that
S dies after that date. Upon S’s death, or upon
the prior exercise or release of the power, the
value of the entire trust is treated as having been
distributed to S, and S is treated as having made
an addition to the trust in the amount of the
entire principal. Any distribution or termination
pursuant to the trust occurring after S’s death is
subject to chapter 13. It is immaterial whether
S’s death occurs before January 1, 1987, since
paragraph (b)(2) of this section is only applicable
where a will or revocable trust was executed
before October 22, 1986.
(c)Additional effective dates. Except
as otherwise provided, the regulations
u n d e r § § 2 6 . 2 6 1 1 – 1 , 2 6 . 2 6 1 2 – 1 ,
26.2613–1, 26.2632–1, 26.2641–1,
26.2642–1, 26.2642–2, 26.2642–3,
26.2642–4, 26.2642–5, 26.2652–1,
26.2652–2, 26.2653–1, 26.2654–1,
26.2663–1, and 26.2663–2 are effective
with respect to generation-skipping
transfers as defined in §26.2611–1
made on or after December 27, 1995.
However, taxpayers may, at their op-
tion, rely on these regulations in the
case of generation-skipping transfers
made, and trusts that became irrevoca-
ble, after December 23, 1992, and
before December 27, 1995.
§26.2611–1 Generation-skipping
transfer defined.
A generation-skipping transfer (GST)
is an event that is either a direct skip, a
taxable distribution, or a taxable termi-
nation. See §26.2612–1 for the defini-
tion of these terms. The determination
as to whether an event is a GST is
made by reference to the most recent
transfer subject to the estate or gift tax.
See §26.2652–1(a)(2) for determining
whether a transfer is subject to Federal
estate or gift tax.
§26.2612–1 Definitions.
(a)Direct skip—(1) In general. A
direct skip is a transfer to a skip person
that is subject to Federal estate or gift
tax. If property is transferred to a trust,
the transfer is a direct skip only if the
trust is a skip person. Only one direct
skip occurs when a single transfer of
property skips two or more generations.
See paragraph (d) of this section for
the definition of skip person. See
§26.2652–1(b) for the definition of
trust. See §26.2632–1(c)(4) for the time
that a direct skip occurs if the trans-
ferred property is subject to an estate
tax inclusion period.

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(2)Special rule for certain lineal
descendants—(i) In general. Solely for
the purpose of determining whether a
transfer to or for the benefit of a lineal
descendant of the transferor, the trans-
feror’s spouse, or a former spouse of
the transferor is a direct skip, the
generation assignment of the descend-
ant is determined by disregarding the
generation of a predeceased individual
who was both an ancestor of the
descendant and a lineal descendant of
the transferor, the transferor’s spouse,
or a former spouse of the transferor (a
predeceased child). If a transfer to a
trust would be a direct skip but for this
paragraph, any generation assignment
determined under this paragraph con-
tinues to apply in determining whether
any subsequent distribution from (or
termination of an interest in) the
portion of the trust attributable to that
transfer is a GST. A living descendant
who dies no later than 90 days after the
subject transfer is treated as having
predeceased the transferor to the extent
that either the governing instrument or
applicable local law provides that such
individual shall be treated as predeceas-
ing the transferor. Except as provided
in this paragraph (a)(2), a living
descendant is not treated as a pre-
deceased child solely by reason of
applicable local law; e.g., an individual
is not treated as a predeceased child
solely because state law treats an
individual executing a disclaimer as
having predeceased the transferor of
the disclaimed property. See §26.2652–
1(a)(1) for the definition of transferor.
See paragraph (e) of this section for the
definition of interest in trust.
(ii)Special rule. If a transferor
makes an addition to an existing trust
after the death of an individual de-
scribed in paragraph (a)(2)(i) of this
section (so that the transferor would be
assigned to a lower generation by
reason of that death), the additional
property is treated as being held in a
separate trust for purposes of chapter
13 and the provisions of §26.2654–
1(a)(2) apply as if the portions of the
single trust had separate transferors.
Subsequent additions are treated as
additions to the appropriate portion of
the single trust.
(b)Taxable termination—(1) In gen-
eral. Except as otherwise provided in
this paragraph (b), a taxable termina-
tion is a termination (occurring for any
reason) of an interest in trust unless—
(i)A transfer subject to Federal
estate or gift tax occurs with respect to
the property held in the trust at the
time of the termination (i.e., a new
transferor is determined with respect to
the property);
(ii)Immediately after the termina-
tion, a person who is not a skip person
has an interest in the trust; or
(iii)At no time after the termination
may a distribution, other than a dis-
tribution the probability of which oc-
curring is so remote as to be negligible
(including a distribution at the termina-
tion of the trust) be made from the
trust to a skip person. For this purpose,
the probability that a distribution will
occur is so remote as to be negligible
only if it can be ascertained by
actuarial standards that there is less
than a 5 percent probability that the
distribution will occur.
(2)Partial termination. If a distribu-
tion of a portion of trust property is
made to a skip person by reason of a
termination occurring on the death of a
lineal descendant of the transferor, the
termination is a taxable termination
with respect to the distributed property.
(3)Simultaneous terminations. A si-
multaneous termination of two or more
interests creates only one taxable
termination.
(c)Taxable distribution—(1) In gen-
eral. A taxable distribution is a dis-
tribution of income or principal from a
trust to a skip person unless the distri-
bution is a taxable termination or a
direct skip. If any portion of GST tax
(including penalties and interest
thereon) imposed on a distributee is
paid from the distributing trust, the
payment is an additional taxable dis-
tribution to the distributee. For pur-
poses of chapter 13, the additional
distribution is treated as having been
made on the last day of the calendar
year in which the original taxable
distribution is made. If Federal estate
or gift tax is imposed on any individual
with respect to an interest in property
held by a trust, the interest in property
is treated as having been distributed to
the individual to the extent that the
value of the interest is subject to
Federal estate or gift tax. See
§26.2652–1(a)(6) Example 5, regarding
the treatment of the lapse of a power of
appointment as a transfer to a trust.
(2)Look-through rule not to apply.
Solely for purposes of determining
whether any transfer from a trust to
another trust is a taxable distribution,
the rules of section 2651(e)(2) do not
apply. If the transferring trust and the
recipient trust have the same transferor,
see §26.2642–4(a)(1) and (2) for rules
for recomputing the applicable fraction
of the recipient trust.
(d)Skip person. A skip person is—
(1)An individual assigned to a
generation more than one generation
below that of the transferor (determined
under the rules of section 2651); or
(2)A trust if—
(i)All interests in the trust are held
by skip persons; or
(ii)No person holds an interest in
the trust and no distributions, other
than a distribution the probability of
which occurring is so remote as to be
negligible (including distributions at
the termination of the trust), may be
made after the transfer to a person
other than a skip person. For this
purpose, the probability that a distribu-
tion will occur is so remote as to be
negligible only if it can be ascertained
by actuarial standards that there is less
than a 5 percent probability that the
distribution will occur.
(e)Interest in trust—(1) In general.
An interest in trust is an interest in
property held in trust as defined in
section 2652(c) and these regulations.
An interest in trust exists if a person—
(i)Has a present right to receive
trust principal or income;
(ii)Is a permissible current recipient
of trust principal or income and is not
described in section 2055(a); or
(iii)Is described in section 2055(a)
and the trust is a charitable remainder
annuity trust or unitrust (as defined in
section 664(d)) or a pooled income
fund (as defined in section 642(c)(5)).
(2)Exceptions—(i) Support obliga-
tions. In general, an individual has a
present right to receive trust income or
principal if trust income or principal
may be used to satisfy the individual’s
support obligations. However, an indi-
vidual does not have an interest in a
trust merely because a support obliga-
tion of that individual may be satisfied
by a distribution that is either within
the discretion of a fiduciary or pursuant
to provisions of local law substantially
equivalent to the Uniform Gifts (Trans-
fers) to Minors Act.
(ii)Certain interests disregarded.
An interest which is used primarily to
postpone or avoid the GST tax is dis-
regarded for purposes of chapter 13.
An interest is considered as used
primarily to postpone or avoid the GST
tax if a significant purpose for the

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creation of the interest is to postpone
or avoid the tax.
(3)Disclaimers. An interest does not
exist to the extent it is disclaimed
pursuant to a disclaimer that constitutes
a qualified disclaimer under section
2518.
(f)Examples. The following exam-
ples illustrate the provisions of this
section. Unless stated otherwise, para-
graph (a)(2) of this section, which
assigns descendants to a higher genera-
tion when there is a predeceased
ancestor, does not apply.
Example 1. Direct skip. T gratuitously conveys
Blackacre to T’s grandchild. Because the transfer
is a transfer to a skip person of property subject
to Federal gift tax, it is a direct skip.
Example 2. Direct skip of more than one
generation. T gratuitously conveys Blackacre to
T’s great-grandchild. The transfer is a direct
skip. Only one GST tax is imposed on the direct
skip although two generations are skipped by the
transfer.
Example 3. Withdrawal power in trust. T
transfers $50,000 to a new trust providing that
trust income is to be paid to T’s child, C, for life
and, on C’s death, the trust principal is to be
paid to T’s descendants. Under the terms of the
trust, T grants four grandchildren the right to
withdraw $10,000 from the trust for a 60 day
period following the transfer. Since C, who is
not a skip person, has an interest in the trust, the
trust is not a skip person. T’s transfer to the trust
is not a direct skip.
Example 4. Taxable termination. T establishes
an irrevocable trust under which the income is to
be paid to T’s child, C, for life. On the death of
C, the trust principal is to be paid to T’s
grandchild, GC. Since C has an interest in the
trust, the trust is not a skip person and the
transfer to the trust is not a direct skip. If C dies
survived by GC, a taxable termination occurs at
C’s death because C’s interest in the trust
terminates and thereafter the trust property is
held by a skip person who occupies a lower
generation than C.
Example 5. Direct skip of property held in
trust. T establishes a testamentary trust under
which the income is to be paid to T’s surviving
spouse, S, for life and the remainder is to be
paid to a grandchild of T and S. T’s executor
elects to treat the trust as qualified terminable
interest property under section 2056(b)(7). The
transfer to the trust is not a direct skip because
S, a person who is not a skip person, holds a
present right to receive income from the trust.
Upon S’s death, the trust property is included in
S’s gross estate under section 2044 and passes
directly to a skip person. The GST occurring at
that time is a direct skip because it is a transfer
subject to chapter 11. The fact that the interest
created by T is terminated at S’s death is
immaterial because S becomes the transferor at
the time of the transfer subject to chapter 11.
Example 6. Predeceased ancestor exception. T
establishes an irrevocable trust providing that
trust income is to be paid to T’s grandchild, GC,
for 5 years. At the end of the 5-year period, the
trust is to terminate and the principal is to be
distributed to GC. T’s child, C, a parent of GC,
is deceased at the time T establishes the trust.
Therefore, GC is treated as a child of T rather
than as a grandchild. As a result, GC is not a
skip person, and the initial transfer to the trust is
not a direct skip. Similarly, distributions to GC
during the term of the trust and at the
termination of the trust will not be GSTs.
Example 7. Predeceased ancestor exception
not applicable. The facts are the same as in
Example 6, except the trust income is to be paid
to T’s spouse, S, during the first two years of the
trust. Since S has an interest in the trust, the trust
is not a skip person and the transfer by T is not a
direct skip. Since the transfer is not a direct skip,
the predeceased ancestor rule does not apply and
GC is not treated as the child of T. A taxable
termination occurs at the expiration of S’s
interest.
Example 8. Taxable termination. T establishes
an irrevocable trust for the benefit of T’s child,
C, T’s grandchild, GC, and T’s great-grandchild,
GGC. Under the terms of the trust, income and
principal may be distributed to any or all of the
living beneficiaries at the discretion of the
trustee. Upon the death of the second beneficiary
to die, the trust principal is to be paid to the
survivor. C dies first. A taxable termination
occurs at that time because, immediately after
C’s interest terminates, all interests in the trust
are held by skip persons (GC and GGC).
Example 9. Taxable termination resulting from
distribution. The facts are the same as in
Example 8, except twenty years after C’s death
the trustee exercises its discretionary power and
distributes the entire principal to GGC. The
distribution results in a taxable termination
because GC’s interest in the trust terminates as a
result of the distribution of the entire trust
property to GGC, a skip person. The result
would be the same if the trustee retained
sufficient funds to pay the GST tax due by
reason of the taxable termination, as well as any
expenses of winding up the trust.
Example 10. Simultaneous termination of
interests of more than one beneficiary. T
establishes an irrevocable trust for the benefit of
T’s child, C, T’s grandchild, GC, and T’s great-
grandchild, GGC. Under the terms of the trust,
income and principal may be distributed to any
or all of the living beneficiaries at the discretion
of the trustee. Upon the death of C, the trust
property is to be distributed to GGC if then
living. If C is survived by both GC and GGC,
both C’s and GC’s interests in the trust will
terminate on C’s death. However, because both
interests will terminate at the same time and as a
result of one event, only one taxable termination
occurs.
Example 11. Partial taxable termination. T
creates an irrevocable trust providing that trust
income is to be paid to T’s children, A and B, in
such proportions as the trustee determines for
their joint lives. On the death of the first child to
die, one-half of the trust principal is to be paid
to T’s then living grandchildren. The balance of
the trust principal is to be paid to T’s
grandchildren on the death of the survivor of A
and B. If A predeceases B, the distribution
occurring on the termination of A’s interest in
the trust is a taxable termination and not a
taxable distribution. It is a taxable termination
because the distribution is a distribution of a
portion of the trust that occurs as a result of the
death of A, a lineal descendant of T. It is
immaterial that a portion of the trust continues
and that B, a person other than a skip person,
thereafter holds an interest in the trust.
E x a m p l e 1 2. T a x a b l e d i s t r i b u t i o n. T
establishes an irrevocable trust under which the
trust income is payable to T’s child, C, for life.
When T’s grandchild, GC, attains 35 years of
age, GC is to receive one-half of the principal.
The remaining one-half of the principal is to be
distributed to GC on C’s death. Assume that C
survives until GC attains age 35. When the
trustee distributes one-half of the principal to GC
on GC’s 35th birthday, the distribution is a
taxable distribution because it is a distribution to
a skip person and is neither a taxable termination
nor a direct skip.
Example 13. Exercise of withdrawal right as
taxable distribution. The facts are the same as in
Example 12, except GC holds a continuing right
to withdraw trust principal and after one year GC
withdraws $10,000. The withdrawal by GC is not
a taxable termination because the withdrawal
does not terminate C’s interest in the trust. The
withdrawal by GC is a taxable distribution to
GC.
Example 14. Interest in trust. T establishes an
irrevocable trust under which the income is to be
paid to T’s child, C, for life. On the death of C,
the trust principal is to be paid to T’s grandchild,
GC. Because C has a present right to receive
income from the trust, C has an interest in the
trust. Because GC cannot currently receive
distributions from the trust, GC does not have an
interest in the trust.
Example 15. Support obligation. T establishes
an irrevocable trust for the benefit of T’s
grandchild, GC. The trustee has discretion to
distribute property for GC’s support without
regard to the duty or ability of GC’s parent, C,
to support GC. Because GC is a permissible
current recipient of trust property, GC has an
interest in the trust. C does not have an interest
in the trust because the potential use of the trust
property to satisfy C’s support obligation is
within the discretion of a fiduciary. C would be
treated as having an interest in the trust if the
trustee was required to distribute trust property
for GC’s support.
§26.2613–1 Skip person.
For the definition of skip person see
§26.2612–1(d).
§26.2632–1 Allocation of GST
exemption.
(a)General rule. Except as other-
wise provided in this section, an
individual or the individual’s executor
may allocate the individual’s $1 million
GST exemption at any time from the
date of the transfer through the date for
filing the individual’s Federal estate tax
return (including any extensions for
filing that have been actually granted).
If no estate tax return is required to be
filed, the GST exemption may be al-
located at any time through the date a
Federal estate tax return would be due
if a return were required to be filed

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(including any extensions actually
granted). If property is held in trust, the
allocation of GST exemption is made
to the entire trust rather than to specific
trust assets. If a transfer is a direct skip
to a trust, the allocation of GST
exemption to the transferred property is
also treated as an allocation of GST
exemption to the trust for purposes of
future GSTs with respect to the trust by
the same transferor.
(b)Lifetime allocations—(1) Auto-
matic allocation to direct skips—(i) In
general. If a direct skip occurs during
the transferor’s lifetime, the transferor’s
GST exemption not previously allo-
cated (unused GST exemption) is auto-
matically allocated to the transferred
property (but not in excess of the fair
market value of the property on the
date of the transfer). The transferor
may prevent the automatic allocation of
GST exemption by describing on a
timely-filed United States Gift (and
Generation-Skipping Transfer) Tax Re-
turn (Form 709) the transfer and the
extent to which the automatic alloca-
tion is not to apply. In addition, a
timely-filed Form 709 accompanied by
payment of the GST tax (as shown on
the return with respect to the direct
skip) is sufficient to prevent an auto-
matic allocation of GST exemption
with respect to the transferred property.
See paragraph (c)(4) of this section for
special rules in the case of direct skips
treated as occurring at the termination
of an estate tax inclusion period.
(ii)Time for filing Form 709. A
Form 709 is timely filed if it is filed on
or before the date required for report-
ing the transfer if it were a taxable gift
(i.e., the date prescribed by section
6075(b), including any extensions to
file actually granted (the due date)).
Except as provided in paragraph (b)(1)-
(iii) of this section, the automatic
allocation of GST exemption (or the
election to prevent the allocation, if
made) is irrevocable after the due date.
An automatic allocation of GST ex-
emption is effective as of the date of
the transfer to which it relates. Except
as provided above, a Form 709 need
not be filed to report an automatic
allocation.
(iii)Transitional rule. An election to
prevent an automatic allocation of GST
exemption filed on or before January
26, 1996, becomes irrevocable on July
24, 1996.
(2)Allocation to other transfers—(i)
In general. An allocation of GST
exemption to property transferred dur-
ing the transferor’s lifetime, other than
in a direct skip, is made on Form 709.
The allocation must clearly identify the
trust to which the allocation is being
made, the amount of GST exemption
allocated to it, and if the allocation is
late or if an inclusion ratio greater than
zero is claimed, the value of the trust
assets at the effective date of the
allocation. See paragraph (b)(2)(ii) of
this section. The allocation should also
state the inclusion ratio of the trust
after the allocation. Except as other-
wise provided in this paragraph, an
allocation of GST exemption may be
made by a formula; e.g., the allocation
may be expressed in terms of the
amount necessary to produce an inclu-
sion ratio of zero. However, formula
allocations made with respect to chari-
table lead annuity trusts are not valid
except to the extent they are dependent
on values as finally determined for
Federal estate or gift tax purposes.
With respect to a timely allocation, an
allocation of GST exemption becomes
irrevocable after the due date of the
r e t u r n . E x c e p t a s p r o v i d e d i n
§26.2642–3 (relating to charitable lead
annuity trusts), an allocation of GST
exemption to a trust is void to the
extent the amount allocated exceeds the
amount necessary to obtain an inclu-
sion ratio of zero with respect to the
trust. See §26.2642–1 for the definition
of inclusion ratio. An allocation is also
void if the allocation is made with
respect to a trust that has no GST
potential with respect to the transferor
making the allocation, at the time of
the allocation. For this purpose, a trust
has GST potential even if the pos-
sibility of a GST is so remote as to be
negligible.
(ii)Effective date of allocation—(A)
In general. (1) Except as otherwise
provided, an allocation of GST exemp-
tion is effective as of the date of any
transfer as to which the Form 709 on
which it is made is a timely filed return
(a timely allocation). If more than one
timely allocation is made, the earlier
allocation is modified only if the later
allocation clearly identifies the transfer
and the nature and extent of the
modification. Except as provided in
paragraph (d)(1) of this section, an
allocation to a trust made on a Form
709 filed after the due date for re-
porting a transfer to the trust (a late
allocation) is effective on the date the
Form 709 is filed and is deemed to
precede in point of time any taxable
event occurring on such date. For
purposes of this paragraph (b)(2)(ii),
the Form 709 is deemed filed on the
date it is postmarked to the Internal
R e v e n u e S e r v i c e C e n t e r . S e e
§26.2642–2 regarding the effect of a
late allocation in determining the inclu-
sion ratio, etc. See paragraph (c)(1) of
this section regarding allocation of
GST exemption to property subject to
an estate tax inclusion period. If it is
unclear whether an allocation of GST
exemption on a Form 709 is a late or a
timely allocation to a trust, the alloca-
tion is effective in the following
order—
(i) To any transfer to the trust
disclosed on the return as to which the
return is a timely return;
(ii) As a late allocation; and
(iii) To any transfer to the trust not
disclosed on the return as to which the
return would be a timely return.
(2) A late allocation to a trust may
be made on a Form 709 that is timely
filed with respect to another transfer. A
late allocation is irrevocable when
made.
(B)Amount of allocation. If other
transfers exist with respect to which
GST exemption could be allocated
under paragraphs (b)(2)(ii)(A)(1)(ii)
and (iii), any GST exemption allocated
under paragraph (b)(2)(ii)(A)(1)(i) of
this section is allocated in an amount
equal to the value of the transferred
property as reported on the Form 709.
Thus, if the GST exemption allocated
on the Form 709 exceeds the value of
the transfers reported on that return that
have generation-skipping potential, the
initial allocation under paragraph
(b)(2)(ii)(A)(1)(i) of this section is in
the amount of the value of those trans-
fers as reported on that return. Any
remaining amount of GST exemption
allocated on that return is then allo-
cated pursuant to paragraphs (b)(2)-
(ii)(A)(1)(ii) and (iii) of this section,
notwithstanding any subsequent upward
adjustment in value of the transfers
reported on the return.
(iii)Examples. The following exam-
ples illustrate the provisions of this
paragraph (b):
Example 1. Modification of allocation of GST
exemption. T transfers $100,000 to an irrevocable
generation-skipping trust on December 1, 1996.
The transfer to the trust is not a direct skip. The
date prescribed for filing the gift tax return
reporting the taxable gift is April 15, 1997. On
February 10, 1997, T files a Form 709 allocating
$50,000 of GST exemption to the trust. On April

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10 of the same year, T files an amended Form
709 allocating $100,000 of GST exemption to
the trust in a manner that clearly indicates the
intention to modify and supersede the prior
allocation with respect to the 1996 transfer. The
allocation made on the April 10 return super-
sedes the prior allocation because it is made on a
timely-filed Form 709 that clearly identifies the
trust and the nature and extent of the modifica-
tion of GST exemption allocation. The allocation
of $100,000 of GST exemption to the trust is
effective as of December 1, 1996. The result
would be the same if the amended Form 709
decreased the amount of the GST exemption
allocated to the trust.
Example 2. Modification of allocation of GST
exemption. The facts are the same as in Example
1, except on July 10, 1997, T files a Form 709
attempting to reduce the earlier allocation. The
return is not a timely-filed return. The $100,000
GST exemption allocated to the trust, as
amended on April 10, 1997, remains in effect
because an allocation, once made, is irrevocable
and may not be modified after the last date on
which a timely-filed Form 709 can be filed.
Example 3. Effective date of late allocation of
GST exemption. T transfers $100,000 to an
irrevocable generation-skipping trust on Decem-
ber 1, 1996. The transfer to the trust is not a
direct skip. The date prescribed for filing the gift
tax return reporting the taxable gift is April 15,
1997. On December 1, 1997, T files a Form 709
and allocates $50,000 to the trust. The allocation
is effective as of December 1, 1997.
Example 4. Effective date of late allocation of
GST exemption. T transfers $100,000 to a
generation-skipping trust on December 1, 1996,
in a transfer that is not a direct skip. T does not
make an allocation of GST exemption on a
timely-filed Form 709. On July 1, 1997, the
trustee makes a taxable distribution from the
trust to T’s grandchild in the amount of $30,000.
Immediately prior to the distribution, the value
of the trust assets was $150,000. On the same
date, T allocates GST exemption to the trust in
the amount of $50,000. The allocation of GST
exemption on the date of the transfer is treated
as preceding in point of time the taxable distri-
bution. At the time of the GST, the trust has an
inclusion ratio of .6667 (1 – (50,000/150,000)).
Example 5. Automatic allocation to split-gift
direct skip. On May 15, 1996, T transfers
$50,000 to a trust in a direct skip. T does not file
a timely gift tax return electing out of the
automatic allocation. On April 30, 1998, T and
T’s spouse, S, file an initial gift tax return for
1996 on which they consent, pursuant to section
2513, to have the gift treated as if one-half had
been made by each. As a result of the election
under section 2513, which is retroactive to the
date of T’s transfer, T and S are each treated as
the transferor of one-half of the property
transferred in the direct skip. Thus, $25,000 of
T’s unused GST exemption and $25,000 of S’s
unused GST exemption is automatically allocated
to the trust. Both allocations are effective on and
after the date that T made the transfer.
(c)Special rules during an estate tax
inclusion period—(1) In general. An
allocation of GST exemption (including
an automatic allocation) to property
subject to an estate tax inclusion period
(ETIP) that is made prior to termina-
tion of the ETIP cannot be revoked, but
becomes effective no earlier than the
date of any termination of the ETIP
with respect to the trust. Where an
allocation has not been made prior to
the termination of the ETIP, an alloca-
tion is effective at the termination of
the ETIP during the transferor’s life-
time if made by the due date for filing
a Form 709 that would apply to a
taxable gift occurring at the time the
ETIP terminates (timely ETIP return).
An allocation is effective in the case of
the termination of the ETIP on the
death of the transferor as provided in
paragraph (d) of this section. If any
part of a trust is subject to an ETIP, the
entire trust is subject to the ETIP. See
§26.2642–1(b)(2) for rules determining
the inclusion ratio applicable in the
case of GSTs during an ETIP.
(2)Estate tax inclusion period
defined—(i) In general. An ETIP is the
period during which, should death
occur, the value of transferred property
would be includible (other than by
reason of section 2035) in the gross
estate of—
(A)The transferor; or
(B)The spouse of the transferor.
(ii)Exceptions—(A) For purposes of
paragraph (c)(2) of this section, the
value of transferred property is not
considered as being subject to inclusion
in the gross estate of the transferor or
the spouse of the transferor if the
possibility that the property will be
included is so remote as to be neglig-
ible. A possibility is so remote as to be
negligible if it can be ascertained by
actuarial standards that there is less
than a 5 percent probability that the
property will be included in the gross
estate.
(B)For purposes of paragraph (c)(2)
of this section, the value of transferred
property is not considered as being
subject to inclusion in the gross estate
of the spouse of the transferor, if the
spouse possesses with respect to any
transfer to the trust, a right to withdraw
no more than the greater of $5,000 or 5
percent of the trust corpus, and such
withdrawal right terminates no later
than 60 days after the transfer to the
trust.
(C)The rules of this paragraph
(c)(2) do not apply to qualified termin-
able interest property with respect to
which the special election under
§26.2652–2 has been made.
(3)Termination of an ETIP. An
ETIP terminates on the first to occur
of—
(i)The death of the transferor;
(ii)The time at which no portion of
the property is includible in the trans-
feror’s gross estate (other than by
reason of section 2035) or, in the case
of an individual who is a transferor
solely by reason of an election under
section 2513, the time at which no
portion would be includible in the
gross estate of the individual’s spouse
(other than by reason of section 2035);
(iii)The time of a GST, but only
with respect to the property involved in
the GST; or
(iv)In the case of an ETIP arising
by reason of an interest or power held
by the transferor’s spouse under sub-
section (c)(2)(i)(B) of this section, at
the first to occur of—
(A)The death of the spouse; or
(B)The time at which no portion of
the property would be includible in the
spouse’s gross estate (other than by
reason of section 2035).
(4)Treatment of direct skips. If
property transferred to a skip person is
subject to an ETIP, the direct skip is
treated as occurring on the termination
of the ETIP.
(5)Examples. The following exam-
ples illustrate the rules of this section
as they apply to the termination of an
ETIP during the lifetime of the trans-
feror. In each example assume that T
transfers $100,000 to an irrevocable
trust:
Example 1. Allocation of GST exemption
during ETIP. The trust instrument provides that
trust income is to be paid to T for 9 years or
until T’s prior death. The trust principal is to be
paid to T’s grandchild on the termination of T’s
income interest. If T dies within the 9-year
period, the value of the trust principal is
includible in T’s gross estate under section
2036(a). Thus, the trust is subject to an ETIP. T
files a timely Form 709 reporting the transfer
and allocating $100,000 of GST exemption to the
trust. The allocation of GST exemption to the
trust is not effective until the termination of the
ETIP.
Example 2. Effect of prior allocation on
termination of ETIP. The facts are the same as in
Example 1, except the trustee has the power to
invade trust principal on behalf of T’s grand-
child, GC, during the term of T’s income
interest. In year 4, when the value of the trust is
$200,000, the trustee distributes $15,000 to GC.
The distribution is a taxable distribution. The
ETIP with respect to the property distributed to
GC terminates at the time of the taxable dis-
tribution. See paragraph (c)(3)(iii) of this section.
Solely for purposes of determining the trust’s
inclusion ratio with respect to the taxable
distribution, the prior $100,000 allocation of
GST exemption (as well as any additional allo-
cation made on a timely ETIP return) is effective
immediately prior to the taxable distribution. See

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§26.2642–1(b)(2). The trust’s inclusion ratio with
respect to the taxable distribution is therefore .50
(1–(100,000/200,000)).
Example 3. Split-gift transfers subject to ETIP.
The trust instrument provides that trust income is
to be paid to T for 9 years or until T’s prior
death. The trust principal is to be paid to T’s
grandchild on the termination of T’s income
interest. T files a timely Form 709 reporting the
transfer. T’s spouse, S, consents to have the gift
treated as made one-half by S under section
2513. Because S is treated as transferring one-
half of the property to T’s grandchild, S becomes
the transferor of one-half of the trust for
purposes of chapter 13. Because the value of the
trust would be includible in T’s gross estate if T
died immediately after the transfer, S’s transfer
is subject to an ETIP. If S should die prior to the
termination of the trust, S’s executor may
allocate S’s GST exemption to the trust, but only
to the portion of the trust for which S is treated
as the transferor. However, the allocation does
not become effective until the earlier of the
expiration of T’s income interest or T’s death.
Example 4. Transfer of retained interest as
ETIP termination. The trust instrument provides
that trust income is to be paid to T for 9 years or
until T’s prior death. The trust principal is to be
paid to T’s grandchild on the termination of T’s
income interest. Four years after the initial
transfer, T transfers the income interest to T’s
sibling. The ETIP with respect to the trust
terminates on T’s transfer of the income interest
because, after the transfer, the trust property
would not be includible in T’s gross estate (other
than by reason of section 2035) if T died at that
time.
(d)Allocations after the transferor’s
death—(1) Allocation by executor. Ex-
cept as otherwise provided in this
paragraph (d), an allocation of a
decedent’s unused GST exemption by
the executor of the decedent’s estate is
made on the appropriate United States
Estate (and Generation-Skipping Trans-
fer) Tax Return (Form 706 or Form
706NA) filed on or before the date pre-
scribed for filing the return by section
6075(a) (including any extensions actu-
ally granted (the due date)). An alloca-
tion of GST exemption with respect to
property included in the gross estate of
a decedent is effective as of the date of
death. A timely allocation of GST
exemption by an executor with respect
to a lifetime transfer of property that is
not included in the transferor’s gross
estate is made on a Form 709. A late
allocation of GST exemption by an
executor, other than an allocation that
is deemed to be made under section
2632(b)(1), with respect to a lifetime
transfer of property is made on Form
706 or Form 706NA and is effective as
of the date the allocation is filed. An
allocation of GST exemption to a trust
(whether or not funded at the time the
Form 706 or Form 706NA is filed) is
effective if the notice of allocation
clearly identifies the trust and the
amount of the decedent’s GST exemp-
tion allocated to the trust. An executor
may allocate the decedent’s GST ex-
emption by use of a formula. For
purposes of this section, an allocation
is void if the allocation is made for a
trust that has no GST potential with
respect to the transferor for whom the
allocation is being made, as of the date
of the transferor’s death. For this
purpose, a trust has GST potential even
if the possibility of a GST is so remote
as to be negligible.
(2)Automatic allocation after death.
A decedent’s unused GST exemption is
automatically allocated on the due date
for filing Form 706 or Form 706NA to
the extent not otherwise allocated by
the decedent’s executor on or before
that date. The automatic allocation
occurs whether or not a return is
actually required to be filed. Unused
GST exemption is allocated pro rata
(subject to the rules of §26.2642–2(b)),
on the basis of the value of the
property as finally determined for
purposes of chapter 11 (chapter 11
value), first to direct skips treated as
occurring at the transferor’s death. The
balance, if any, of unused GST exemp-
tion is allocated pro rata (subject to the
rules of §26.2642–2(b)) on the basis of
the chapter 11 value of the nonexempt
portion of the trust property (or in the
case of trusts that are not included in
the gross estate, on the basis of the
date of death value of the trust) to
trusts with respect to which a taxable
termination may occur or from which a
taxable distribution may be made. The
automatic allocation of GST exemption
is irrevocable, and an allocation made
by the executor after the automatic
allocation is made is ineffective. No
automatic allocation of GST exemption
is made to a trust that will have a new
transferor with respect to the entire
trust prior to the occurrence of any
GST with respect to the trust. In
addition, no automatic allocation of
GST exemption is made to a trust if,
during the nine month period ending
immediately after the death of the
transferor—
(i)No GST has occurred with re-
spect to the trust; and
(ii)At the end of such period no
future GST can occur with respect to
the trust.
§26.2641–1 Applicable rate of tax.
The rate of tax applicable to any
GST (applicable rate) is determined by
multiplying the maximum Federal
estate tax rate in effect at the time of
the GST by the inclusion ratio (as
defined in §26.2642–1). For this pur-
pose, the maximum Federal estate tax
rate is the maximum rate set forth
under section 2001(c) (without regard
to section 2001(c)(2)).
§26.2642–1 Inclusion ratio.
(a)In general. Except as otherwise
provided in this section, the inclusion
ratio is determined by subtracting the
applicable fraction (rounded to the
nearest one-thousandth (.001)) from 1.
In rounding the applicable fraction to
the nearest one-thousandth, any amount
that is midway between one one-
thousandth and another one-thousandth
is rounded up to the higher of those
two amounts.
( b )N u m e r a t o r o f a p p l i c a b l e
fraction—(1) In general. Except as
otherwise provided in this paragraph
(b), and in §§26.2642–3 (providing a
special rule for charitable lead annuity
trusts) and 26.2642–4 (providing rules
for the redetermination of the applica-
ble fraction), the numerator of the
applicable fraction is the amount of
GST exemption allocated to the trust
(or to the transferred property in the
case of a direct skip not in trust).
(2)GSTs occurring during an
ETIP—(i) In general. For purposes of
determining the inclusion ratio with
respect to a taxable termination or a
taxable distribution that occurs during
an ETIP, the numerator of the applica-
ble fraction is the sum of—
(A)The GST exemption previously
allocated to the trust (including any
allocation made to the trust prior to any
taxable termination or distribution) re-
duced (but not below zero) by the
nontax amount of any prior GSTs with
respect to the trust; and
(B)Any GST exemption allocated to
the trust on a timely ETIP return filed
after the termination of the ETIP. See
§26.2632–1(c)(5) Example 2.
(ii)Nontax amount of a prior GST.
(1) The nontax amount of a prior GST
with respect to the trust is the amount
of the GST multiplied by the applicable
fraction attributable to the trust at the
time of the prior GST.
(2) For rules regarding the allocation
of GST exemption to property during
an ETIP, see §26.2632–1(c).
( c )D e n o m i n a t o r o f a p p l i c a b l e
fraction—(1) In general. Except as

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otherwise provided in this paragraph
(c) and in §§26.2642–3 and 26.2642–4,
the denominator of the applicable frac-
tion is the value of the property
transferred to the trust (or transferred in
a direct skip not in trust) (as deter-
mined under §26.2642–2) reduced by
the sum of—
(i)Any Federal estate tax and any
State death tax incurred by reason of
the transfer that is chargeable to the
trust and is actually recovered from the
trust;
(ii)The amount of any charitable
deduction allowed under section 2055,
2106, or 2522 with respect to the
transfer; and
(iii)In the case of a direct skip, the
value of the portion of the transfer that
is a nontaxable gift. See paragraph
(c)(3) of this section for the definition
of nontaxable gift.
(2)Zero denominator. If the de-
nominator of the applicable fraction is
zero, the inclusion ratio is zero.
(3)Nontaxable gifts. Generally, for
purposes of chapter 13, a transfer is a
nontaxable gift to the extent the trans-
fer is excluded from taxable gifts by
reason of section 2503(b) (after ap-
plication of section 2513) or section
2503(e). However, a transfer to a trust
for the benefit of an individual is not a
nontaxable gift for purposes of this
section unless—
(i)Trust principal or income may,
during the individual’s lifetime, be
distributed only to or for the benefit of
the individual; and
(ii)The assets of the trust will be
includible in the gross estate of the
individual if the individual dies before
the trust terminates.
(d)Examples. The following exam-
ples illustrate the provisions of this
section. See §26.2652–2(d) Examples 2
and 3 for illustrations of the computa-
tion of the inclusion ratio where the
special (reverse QTIP) election may be
applicable.
Example 1. Computation of the inclusion ratio.
T transfers $100,000 to a newly-created irrevoca-
ble trust providing that income is to be ac-
cumulated for 10 years. At the end of 10 years,
the accumulated income is to be distributed to
T’s child, C, and the trust principal is to be paid
to T’s grandchild. T allocates $40,000 of T’s
GST exemption to the trust on a timely-filed gift
tax return. The applicable fraction with respect to
the trust is .40 ($40,000 (the amount of GST
exemption allocated to the trust) over $100,000
(the value of the property transferred to the
trust)). The inclusion ratio is .60 (1 – .40). If the
maximum Federal estate tax rate is 55 percent at
the time of a GST, the rate of tax applicable to
the transfer (applicable rate) will be .333 (55
percent (the maximum estate tax rate) 3 .60 (the
inclusion ratio)).
Example 2. Gift entirely nontaxable. On
December 1, 1996, T transfers $10,000 to an
irrevocable trust for the benefit of T’s grand-
child, GC. GC possesses a right to withdraw any
contributions to the trust such that the entire
transfer qualifies for the annual exclusion under
section 2503(b). Under the terms of the trust, the
income is to be paid to GC for 10 years or until
GC’s prior death. Upon the expiration of GC’s
income interest, the trust principal is payable to
GC or GC’s estate. The transfer to the trust is a
direct skip. T made no prior gifts to or for the
benefit of GC during 1996. The entire $10,000
transfer is a nontaxable transfer. For purposes of
computing the tax on the direct skip, the
denominator of the applicable fraction is zero,
and thus, the inclusion ratio is zero.
Example 3. Gift nontaxable in part. T transfers
$12,000 to an irrevocable trust for the benefit of
T’s grandchild, GC. Under the terms of the trust,
the income is to be paid to GC for 10 years or
until GC’s prior death. Upon the expiration of
GC’s income interest, the trust principal is
payable to GC or GC’s estate. Further, GC has
the right to withdraw $10,000 of any contribution
to the trust such that $10,000 of the transfer
qualifies for the annual exclusion under section
2503(b). The amount of the nontaxable transfer
is $10,000. Solely for purposes of computing the
tax on the direct skip, T’s transfer is divided into
two portions. One portion is equal to the amount
of the nontaxable transfer ($10,000) and has a
zero inclusion ratio; the other portion is $2,000
($12,000 – $10,000). With respect to the $2,000
portion, the denominator of the applicable frac-
tion is $2,000. Assuming that T has sufficient
GST exemption available, the numerator of the
applicable fraction is $2,000 (unless T elects to
have the automatic allocation provisions not
apply). Thus, assuming T does not elect to have
the automatic allocation not apply, the applicable
fraction is one ($2,000/$2,000 = 1) and the
inclusion ratio is zero (1 – 1 = 0).
Example 4. Gift nontaxable in part. Assume
the same facts as in Example 3, except T files a
timely Form 709 electing that the automatic
allocation of GST exemption not apply to the
$12,000 transferred in the direct skip. T’s
transfer is divided into two portions, a $10,000
portion with a zero inclusion ratio and a $2,000
portion with an applicable fraction of zero
(0/$2,000 = 0) and an inclusion ratio of one (1 –
0 = 1).
§26.2642–2 Valuation.
(a)Lifetime transfers—(1) In gen-
eral. For purposes of determining the
denominator of the applicable fraction,
the value of property transferred during
life is its fair market value on the
effective date of the allocation of GST
exemption. In the case of a timely al-
location under §26.2632–1(b)(2)(ii), the
denominator of the applicable fraction
is the fair market value of the property
as finally determined for purposes of
chapter 12.
(2)Special rule for late allocations
during life. If a transferor makes a late
allocation of GST exemption to a trust,
the value of the property transferred to
the trust is the fair market value of the
trust assets determined on the effective
date of the allocation of GST exemp-
tion. Except as otherwise provided in
this paragraph (a)(2), if a transferor
makes a late allocation of GST exemp-
tion to a trust, the transferor may,
solely for purposes of determining the
fair market value of the trust assets,
elect to treat the allocation as having
been made on the first day of the
month during which the late allocation
is made (valuation date). An election
under this paragraph (a)(2) is not
effective with respect to a life insur-
ance policy or a trust holding a life
insurance policy, if the insured individ-
ual has died. An allocation subject to
the election contained in this paragraph
(a)(2) is not effective until it is actually
filed with the Internal Revenue Service.
The election is made by stating on the
Form 709 on which the allocation is
made—
(i)That the election is being made;
(ii)The applicable valuation date;
and
(iii)The fair market value of the
trust assets on the valuation date.
(b)Transfers at death—(1) In gen-
eral. Except as provided in paragraphs
(b)(2) and (3) of this section, in
determining the denominator of the
applicable fraction, the value of prop-
erty included in the decedent’s gross
estate is its value for purposes of
chapter 11. In the case of qualified real
property with respect to which the
election under section 2032A is made,
the value of the property is the value
determined under section 2032A pro-
vided the recapture agreement de-
scribed in section 2032A(d)(2) filed
with the Internal Revenue Service
specifically provides for the signato-
ries’ consent to the imposition of, and
personal liability for, additional GST
tax in the event an additional estate tax
is imposed under section 2032A(c). See
§26.2642–4(a)(4). If the recapture
agreement does not contain these provi-
sions, the value of qualified real
property as to which the election under
section 2032A is made is the fair
market value of the property deter-
mined without regard to the provisions
of section 2032A.
(2)Special rule for pecuniary
payments—(i) In general. If a pecuni-
ary payment is satisfied with cash, the
denominator of the applicable fraction

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is the pecuniary amount. If property
other than cash is used to satisfy a
pecuniary payment, the denominator of
the applicable fraction is the pecuniary
amount only if payment must be made
with property on the basis of the value
of the property on—
(A)The date of distribution; or
(B)A date other than the date of
distribution, but only if the pecuniary
payment must be satisfied on a basis
that fairly reflects net appreciation and
depreciation (occurring between the
valuation date and the date of distribu-
tion) in all of the assets from which the
distribution could have been made.
(ii)Other pecuniary amounts pay-
able in kind. The denominator of the
applicable fraction with respect to any
property used to satisfy any other
pecuniary payment payable in kind is
the date of distribution value of the
property.
(3)Special rule for residual trans-
fers after payment of a pecuniary pay-
ment—(i) In general. Except as other-
wise provided in this paragraph (b)(3),
the denominator of the applicable frac-
tion with respect to a residual transfer
of property after the satisfaction of a
pecuniary payment is the estate tax
value of the assets available to satisfy
the pecuniary payment reduced, if the
pecuniary payment carries appropriate
interest (as defined in paragraph (b)(4)
of this section), by the pecuniary
amount. The denominator of the appli-
cable fraction with respect to a residual
transfer of property after the satisfac-
tion of a pecuniary payment that does
not carry appropriate interest is the
estate tax value of the assets available
to satisfy the pecuniary payment re-
duced by the present value of the
pecuniary payment. For purposes of
this paragraph (b)(3)(i), the present
value of the pecuniary payment is
determined by using—
(A)The interest rate applicable un-
der section 7520 at the death of the
transferor; and
(B)The period between the date of
the transferor’s death and the date the
pecuniary amount is paid.
(ii)Special rule for residual trans-
fers after pecuniary payments payable
in kind. The denominator of the appli-
cable fraction with respect to any
residual transfer after satisfaction of a
pecuniary payment payable in kind is
the date of distribution value of the
property distributed in satisfaction of
the residual transfer, unless the pecuni-
ary payment must be satisfied on the
basis of the value of the property on—
(A)The date of distribution; or
(B)A date other than the date of
distribution, but only if the pecuniary
payment must be satisfied on a basis
that fairly reflects net appreciation and
depreciation (occurring between the
date of death and the date of distribu-
tion) in all of the assets from which the
distribution could have been made.
(4)Appropriate interest—(i) In gen-
eral. For purposes of this section and
§26.2654–1 (relating to certain trusts
treated as separate trusts), appropriate
interest means that interest must be
payable from the date of death of the
transferor (or from the date specified
under applicable State law requiring the
payment of interest) to the date of
payment at a rate—
(A)At least equal to—
(1) The statutory rate of interest, if
any, applicable to pecuniary bequests
under the law of the State whose law
governs the administration of the estate
or trust; or
(2) If no such rate is indicated under
applicable State law, 80 percent of the
rate that is applicable under section
7520 at the death of the transferor; and
(B)Not in excess of the greater of—
(1) The statutory rate of interest, if
any, applicable to pecuniary bequests
under the law of the State whose law
governs the administration of the trust;
or
(2) 120 percent of the rate that is
applicable under section 7520 at the
death of the transferor.
(ii)Pecuniary payments deemed to
carry appropriate interest. For pur-
poses of this paragraph (b)(4), if a
pecuniary payment does not carry
appropriate interest, the pecuniary pay-
ment is considered to carry appropriate
interest to the extent—
(A)The entire payment is made or
property is irrevocably set aside to
satisfy the entire pecuniary payment
within 15 months of the transferor’s
death; or
(B)The governing instrument or
applicable local law specifically re-
quires the executor or trustee to allo-
cate to the pecuniary payment a pro
rata share of the income earned by the
fund from which the pecuniary pay-
ment is to be made between the date of
death of the transferor and the date of
payment. For purposes of paragraph
(b)(4)(ii)(A) of this section, property is
irrevocably set aside if it is segregated
and held in a separate account pending
distribution.
(c)Examples. The following exam-
ples illustrate the provisions of this
section:
Example 1. T transfers $100,000 to a newly-
created irrevocable trust on December 15, 1996.
The trust provides that income is to be paid to
T’s child for 10 years. At the end of the 10-year
period, the trust principal is to be paid to T’s
grandchild. T does not allocate any GST
exemption to the trust on the gift tax return
reporting the transfer. On November 15, 1997, T
files a Form 709 allocating $50,000 of GST
exemption to the trust. Because the allocation
was made on a late filed return, the value of the
property transferred to the trust is determined on
the date the allocation is filed (unless an election
is made pursuant to paragraph (a)(2) of this
section to value the trust property as of the first
day of the month in which the allocation
document is filed with the Internal Revenue
Service). On November 15, 1997, the value of
the trust property is $150,000. Effective as of
November 15, 1997, the applicable fraction with
respect to the trust is .333 ($50,000 (the amount
of GST exemption allocated to the trust) over
$150,000 (the value of the trust principal on the
effective date of the GST exemption allocation)),
and the inclusion ratio is .667 (1.0 – .333).
Example 2. The facts are the same as in
Example 1, except the value of the trust property
is $80,000 on November 15, 1997. The applica-
ble fraction is .625 ($50,000 over $80,000) and
the inclusion ratio is .375 (1.0 – .625).
Example 3. T transfers $100,000 to a newly-
created irrevocable trust on December 15, 1996.
The trust provides that income is to be paid to
T’s child for 10 years. At the end of the 10-year
period, the trust principal is to be paid to T’s
grandchild. T does not allocate any GST
exemption to the trust on the gift tax return
reporting the transfer. On November 15, 1997, T
files a Form 709 allocating $50,000 of GST
exemption to the trust. T elects to value the trust
principal on the first day of the month in which
the allocation is made pursuant to the election
provided in paragraph (a)(2) of this section.
Because the late allocation is made in November,
the value of the trust is determined as of
November 1, 1997.
§26.2642–3 Special rule for
charitable lead annuity trusts.
(a)In general. In determining the
applicable fraction with respect to a
charitable lead annuity trust—
(1)The numerator is the adjusted
generation-skipping transfer tax exemp-
tion (adjusted GST exemption); and
(2)The denominator is the value of
all property in the trust immediately
after the termination of the charitable
lead annuity.
(b)Adjusted GST exemption defined.
The adjusted GST exemption is the
amount of GST exemption allocated to
the trust increased by an amount equal

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to the interest that would accrue if an
amount equal to the allocated GST
exemption were invested at the rate
used to determine the amount of the
estate or gift tax charitable deduction,
compounded annually, for the actual
period of the charitable lead annuity. If
a late allocation is made to a charitable
lead annuity trust, the adjusted GST
exemption is the amount of GST
exemption allocated to the trust in-
creased by the interest that would
accrue if invested at such rate for the
period beginning on the date of the late
allocation and extending for the bal-
ance of the actual period of the
charitable lead annuity. The amount of
GST exemption allocated to a chari-
table lead annuity trust is not reduced
even though it is ultimately determined
that the allocation of a lesser amount of
GST exemption would have resulted in
an inclusion ratio of zero. For purposes
of chapter 13, a charitable lead annuity
trust is any trust providing an interest
in the form of a guaranteed annuity
described in §25.2522(c)–3(c)(2)(vi) of
this chapter for which the transferor is
allowed a charitable deduction for
Federal estate or gift tax purposes.
(c)Example. The following example
illustrates the provisions of this section:
Example. T creates a charitable lead annuity
trust for a 10-year term with the remainder
payable to T’s grandchild. T timely allocates an
amount of GST exemption to the trust which T
expects will ultimately result in a zero inclusion
ratio. However, at the end of the charitable lead
interest, because the property has not appreciated
to the extent T anticipated, the numerator of the
applicable fraction is greater than the denomina-
tor. The inclusion ratio for the trust is zero. No
portion of the GST exemption allocated to the
trust is restored to T or to T’s estate.
§26.2642–4 Redetermination of
applicable fraction.
(a)In general. The applicable frac-
tion for a trust is redetermined when-
ever additional exemption is allocated
to the trust or when certain changes
occur with respect to the principal of
the trust. Except as otherwise provided
in this paragraph (a), the numerator of
the redetermined applicable fraction is
the sum of the amount of GST
exemption currently being allocated to
the trust (if any) plus the value of the
nontax portion of the trust, and the
denominator of the redetermined appli-
cable fraction is the value of the trust
principal immediately after the event
occurs. The nontax portion of a trust is
determined by multiplying the value of
the trust assets, determined imme-
diately prior to the event, by the then
applicable fraction.
(1)Multiple transfers to a single
trust. If property is added to an
existing trust, the denominator of the
redetermined applicable fraction is the
value of the trust immediately after the
addition reduced as provided in
§26.2642–1(c).
(2)Consolidation of separate trusts.
If separate trusts created by one trans-
feror are consolidated, a single applica-
ble fraction for the consolidated trust is
determined. The numerator of the re-
determined applicable fraction is the
sum of the nontax portions of each
t r u s t i m m e d i a t e l y p r i o r t o t h e
consolidation.
(3)Property included in transferor’s
gross estate. If the value of property
held in a trust created by the transferor,
with respect to which an allocation was
made at a time that the trust was not
subject to an ETIP, is included in the
transferor’s gross estate, the applicable
fraction is redetermined if additional
GST exemption is allocated to the
property. The numerator of the redeter-
mined applicable fraction is an amount
equal to the nontax portion of the
property immediately after the death of
the transferor increased by the amount
of GST exemption allocated by the
executor of the transferor’s estate to the
trust. If additional GST exemption is
not allocated to the trust, the applicable
fraction immediately before death is
not changed, if the trust was not
subject to an ETIP at the time GST
exemption was allocated to the trust.
The denominator of the applicable
fraction is reduced to reflect any
federal or state, estate or inheritance
taxes paid from the trust.
(4)Imposition of recapture tax un-
der section 2032A—(i) If an additional
estate tax is imposed under section
2032A and if the section 2032A
e l e c t i o n w a s e f f e c t i v e ( u n d e r
§26.2642–2(b)) for purposes of the
GST tax, the applicable fraction with
respect to the property is redetermined
as of the date of death of the transferor.
In making the redetermination, any
available GST exemption not allocated
at the death of the transferor (or at a
prior recapture event) is automatically
allocated to the property. The de-
nominator of the applicable fraction is
the fair market value of the property at
the date of the transferor’s death
reduced as provided in §26.2642–1(c)
and further reduced by the amount of
the additional GST tax actually re-
covered from the trust.
(ii)The GST tax imposed with
respect to any taxable termination,
taxable distribution, or direct skip
occurring prior to the recapture event is
recomputed based on the applicable
fraction as redetermined. Any addi-
tional GST tax as recomputed is due
and payable on the date that is six
months after the event that causes the
imposition of the additional estate tax
under section 2032A. The additional
GST tax is remitted with Form 706-A
and is reported by attaching a statement
to Form 706–A showing the computa-
tion of the additional GST tax.
(iii)The applicable fraction, as re-
determined under this section, is also
used in determining any GST tax
imposed with respect to GSTs occur-
ring after the date of the recapture
event.
(b)Examples. The following exam-
ples illustrate the principles of this
section:
Example 1. Allocation of additional exemption.
T transfers $200,000 to an irrevocable trust
under which the income is payable to T’s child,
C, for life. Upon the termination of the trust, the
remainder is payable to T’s grandchild, GC. At a
time when no ETIP exists with respect to the
trust property, T makes a timely allocation of
$100,000 of GST exemption, resulting in an
inclusion ratio of .50. Subsequently, when the
entire trust property is valued at $500,000, T
allocates an additional $100,000 of T’s unused
GST exemption to the trust. The inclusion ratio
of the trust is recomputed at that time. The
numerator of the applicable fraction is $350,000
($250,000 (the nontax portion as of the date of
the allocation) plus $100,000 (the GST exemp-
tion currently being allocated)). The denominator
is $500,000 (the date of allocation fair market
value of the trust). The inclusion ratio is .30 (1 –
.70).
Example 2. Multiple transfers to a trust,
allocation both timely and late. On December
10, 1993, T transfers $10,000 to an irrevocable
trust that does not satisfy the requirements of
section 2642(c)(2). T makes identical transfers to
the trust on December 10, 1994, 1995, 1996, and
on January 15, 1997. Immediately after the
transfer on January 15, 1997, the value of the
trust principal is $40,000. On January 14, 1998,
when the value of the trust principal is $50,000,
T allocates $30,000 of GST exemption to the
trust. T discloses the 1997 transfer on the Form
709 filed on January 14, 1998. Thus, T’s
allocation is a timely allocation with respect to
the transfer in 1997, $10,000 of the allocation is
effective as of the date of that transfer, and, on
and after January 15, 1997, the inclusion ratio of
the trust is .75 (1 – ($10,000/$40,000)). The
balance of the allocation is a late allocation with
respect to prior transfers to the trust and is
effective as of January 14, 1998. In redetermin-
ing the inclusion ratio as of that date, the
numerator of the redetermined applicable fraction

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is $32,500 ($12,500 (.25 3 $50,000), the nontax
portion of the trust on January 14, 1998) plus
$20,000 (the amount of GST exemption allocated
late to the trust). The denominator of the new
applicable fraction is $50,000 (the value of the
trust principal at the time of the late allocation).
Example 3. Excess allocation. (i) T creates an
irrevocable trust for the benefit of T’s child and
grandchild in 1996 transferring $50,000 to the
trust on the date of creation. T allocates no GST
exemption to the trust on the Form 709 reporting
the transfer. On July 1, 1997 (when the value of
the trust property is $60,000), T transfers an
additional $40,000 to the trust.
(ii)On April 15, 1998, when the value of the
trust is $150,000, T files a Form 709 reporting
the 1997 transfer and allocating $150,000 of
GST exemption to the trust. The allocation is a
timely allocation of $40,000 with respect to the
1997 transfer and is effective as of that date.
Thus, the applicable fraction for the trust as of
July 1, 1997 is .40 ($40,000/$100,000 ($40,000 +
$60,000)).
(iii)The allocation is also a late allocation of
$90,000, the amount necessary to attain a zero
inclusion ratio on April 15, 1998, computed as
follows: $60,000 (the nontax portion immediately
prior to the allocation (.40 3 $150,000)) plus
$90,000 (the additional allocation necessary to
produce a zero inclusion ratio based on a
denominator of $150,000)/$150,000 equals one
and, thus, an inclusion ratio of zero. The balance
of the allocation, $20,000 ($150,000 less the
timely allocation of $40,000 less the late
allocation of $90,000) is void.
Example 4. Undisclosed transfer. (i) The facts
are the same as in Example 3, except that on
February 1, 1998 (when the value of the trust is
$150,000), T transfers an additional $50,000 to
the trust and the value of the entire trust corpus
on April 15, 1998 is $220,000. The Form 709
filed on April 15, 1998 does not disclose the
1998 transfer. Under the rule in §26.2632–1(b)-
(2)(ii), the allocation is effective first as a timely
allocation to the 1997 transfer; second, as a late
allocation to the trust as of April 15, 1998; and,
finally as a timely allocation to the February 1,
1998 transfer. As of April 15, 1998, $55,000, a
pro rata portion of the trust assets, is considered
to be the property transferred to the trust on
February 1, 1998 (($50,000/$200,000) 3
$220,000). The balance of the trust, $165,000,
represents prior transfers to the trust.
(ii)As in Example 3, the allocation is a timely
allocation as to the 1997 transfer (and the
applicable fraction as of July 1, 1997 is .40) and
a late allocation as of 1998. The amount of the
late allocation is $99,000, computed as follows:
(.40 3 $165,000 plus $99,000)/$165,000 = one.
(iii)The balance of the allocation, $11,000
($150,000 less the timely allocation of $40,000
less the late allocation of $99,000) is a timely
allocation as of February 1, 1998. The applicable
fraction with respect to the trust, as of February
1, 1998, is .355, computed as follows: $60,000
(the nontax portion of the trust immediately prior
to the February 1, 1998 transfer (.40 3
$150,000)) plus $11,000 (the amount of the
timely allocation to the 1998 transfer)/$200,000
(the value of the trust on February 1, 1998, after
the transfer on that date) = $71,000/$200,000 =
.355.
(iv)The applicable fraction with respect to the
trust, as of April 15, 1998, is .805 computed as
follows: $78,100 (the nontax portion immediately
prior to the allocation (.355 3 $220,000)) plus
$99,000 (the amount of the late allocation)/
$220,000 = $177,100/$220,000 = .805.
Example 5. Redetermination of inclusion ratio
on ETIP termination. (i) T transfers $100,000 to
an irrevocable trust. The trust instrument pro-
vides that trust income is to be paid to T for 9
years or until T’s prior death. The trust principal
is to be paid to T’s grandchild, GC, on the
termination of T’s income interest. The trustee
has the power to invade trust principal for the
benefit of GC during the term of T’s income
interest. The trust is subject to an ETIP while T
holds the retained income interest. T files a
timely Form 709 reporting the transfer and
allocates $100,000 of GST exemption to the
trust. In year 4, when the value of the trust is
$200,000, the trustee distributes $15,000 to GC.
The distribution is a taxable distribution. Because
of the existence of the ETIP, the inclusion ratio
with respect to the taxable distribution is deter-
mined immediately prior to the occurrence of the
GST. Thus, the inclusion ratio applicable to the
year 4 GST is .50 (1 – ($100,000/$200,000 =
.50).
(ii)In year 5, when the value of the trust is
again $200,000, the trustee distributes another
$15,000 to GC. Because the trust is still subject
to the ETIP in year 5, the inclusion ratio with
respect to the year 5 GST is again computed
immediately prior to the GST. In computing the
new inclusion ratio, the numerator of the
applicable fraction is reduced by the nontax
portion of prior GSTs occurring during the ETIP.
Thus, the numerator of the applicable fraction
with respect to the GST in year 5 is $92,500
($100,000 – (.50 3 $15,000)) and the inclusion
ratio applicable with respect to the GST in year
5 is .537 (1 – ($92,500/$200,000) = .463). Any
additional GST exemption allocated on a timely
ETIP return with respect to the GST in year 5 is
effective immediately prior to the transfer.
§26.2642–5 Finality of inclusion
ratio.
(a)Direct skips. The inclusion ratio
applicable to a direct skip becomes
final when no additional GST tax
(including additional GST tax payable
as a result of a cessation, etc. of
qualified use under section 2032A(c))
may be assessed with respect to the
direct skip.
(b)Other GSTs. With respect to
taxable distributions and taxable termi-
nations, the inclusion ratio for a trust
becomes final, on the later of—
(1)The expiration of the period for
assessment with respect to the first
GST tax return filed using that inclu-
sion ratio; (unless the trust is subject to
an election under section 2032A in
which case the applicable date under
this subsection is the expiration of the
period of assessment of any additional
GST tax due as a result of a cessation,
etc. of qualified use under section
2032A); or
(2)The expiration of the period for
assessment of Federal estate tax with
respect to the estate of the transferor.
For purposes of this paragraph (b)(2),
if an estate tax return is not required to
be filed, the period for assessment is
determined as if a return were required
to be filed and as if the return were
timely filed within the period pre-
scribed by section 6075(a).
§26.2652–1 Transferor defined; other
definitions.
(a)Transferor defined—(1) In gen-
eral. Except as otherwise provided in
paragraph (a)(3) of this section, the
individual with respect to whom prop-
erty was most recently subject to
Federal estate or gift tax is the
transferor of that property for purposes
of chapter 13. An individual is treated
as transferring any property with re-
spect to which the individual is the
transferor. Thus, an individual may be
a transferor even though there is no
transfer of property under local law at
the time the Federal estate or gift tax
applies. For purposes of this paragraph,
a surviving spouse is the transferor of a
qualified domestic trust created by the
deceased spouse that is included in the
surviving spouse’s gross estate, pro-
vided the trust is not subject to the
election described in §26.2652–2 (re-
verse QTIP election). A surviving
spouse is also the transferor of a
qualified domestic trust created by the
surviving spouse pursuant to section
2056(d)(2)(B).
(2)Transfers subject to Federal
estate or gift tax. For purposes of this
section, a transfer is subject to Federal
gift tax if a gift tax is imposed under
section 2501(a). A transfer is subject to
Federal estate tax if the value of the
property is includible in the decedent’s
gross estate as determined under sec-
tion 2031 or section 2103.
(3)Special rule for certain QTIP
trusts. Solely for purposes of chapter
13, if a transferor of qualified termin-
able interest property (QTIP) elects
under §26.2652–2(a) to treat the prop-
erty as if the QTIP election had not
been made (reverse QTIP election), the
identity of the transferor of the prop-
erty is determined without regard to the
application of sections 2044, 2207A,
and 2519.
(4)Exercise of certain nongeneral
powers of appointment. The exercise of
a power of appointment that is not a
general power of appointment (as de-
fined in section 2041(b)) is treated as a
transfer subject to Federal estate or gift
tax by the holder of the power if the
power is exercised in a manner that

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may postpone or suspend the vesting,
absolute ownership, or power of aliena-
tion of an interest in property for a
period, measured from the date of
creation of the trust, extending beyond
any specified life in being at the date
of creation of the trust plus a period of
21 years plus, if necessary, a reason-
able period of gestation (perpetuities
period). For purposes of this paragraph
(a)(4), the exercise of a power of
appointment that validly postpones or
suspends the vesting, absolute owner-
ship, or power of alienation of an
interest in property for a term of years
that will not exceed 90 years (measured
from the date of creation of the trust) is
not an exercise that may extend beyond
the perpetuities period.
(5)Split-gift transfers. In the case of
a transfer with respect to which the
donor’s spouse makes an election under
section 2513 to treat the gift as made
one-half by the spouse, the electing
spouse is treated as the transferor of
one-half of the entire value of the
property transferred by the donor,
regardless of the interest the electing
spouse is actually deemed to have
transferred under section 2513. The
donor is treated as the transferor of
one-half of the value of the entire
property. See §26.2632–1(c)(5) Exam-
ple 3, regarding allocation of GST
exemption with respect to split-gift
transfers subject to an ETIP.
(6)Examples. The following exam-
ples illustrate the principles of this
paragraph (a):
Example 1. Identity of transferor. T transfers
$100,000 to a trust for the sole benefit of T’s
grandchild. The transfer is a completed gift
under §25.2511–2 of this chapter. Thus, for
purposes of chapter 13, T is the transferor of the
$100,000. It is immaterial that a portion of the
transfer is excluded from the total amount of T’s
taxable gift by reason of section 2503(b).
Example 2. Gift splitting and identity of
transferor. The facts are the same as in Example
1, except T’s spouse, S, consents under section
2513 to split the gift with T. For purposes of
chapter 13, S and T are each treated as a
transferor of $50,000 to the trust.
Example 3. Change of transferor on subse-
quent transfer tax event. T transfers $100,000 to
a trust providing that all the net trust income is
to be paid to T’s spouse, S, for S’s lifetime. T
elects under section 2523(f) to treat the transfer
as a transfer of qualified terminable interest
property, and T does not make the reverse QTIP
election under section 2652(a)(3). On S’s death,
the trust property is included in S’s gross estate
under section 2044. Thus, S becomes the
transferor at the time of S’s death.
Example 4. Effect of transfer of an interest in
trust on identity of the transferor. T transfers
$100,000 to a trust providing that all of the net
income is to be paid to T’s child, C, for C’s
lifetime. At C’s death, the trust property is to be
paid to T’s grandchild. C transfers the income
interest to X, an unrelated party, in a transfer
that is a completed transfer for Federal gift tax
purposes. Because C’s transfer is a transfer of a
term interest in the trust that does not affect the
rights of other parties with respect to the trust
property, T remains the transferor with respect to
the trust.
Example 5. Effect of lapse of withdrawal right
on identity of transferor. T transfers $10,000 to a
new trust providing that the trust income is to be
paid to T’s child, C, for C’s life and, on the
death of C, the trust principal is to be paid to T’s
grandchild, GC. The trustee has discretion to
distribute principal for GC’s benefit during C’s
lifetime. C has a right to withdraw $10,000 from
the trust for a 60-day period following the
transfer. Thereafter, the power lapses. C does not
exercise the withdrawal right. The transfer by T
is a completed transfer within the meaning of
§25.2511–2 of this chapter and, thus, T is treated
as having transferred the entire $10,000 to the
trust. On the lapse of the withdrawal right, C
becomes a transferor to the extent C is treated as
having made a completed transfer for purposes
of chapter 12. Therefore, except to the extent
that the amount with respect to which the power
of withdrawal lapses exceeds the greater of
$5,000 or 5% of the value of the trust property,
T remains the transferor of the trust property for
purposes of chapter 13.
Example 6. Effect of reverse QTIP election on
identity of the transferor. T establishes a
testamentary trust having a principal of
$500,000. Under the terms of the trust, all trust
income is payable to T’s surviving spouse, S,
during S’s lifetime. T’s executor makes an
election to treat the trust property as qualified
terminable interest property and also makes the
reverse QTIP election. For purposes of chapter
13, T is the transferor with respect to the trust.
On S’s death, the then full fair market value of
the trust is includible in S’s gross estate under
section 2044. However, because of the reverse
QTIP election, S does not become the transferor
with respect to the trust; T continues to be the
transferor.
Example 7. Effect of reverse QTIP election on
constructive additions. The facts are the same as
in Example 6, except the inclusion of the QTIP
trust in S’s gross estate increased the Federal
estate tax liability of S’s estate by $200,000. The
estate does not exercise the right of recovery
from the trust granted under section 2207A.
Under local law, the beneficiaries of S’s
residuary estate (which bears all estate taxes
under the will) could compel the executor to
exercise the right of recovery but do not do so.
Solely for purposes of chapter 13, the benefici-
aries of the residuary estate are not treated as
having made an addition to the trust by reason of
their failure to exercise their right of recovery.
Because of the reverse QTIP election, for GST
purposes, the trust property is not treated as
includible in S’s gross estate and, under those
circumstances, no right of recovery exists.
Example 8. Effect of reverse QTIP election on
constructive additions. S, the surviving spouse of
T, dies testate. At the time of S’s death, S was
the beneficiary of a trust with respect to which
T’s executor made a QTIP election under section
2056(b)(7). Thus, the trust is includible in S’s
gross estate under section 2044. T’s executor
also made the reverse QTIP election with respect
to the trust. S’s will provides that all death taxes
payable with respect to the trust are payable
from S’s residuary estate. Since the transferor of
the property is determined without regard to
section 2044 and section 2207A, S is not treated
as making a constructive addition to the trust by
reason of the tax apportionment clause in S’s
will.
Example 9. Exercise of a nongeneral power of
appointment. On May 15, 1990, T established an
irrevocable trust under which the trust income is
to be paid to T’s child, C, for life. C is given a
testamentary power to appoint the remainder in
further trust for the benefit of C’s issue. In
default of C’s exercise of the power, the
remainder is to pass to charity. C dies on
February 3, 1997, survived by two children and a
sibling, S (who was born prior to May 15, 1990).
C exercises the power in a manner that validly
extends the trust in favor of C’s issue until the
later of May 15, 2070 (80 years from the date
the trust was created), or the death of S. C’s
exercise of the power is considered a transfer by
C that is subject to the estate or gift tax because
it may extend the term of the trust beyond the
perpetuities period.
Example 10. Exercise of a nongeneral power
of appointment. The facts are the same as in
Example 9, except local law provides that the
effect of C’s exercise is to extend the term of the
trust until May 15, 2070, whether or not S
survives that date. C is not treated as having
made a transfer to the trust as a result of the
exercise of the power because the exercise of the
power does not extend the term of the trust
beyond a period of 90 years measured from the
creation of the trust. The result would be the
same if the effect of C’s exercise is either to
extend the term of the trust until the death of S
or to extend the term of the trust until the first to
occur of May 15, 2070, or the death of S.
Example 11. Split-gift transfers. T transfers
$100,000 to an inter vivos trust that provides T
with an annuity payable for ten years or until T’s
prior death. The annuity satisfies the definition
of a qualified interest under section 2702(b).
When the trust terminates, the corpus is to be
paid to T’s grandchild, GC. T’s spouse, S,
consents under section 2513 to have the gift
treated as made one-half by S. Under section
2513, only the actuarial value of the gift to GC
is eligible to be treated as made one-half by S.
However, because S is treated as the donor of
one-half of the gift to GC, S becomes the
transferor of one-half of the entire trust
($50,000) for purposes of Chapter 13.
(b)Trust defined—(1) In general. A
trust includes any arrangement (other
than an estate) that has substantially the
same effect as a trust. Thus, for
example, arrangements involving life
estates and remainders, estates for
years, and insurance and annuity con-
tracts are trusts. Generally, a transfer as
to which the identity of the transferee
is contingent upon the occurrence of an
event is a transfer in trust; however, a
transfer of property included in the
transferor’s gross estate, as to which
the identity of the transferee is con-
tingent upon an event that must occur
within 6 months of the transferor’s
death, is not considered a transfer in

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trust solely by reason of the existence
of the contingency.
(2)Examples. The following exam-
ples illustrate the provisions of this
paragraph (b):
Example 1. Uniform gifts to minors transfers.
T transfers cash to an account in the name of T’s
child, C, as custodian for C’s child, GC (who is
a minor), under a state statute substantially
similar to the Uniform Gifts to Minors Act. For
purposes of chapter 13, the transfer to the
custodial account is treated as a transfer to a
trust.
Example 2. Contingent transfers. T bequeaths
$200,000 to T’s child, C, provided that if C does
not survive T by more than 6 months, the
bequest is payable to T’s grandchild, GC. C dies
4 months after T. The bequest is not a transfer in
trust because the contingency that determines the
recipient of the bequest must occur within 6
months of T’s death. The bequest to GC is a
direct skip.
Example 3. Contingent transfers. The facts are
the same as in Example 2, except C must survive
T by 18 months to take the bequest. The bequest
is a transfer in trust for purposes of chapter 13,
and the death of C is a taxable termination.
(c)Trustee defined. The trustee of a
trust is the person designated as trustee
under local law or, if no such person is
so designated, the person in actual or
constructive possession of property
held in trust.
(d)Executor defined. For purposes
of chapter 13, the executor is the
executor or administrator of the dece-
dent’s estate. However, if no executor
or administrator is appointed, qualified
or acting within the United States, the
executor is the fiduciary who is pri-
marily responsible for payment of the
decedent’s debts and expenses. If there
is no such executor, administrator or
fiduciary, the executor is the person in
actual or constructive possession of the
largest portion of the value of the
decedent’s gross estate.
(e)Interest in trust. See §26.2612–
1(e) for the definition of interest in
trust.
§26.2652–2 Special election for
qualified terminable interest property.
(a)In general. If an election is made
to treat property as qualified terminable
interest property (QTIP) under section
2523(f) or section 2056(b)(7), the
person making the election may, for
purposes of chapter 13, elect to treat
the property as if the QTIP election
had not been made (reverse QTIP
election). An election under this section
is irrevocable. An election under this
section is not effective unless it is
made with respect to all of the property
in the trust to which the QTIP election
applies. See, however, §26.2654–
1(b)(1). Property that qualifies for a
deduction under section 2056(b)(5) is
not eligible for the election under this
section.
(b)Time and manner of making
election. An election under this section
is made on the return on which the
QTIP election is made. If a protective
QTIP election is made, no election
under this section is effective unless a
protective reverse QTIP election is also
made.
(c)Transitional rule. If a reverse
QTIP election is made with respect to a
trust prior to December 27, 1995, and
GST exemption has been allocated to
that trust, the transferor (or the trans-
feror’s executor) may elect to treat the
trust as two separate trusts, one of
which has a zero inclusion ratio by
reason of the transferor’s GST exemp-
tion previously allocated to the trust.
The separate trust with the zero inclu-
sion ratio consists of that fractional
share of the value of the entire trust
equal to the value of the nontax portion
of the trust under §26.2642–4(a). The
reverse QTIP election is treated as
applying only to the trust with the zero
inclusion ratio. An election under this
paragraph (c) is made by attaching a
statement to a copy of the return on
which the reverse QTIP election was
made under section 2652(a)(3). The
statement must indicate that an election
is being made to treat the trust as two
separate trusts and must identify the
values of the two separate trusts. The
statement is to be filed in the same
place in which the original return was
filed and must be filed before June 24,
1996. A trust subject to the election
described in this paragraph is treated as
a trust that was created by two
transferors. See §26.2654–1(a)(2) for
special rules involving trusts with
multiple transferors.
(d)Examples. The following exam-
ples illustrate the provisions of this
section:
Example 1. Special (reverse QTIP) election
under section 2652(a)(3). T transfers $1,000,000
to a trust providing that all trust income is to be
paid to T’s spouse, S, for S’s lifetime. On S’s
death, the trust principal is payable to GC, a
grandchild of S and T. T elects to treat all of the
transfer as a transfer of QTIP and also makes the
reverse QTIP election for all of the property.
Because of the reverse QTIP election, T con-
tinues to be treated as the transferor of the
property after S’s death for purposes of chapter
13. A taxable termination rather than a direct
skip occurs on S’s death.
Example 2. Election under transition rule. In
1994, T died leaving $4 million in trust for the
benefit of T’s surviving spouse, S. On January
16, 1995, T’s executor filed T’s Form 706 on
which the executor elects to treat the entire trust
as qualified terminable interest property. The
executor also makes a reverse QTIP election.
The reverse QTIP election is effective with
respect to the entire trust even though T’s
executor could allocate only $1 million of GST
exemption to the trust. T’s executor may elect to
treat the trust as two separate trusts, one having
a value of 25% of the value of the single trust
and an inclusion ratio of zero, but only if the
election is made prior to June 24, 1996. If the
executor makes the transitional election, the
other separate trust, having a value of 75% of the
value of the single trust and an inclusion ratio of
one, is not treated as subject to the reverse QTIP
election.
Example 3. Denominator of the applicable
fraction of QTIP trust. T bequeaths $1,500,000
to a trust in which T’s surviving spouse, S,
receives an income interest for life. Upon the
death of S, the property is to remain in trust for
the benefit of C, the child of T and S. Upon C’s
death, the trust is to terminate and the trust
property paid to the descendants of C. The
bequest qualifies for the estate tax marital
deduction under section 2056(b)(7) as QTIP. The
executor does not make the reverse QTIP
election under section 2652(a)(3). As a result, S
becomes the transferor of the trust at S’s death
when the value of the property in the QTIP trust
is included in S’s gross estate under section
2044. For purposes of computing the applicable
fraction with respect to the QTIP trust upon S’s
death, the denominator of the fraction is reduced
by any Federal estate tax (whether imposed
under section 2001, 2101 or 2056A(b)) and State
death tax attributable to the trust property that is
actually recovered from the trust.
§26.2653–1 Taxation of multiple
skips.
(a)General rule. If property is held
in trust immediately after a GST, solely
for purposes of determining whether
future events involve a skip person, the
transferor is thereafter deemed to oc-
cupy the generation immediately above
the highest generation of any person
holding an interest in the trust imme-
diately after the transfer. If no person
holds an interest in the trust imme-
diately after the GST, the transferor is
treated as occupying the generation
above the highest generation of any
person in existence at the time of the
GST who then occupies the highest
generation level of any person who
may subsequently hold an interest in
the trust. See §26.2612–1(e) for rules
determining when a person has an
interest in property held in trust.
(b)Examples. The following exam-
ples illustrate the provisions of this
section:

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Example 1. T transfers property to an irrevoca-
ble trust for the benefit of T’s grandchild, GC,
and great-grandchild, GGC. During GC’s life, the
trust income may be distributed to GC and GGC
in the trustee’s absolute discretion. At GC’s
death, the trust property passes to GGC. Both
GC and GGC have an interest in the trust for
purposes of chapter 13. The transfer by T to the
trust is a direct skip, and the property is held in
trust immediately after the transfer. After the
direct skip, the transferor is treated as being one
generation above GC, the highest generation
individual having an interest in the trust.
Therefore, GC is no longer a skip person and
distributions to GC are not taxable distributions.
However, because GGC occupies a generation
that is two generations below the deemed
generation of T, GGC is a skip person and
distributions of trust income to GGC are taxable
distributions.
Example 2. T transfers property to an irrevoca-
ble trust providing that the income is to be paid
to T’s child, C, for life. At C’s death, the trust
income is to be accumulated for 10 years and
added to principal. At the end of the 10-year
accumulation period, the trust income is to be
paid to T’s grandchild, GC, for life. Upon GC’s
death, the trust property is to be paid to T’s
great-grandchild, GGC, or to GGC’s estate. A
GST occurs at C’s death. Immediately after C’s
death and during the 10-year accumulation
period, no person has an interest in the trust
within the meaning of section 2652(c) and
§26.2612–1(e) because no one can receive
current distributions of income or principal.
Immediately after C’s death, T is treated as
occupying the generation above the generation of
GC (the trust beneficiary in existence at the time
of the GST who then occupies the highest
generation level of any person who may
subsequently hold an interest in the trust). Thus,
subsequent income distributions to GC are not
taxable distributions.
§26.2654–1 Certain trusts treated as
separate trusts.
(a)Single trust treated as separate
trusts—(1) Substantially separate and
independent shares—(i) In general. If a
single trust consists solely of substan-
tially separate and independent shares
for different beneficiaries, the share
attributable to each beneficiary (or
group of beneficiaries) is treated as a
separate trust for purposes of chapter
13. The phrase ‘‘substantially separate
and independent shares’’ generally has
the same meaning as provided in
§1.663(c)–3 of this chapter. However, a
portion of a trust is not a separate share
unless such share exists from and at all
times after the creation of the trust. For
purposes of this paragraph (a)(1), a
trust is treated as created at the date of
death of the grantor if the trust is
includible in its entirety in the grantor’s
gross estate for Federal estate tax
purposes. Further, treatment of a single
trust as separate trusts under this
paragraph (a)(1) does not permit treat-
ment of those portions as separate
trusts for purposes of filing returns and
payment of tax or for purposes of
computing any other tax imposed under
the Internal Revenue Code. Also, addi-
tions to, and distributions from, such
trusts are allocated pro rata among the
separate trusts, unless the governing
instrument expressly provides other-
wise.
(ii)Certain pecuniary amounts. For
purposes of this section, if a person
holds the current right to receive a
mandatory (i.e., nondiscretionary and
noncontingent) payment of a pecuniary
amount at the death of the transferor
from an inter vivos trust that is
includible in the transferor’s gross
estate, or a testamentary trust, the
pecuniary amount is a separate and
independent share if—
(A)The trustee is required to pay
appropriate interest (as defined in
§26.2642–2(b)(4)(i) and (ii)) to the
person; or
(B)If the pecuniary amount is pay-
able in kind on the basis of value other
than the date of distribution value of
the assets, the trustee is required to
allocate assets to the pecuniary pay-
ment in a manner that fairly reflects net
appreciation or depreciation in the
value of the assets in the fund available
to pay the pecuniary amount measured
from the date of death to the date of
payment.
(2)Multiple transferors with respect
to single trust—(i) In general. If there
is more than one transferor with respect
to a trust, the portions of the trust
attributable to the different transferors
are treated as separate trusts for pur-
poses of chapter 13. Treatment of a
single trust as separate trusts under this
paragraph (a)(2) does not permit treat-
ment of those portions as separate
trusts for purposes of filing returns and
payment of tax or for purposes of
computing any other tax imposed under
the Internal Revenue Code. Also, addi-
tions to, and distributions from, such
trusts are allocated pro rata among the
separate trusts unless otherwise ex-
pressly provided in the governing
instrument.
(ii)Addition by a transferor. If an
individual makes an addition to a trust
of which the individual is not the sole
transferor, the portion of the single
trust attributable to each separate trust
is determined by multiplying the fair
market value of the single trust imme-
diately after the contribution by a
fraction. The numerator of the fraction
is the value of the separate trust
immediately after the contribution. The
denominator of the fraction is the fair
market value of all the property in the
single trust immediately after the
transfer.
(3)Severance of a single trust. A
single trust treated as separate trusts
under paragraphs (a)(1) or (2) of this
section may be divided at any time into
separate trusts to reflect that treatment.
For this purpose, the rules of paragraph
(b)(1)(ii)(C) of this section apply with
respect to the severance and funding of
the severed trusts.
(4)Allocation of exemption—(i) In
general. With respect to a separate
share treated as a separate trust under
paragraph (a)(1) or (2) of this section,
an individual’s GST exemption is
allocated to the separate trust. See
§26.2632–1 for rules concerning the
allocation of GST exemption.
(ii)Automatic allocation to direct
skips. If the transfer is a direct skip to
a trust that occurs during the trans-
feror’s lifetime and is treated as a
transfer to separate trusts under para-
graphs (a)(1) or (a)(2) of this section,
the transferor’s GST exemption not
previously allocated is automatically
allocated on a pro rata basis among the
separate trusts. The transferor may
prevent an automatic allocation of GST
exemption to a separate share of a
single trust by describing on a timely-
f i l e d U n i t e d S t a t e s G i f t ( a n d
Generation-Skipping Transfer) Tax Re-
turn (Form 709) the transfer and the
extent to which the automatic alloca-
tion is not to apply to a particular
share. See §26.2632–1(b) for rules for
avoiding the automatic allocation of
GST exemption.
(5)Examples. The following exam-
ples illustrate the principles of this
section (a):
Example 1. Separate shares as separate trusts.
T transfers $100,000 to a trust under which
income is to be paid in equal shares for 10 years
to T’s child, C, and T’s grandchild, GC (or their
respective estates). The trust does not permit
distributions of principal during the term of the
trust. At the end of the 10-year term, the trust
principal is to be distributed to C and GC in
equal shares. The shares of C and GC in the trust
are separate and independent and, therefore, are
treated as separate trusts. The result would not
be the same if the trust permitted distributions of
principal unless the distributions could only be
made from a one-half separate share of the initial
trust principal and the distributee’s future rights
with respect to the trust are correspondingly
reduced. T may allocate part of T’s GST

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exemption under section 2632(a) to the share
held for the benefit of GC.
Example 2. Separate share rule inapplicable.
The facts are the same as in Example 1, except
the trustee holds the discretionary power to
distribute the income in any proportion between
C and GC during the last year of the trust. The
shares of C and GC in the trust are not separate
and independent shares throughout the entire
term of the trust and, therefore, are not treated as
separate trusts for purposes of chapter 13.
Example 3. Pecuniary payment as separate
share. T creates a lifetime revocable trust
providing that on T’s death $500,000 is payable
to T’s spouse, S, with the balance of the
principal to be held for the benefit of T’s
grandchildren. The value of the trust is includible
in T’s gross estate upon T’s death. Under the
terms of the trust, the payment to S is required to
be made in cash, and under local law S is
entitled to receive interest on the payment at an
annual rate of 6 percent, commencing imme-
diately upon T’s death. For purposes of chapter
13, the trust is treated as created at T’s death,
and the $500,000 payable to S from the trust is
treated as a separate share. The result would be
the same if the payment to S could be satisfied
using noncash assets at their value on the date of
distribution. Further, the result would be the
same if the decedent’s probate estate poured over
to the revocable trust on the decedent’s death
and was then distributed in accordance with the
terms of the trust.
Example 4. Pecuniary payment not treated as
separate share. The facts are the same as in
Example 3, except the bequest to S is to be paid
in noncash assets valued at their values as finally
determined for Federal estate tax purposes.
Neither the trust instrument nor local law
requires that the assets distributed in satisfaction
of the bequest fairly reflect net appreciation or
depreciation in all the assets from which the
bequest may be funded. S’s $500,000 bequest is
not treated as a separate share and the trust is
treated as a single trust for purposes of chapter
13.
Example 5. Multiple transferors to single trust.
A transfers $100,000 to an irrevocable
generation-skipping trust; B simultaneously
transfers $50,000 to the same trust. As of the
time of the transfers, the single trust is treated as
two trusts for purposes of chapter 13. Because A
contributed
2
⁄3 of the value of the initial corpus,
2
⁄3 of the single trust principal is treated as a
separate trust created by A. Similarly, because B
contributed
1
⁄3 of the value of the initial corpus,
1
⁄3 of the single trust is treated as a separate trust
created by B. A or B may allocate their GST
exemption under section 2632(a) to the respec-
tive separate trusts.
Example 6. Additional contributions. A trans-
fers $100,000 to an irrevocable generation-
skipping trust; B simultaneously transfers
$50,000 to the same trust. When the value of the
single trust has increased to $180,000, A
contributes an additional $60,000 to the trust. At
the time of the additional contribution, the
portion of the single trust attributable to each
grantor’s separate trust must be redetermined.
The portion of the single trust attributable to A’s
separate trust immediately after the contribution
is
3
⁄4 ((
2
⁄3 3 $180,000) + $60,000)/$240,000).
The portion attributable to B’s separate trust
after A’s addition is
1
⁄4.
Example 7. Distributions from a separate
share. The facts are the same as in Example 6,
except that, after A’s second contribution,
$50,000 is distributed to a beneficiary of the
trust. Absent a provision in the trust instrument
that charges the distribution against the contribu-
tion of either A or B,
3
⁄4 of the distribution is
treated as made from the separate trust of which
A is the transferor and
1
⁄4 from the separate trust
of which B is the transferor.
Example 8. Separate share rule inapplicable.
T creates an irrevocable trust that provides the
trustee with the discretionary power to distribute
income or corpus to T’s children and grand-
children. The trust provides that, when T’s
youngest child reaches age 21, the trust will be
divided into separate shares, one share for each
child of T. The income from a respective child’s
share will be paid to the child during the child’s
life with the remainder passing to such child’s
children (grandchildren of T). The separate
shares that come into existence when the
youngest child reaches age 21 will not be
recognized as separate trusts for purposes of
Chapter 13 because the shares did not exist from
and at all times after the creation of the trust.
Any allocation of GST exemption to the trust
either before or after T’s youngest child reaches
age 21 will apply with respect to the entire trust.
Thus, the inclusion ratio will be the same with
respect to any distribution from the trust or the
separate shares. The result would be the same if,
the trust instrument provided that the trust was to
be divided into separate trusts when T’s youngest
child reached age 21.
(b)Division of a trust included in
the gross estate—(1) In general. The
severance of a trust that is included in
the transferor’s gross estate (or created
under the transferor’s will) into two or
more trusts is recognized for purposes
of chapter 13 if—
(i)The trust is severed pursuant to a
direction in the governing instrument
providing that the trust is to be divided
upon the death of the transferor; or
(ii)The governing instrument does
not require or otherwise direct sever-
ance but the trust is severed pursuant to
discretionary authority granted either
under the governing instrument or
under local law; and
(A)The terms of each of the new
trusts provide for the same succession
of interests and beneficiaries as are
provided in the original trust;
(B)The severance occurs (or a
reformation proceeding, if required, is
commenced) prior to the date pre-
scribed for filing the Federal estate tax
return (including extensions actually
granted) for the estate of the transferor;
and
(C)Either—
(1) The new trusts are severed on a
fractional basis. If severed on a frac-
tional basis, the separate trusts need not
be funded with a pro rata portion of
each asset held by the undivided trust.
The trusts may be funded on a nonpro
rata basis provided funding is based on
either the fair market value of the
assets on the date of funding or in a
manner that fairly reflects the net
appreciation or depreciation in the
value of the assets measured from the
date of death to the date of funding; or
(2) If the severance is required (by
the terms of the governing instrument)
to be made on the basis of a pecuniary
amount, the pecuniary payment is
satisfied in a manner that would meet
the requirements of paragraph (a)(1)(ii)
of this section if it were paid to an
individual.
(2)Special rule. If a court order
severing the trust has not been issued
at the time the Federal estate tax return
is filed, the executor must indicate on a
statement attached to the return that a
proceeding has been commenced to
sever the trust and describe the manner
in which the trust is proposed to be
severed. A copy of the petition or other
instrument used to commence the pro-
ceeding must also be attached to the
return. If the governing instrument of a
trust or local law authorizes the sever-
ance of the trust, a severance pursuant
to that authorization is treated as
meeting the requirement of paragraph
(b)(1)(ii)(B) of this section if the
executor indicates on the Federal estate
tax return that separate trusts will be
created (or funded) and clearly sets
forth the manner in which the trust is
to be severed and the separate trusts
funded.
(3)Allocation of exemption. An indi-
vidual’s GST exemption under §2632
may be allocated to the separate trusts
created pursuant to this section at the
discretion of the executor or trustee.
(4)Examples. The following exam-
ples illustrate the provisions of this
section (b):
Example 1. Severance of single trust. T’s will
establishes a testamentary trust providing that
income is to be paid to T’s spouse for life. At
the spouse’s death, one-half of the corpus is to
be paid to T’s child, C, or C’s estate (if C fails
to survive the spouse) and one-half of the corpus
is to be paid to T’s grandchild, GC, or GC’s
estate (if GC fails to survive the spouse). If the
requirements of paragraph (b) of this section are
otherwise satisfied, T’s executor may divide the
testamentary trust equally into two separate
trusts, one trust providing an income interest to
spouse for life with remainder to C, and the
other trust with an income interest to spouse for
life with remainder to GC. Furthermore, if the
requirements of paragraph (b) of this section are
satisfied, the executor or trustee may further
divide the trust for the benefit of GC. GST
exemption may be allocated to any of the divided
trusts.
Example 2. Severance of revocable trust. T
creates an inter vivos revocable trust providing

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that, at T’s death and after payment of all taxes
and administration expenses, the remaining
corpus will be divided into two trusts. One trust,
for the benefit of T’s spouse, is to be funded
with the smallest amount that, if qualifying for
the marital deduction, will reduce the estate tax
to zero. The other trust, for the benefit of T’s
descendants, is to be funded with the balance of
the revocable trust corpus. The trust corpus is
includible in T’s gross estate. Each trust is
recognized as a separate trust for purposes of
chapter 13.
26.2662–1 Generation-skipping
transfer tax return requirements.
(a)In general. Chapter 13 imposes a
tax on generation-skipping transfers (as
defined in section 2611). The require-
ments relating to the return of tax
depend on the type of generation-
skipping transfer involved. This section
contains rules for filing the required tax
return. Paragraph (c)(2) of this section
provides special rules concerning the
return requirements for generation-
skipping transfers pursuant to certain
trust arrangements (as defined in para-
graph (c)(2)(ii) of this section), such as
life insurance policies and annuities.
(b)Form of return—(1) Taxable
distributions. Form 706GS(D) must be
filed in accordance with its instructions
for any taxable distribution (as defined
in section 2612(b)). The trust involved
in a transfer described in the preceding
sentence must file Form 706GS(D–1)
in accordance with its instructions. A
copy of Form 706GS(D–1) shall be
sent to each distributee.
(2)Taxable terminations. Form
706GS(T) must be filed in accordance
with its instructions for any taxable
termination (as defined in section
2612(a)).
(3)Direct skip—(i) Inter vivos di-
rect skips. Form 709 must be filed in
accordance with its instructions for any
direct skip (as defined in section
2612(c)) that is subject to chapter 12
and occurs during the life of the
transferor.
(ii)Direct skips occurring at
death—(A) In general. Form 706 or
Form 706NA must be filed in accord-
ance with its instructions for any direct
skips (as defined in section 2612(c))
that are subject to chapter 11 and occur
at the death of the decedent.
(B)Direct skips payable from a
trust. Schedule R–1 of Form 706 must
be filed in accordance with its instruc-
tions for any direct skip from a trust if
such direct skip is subject to chapter
11. See paragraph (c)(2) of this section
for special rules relating to the person
liable for tax and required to make the
return under certain circumstances.
(c)Person liable for tax and re-
quired to make return—(1) In general.
Except as otherwise provided in this
section, the following person is liable
for the tax imposed by section 2601
and must make the required tax
return—
(i)The transferee in a taxable dis-
tribution (as defined in section
2612(b));
(ii)The trustee in the case of a
taxable termination (as defined in sec-
tion 2612(a));
(iii)The transferor (as defined in
section 2652(a)(1)(B)) in the case of an
inter vivos direct skip (as defined in
section 2612(c));
(iv)The trustee in the case of a
direct skip from a trust or with respect
to property that continues to be held in
trust; or
(v)The executor in the case of a
direct skip (other than a direct skip
described in paragraph (c)(1)(iv) of this
section) if the transfer is subject to
chapter 11. See paragraph (c)(2) of this
section for special rules relating to
direct skips to or from certain trust
arrangements (as defined in paragraph
(c)(2)(ii) of this section).
(2)Special rule for direct skips oc-
curring at death with respect to prop-
erty held in trust arrangements—(i) In
general. In the case of certain property
held in a trust arrangement (as defined
in paragraph (c)(2)(ii) of this section)
at the date of death of the transferor,
the person who is required to make the
return and who is liable for the tax
imposed by chapter 13 is determined
under paragraphs (c)(2)(iii) and (iv) of
this section.
(ii)Trust arrangement defined. For
purposes of this section, the term trust
arrangement includes any arrangement
(other than an estate) which, although
not an explicit trust, has the same
effect as an explicit trust. For purposes
of this section, the term ‘‘explicit
trust’’ means a trust described in
§301.7701–4(a).
(iii)Executor’s liability in the case
of transfers with respect to decedents
dying on or after June 24, 1996, if the
transfer is less than $250,000. In the
case of a direct skip occurring at death,
the executor of the decedent’s estate is
liable for the tax imposed on that direct
skip by chapter 13 and is required to
file Form 706 or Form 706NA (and not
Schedule R–1 of Form 706) if, at the
date of the decedent’s death—
(A)The property involved in the
direct skip is held in a trust arrange-
ment; and
(B)The total value of the property
involved in direct skips with respect to
the trustee of that trust arrangement is
less than $250,000.
(iv)Executor’s liability in the case
of transfers with respect to decedents
dying prior to June 24, 1996, if the
transfer is less than $100,000. In the
case of a direct skip occurring at death
with respect to a decedent dying prior
to June 24, 1996, the rule in paragraph
(c)(2)(iii) of this section that imposes
liability upon the executor applies only
if the property involved in the direct
skip with respect to the trustee of the
trust arrangement, in the aggregate, is
less than $100,000.
(v)Executor’s right of recovery. In
cases where the rules of paragraphs
(c)(2)(iii) and (iv) of this section
impose liability for the generation-
skipping transfer tax on the executor,
the executor is entitled to recover from
the trustee (if the property continues to
be held in trust) or from the recipient
of the property (in the case of a
transfer from a trust), the generation-
skipping transfer tax attributable to the
transfer.
(vi)Examples. The following exam-
ples illustrate the application of this
paragraph (c)(2) with respect to dece-
dents dying on or after June 24, 1996:
Example 1. Insurance proceeds less than
$250,000. On August 1, 1997, T, the insured
under an insurance policy, died. The proceeds
($200,000) were includible in T’s gross estate for
Federal estate tax purposes. T’s grandchild GC,
was named the sole beneficiary of the policy.
The insurance policy is treated as a trust under
section 2652(b)(1), and the payment of the
proceeds to GC is a transfer from a trust for
purposes of chapter 13. Therefore, the payment
of the proceeds to GC is a direct skip. Since the
proceeds from the policy ($200,000) are less than
$250,000, the executor is liable for the tax
imposed by chapter 13 and is required to file
Form 706.
Example 2. Aggregate insurance proceeds of
$250,000 or more. Assume the same facts as in
Example 1, except T is the insured under two
insurance policies issued by the same insurance
company. The proceeds ($150,000) from each
policy are includible in T’s gross estate for
Federal estate tax purposes. T’s grandchild, GC1,
was named the sole beneficiary of Policy 1, and
T’s other grandchild, GC2, was named the sole
beneficiary of Policy 2. GC1 and GC2 are skip
persons (as defined in section 2613). Therefore,
the payments of the proceeds are direct skips.
Since the total value of the policies ($300,000)

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exceeds $250,000, the insurance company is
liable for the tax imposed by chapter 13 and is
required to file Schedule R–1 of Form 706.
Example 3. Insurance proceeds of $250,000 or
more held by insurance company. On August 1,
1997, T, the insured under an insurance policy,
dies. The policy provides that the insurance
company shall make monthly payments of $750
to GC, T’s grandchild, for life with the
remainder payable to T’s great grandchild, GGC.
The face value of the policy is $300,000. Since
the proceeds continue to be held by the insurance
company (the trustee), the proceeds are treated as
if they were transferred to a trust for purposes of
chapter 13. The trust is a skip person (as defined
in section 2613(a)(2)) and the transfer is a direct
skip. Since the total value of the policy
($300,000) exceeds $250,000, the insurance
company is liable for the tax imposed by chapter
13 and is required to file Schedule R–1 of Form
706.
Example 4. Insurance proceeds less than
$250,000 held by insurance company. Assume
the same facts as in Example 3, except the policy
provides that the insurance company shall make
monthly payments of $500 to GC and that the
face value of the policy is $200,000. The transfer
is a transfer to a trust for purposes of chapter 13.
However, since the total value of the policy
($200,000) is less than $250,000, the executor is
liable for the tax imposed by chapter 13 and is
required to file Form 706.
Example 5. On August 1, 1997, A, the insured
under a life insurance policy, dies. The insurance
proceeds on A’s life that are payable under
policies issued by Company X are in the
aggregate amount of $200,000 and are includible
in A’s gross estate. Because the proceeds are
includible in A’s gross estate, the generation-
skipping transfer that occurs upon A’s death, if
any, will be a direct skip rather than a taxable
distribution or a taxable termination. Accord-
ingly, because the aggregate amount of insurance
proceeds with respect to Company X is less than
$250,000, Company X may pay the proceeds
without regard to whether the beneficiary is a
skip person in relation to the decedent-transferor.
(3)Limitation on personal liability
of trustee. Except as provided in
paragraph (c)(3)(iii) of this section, a
trustee is not personally liable for any
increases in the tax imposed by section
2601 which is attributable to the fact
that—
(i)A transfer is made to the trust
during the life of the transferor for
which a gift tax return is not filed; or
(ii)The inclusion ratio with respect
to the trust, determined by reference to
the transferor’s gift tax return, is
erroneous, the actual inclusion ratio
being greater than the reported inclu-
sion ratio.
(iii)This paragraph (c)(3) does not
apply if the trustee has or is deemed to
have knowledge of facts sufficient to
reasonably conclude that a gift tax
return was required to be filed or that
the inclusion ratio is erroneous. A
trustee is deemed to have knowledge of
such facts if the trustee’s agent,
employee, partner, or co-trustee has
knowledge of such facts.
(4)Exceptions—(i) Legal or mental
incapacity. If a distributee is legally or
mentally incapable of making a return,
the return may be made for the
distributee by the distributee’s guardian
or, if no guardian has been appointed,
by a person charged with the care of
the distributee’s person or property.
(ii)Returns made by fiduciaries. See
section 6012(b) for a fiduciary’s re-
sponsibilities regarding the returns of
decedents, returns of persons under a
disability, returns of estates and trusts,
and returns made by joint fiduciaries.
(d)Time and manner of filing re-
turn—(1) In general. Forms 706,
706NA, 706GS(D), 706GS(D–1),
706GS(T), 709, and Schedule R–1 of
Form 706 must be filed with the
Internal Revenue Service office with
which an estate or gift tax return of the
transferor must be filed. The return
shall be filed—
(i)Direct skip. In the case of a
direct skip, on or before the date on
which an estate or gift tax return is
required to be filed with respect to the
transfer (see section 6075(b)(3)); and
(ii)Other transfers. In all other
cases, on or before the 15th day of the
4th month after the close of the
calendar year in which such transfer
occurs. See paragraph (d)(2) of this
section for an exception to this rule
when an election is made under section
2624(c) to value property included in
certain taxable terminations in accord-
ance with section 2032.
(2)Exception for alternative valua-
tion of taxable termination. In the case
of a taxable termination with respect to
which an election is made under
section 2624(c) to value property in
accordance with section 2032, a Form
706GS(T) must be filed on or before
the 15th day of the 4th month after the
close of the calendar year in which the
taxable termination occurred, or on or
before the 10th month following the
month in which the death that resulted
in the taxable termination occurred,
whichever is later.
(e)Place for filing returns. See
section 6091 for the place for filing
any return, declaration, statement, or
other document, or copies thereof,
required by chapter 13.
(f)Lien on property. The liens im-
posed under sections 6324, 6324A, and
6324B are applicable with respect to
the tax imposed under chapter 13.
Thus, a lien under section 6324 is
imposed in the amount of the tax
imposed by section 2601 on all prop-
erty transferred in a generation-
skipping transfer until the tax is fully
paid or becomes uncollectible by rea-
son of lapse of time. The lien attaches
at the time of the generation-skipping
transfer and is in addition to the lien
for taxes under section 6321.
§26.2663–1 Recapture tax under
section 2032A.
See §26.2642–4(a)(4) for rules relat-
ing to the recomputation of the applica-
ble fraction and the imposition of
additional GST tax, if additional estate
tax is imposed under section 2032A.
§26.2663–2 Application of chapter 13
to transfers by nonresidents not
citizens of the United States.
(a)In general. This section provides
rules for applying chapter 13 of the
Internal Revenue Code to transfers by a
transferor who is a nonresident not a
citizen of the United States (NRA
transferor). For purposes of this sec-
tion, an individual is a resident or
citizen of the United States if that
individual is a resident or citizen of the
United States under the rules of chapter
11 or 12 of the Internal Revenue Code,
as the case may be. Every NRA
transferor is allowed a GST exemption
of $1,000,000. See §26.2632–1 regard-
ing the allocation of the exemption.
(b)Transfers subject to chapter
13—(1) Direct skips. A transfer by a
NRA transferor is a direct skip subject
to chapter 13 only to the extent that the
transfer is subject to the Federal estate
or gift tax within the meaning of
§26.2652–1(a)(2). See §26.2612–1(a)
for the definition of direct skip.
(2)Taxable distributions and taxable
terminations. Chapter 13 applies to a
taxable distribution or a taxable termi-
nation to the extent that the initial
transfer of property to the trust by a
NRA transferor, whether during life or
at death, was subject to the Federal
estate or gift tax within the meaning of
§26.2652–1(a)(2). See §26.2612–1(b)
for the definition of a taxable termina-
tion and §26.2612–1(c) for the defini-
tion of a taxable distribution.
(c)Trusts funded in part with prop-
erty subject to chapter 13 and in part
with property not subject to chapter

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13—(1) In general. If a single trust
created by a NRA transferor is in part
subject to chapter 13 under the rules of
paragraph (b) of this section and in part
not subject to chapter 13, the applica-
ble fraction with respect to the trust is
determined as of the date of the
transfer, except as provided in para-
graph (c)(3) of this section.
(i)Numerator of applicable fraction.
The numerator of the applicable frac-
tion is the sum of the amount of GST
exemption allocated to the trust (if any)
plus the value of the nontax portion of
the trust.
(ii)Denominator of applicable frac-
tion. The denominator of the applicable
fraction is the value of the property
transferred to the trust reduced as
provided in §26.2642–1(c).
(2)Nontax portion of the trust. The
nontax portion of a trust is a fraction,
the numerator of which is the value of
property not subject to chapter 13
determined as of the date of the initial
completed transfer to the trust, and the
denominator of which is the value of
the entire trust. For example, T, a NRA
transferor, transfers property that has a
value of $1,000 to a generation-
skipping trust. Of the property trans-
ferred to the trust, property having a
value of $200 is subject to chapter 13
and property having a value of $800 is
not subject to chapter 13. The nontax
portion is .8 ($800 (the value of the
property not subject to chapter 13) over
$1,000 (the total value of the property
transferred to the trust).
(3)Special rule with respect to the
estate tax inclusion period. For pur-
poses of this section, the provisions of
§26.2632–1(c), providing rules applica-
ble in the case of an estate tax
inclusion period (ETIP), apply only if
the property transferred by the NRA
transferor is subsequently included in
the transferor’s gross estate. If the
property is not subsequently included
in the gross estate, then the nontax
portion of the trust and the applicable
fraction are determined as of the date
of the initial transfer. If the property is
subsequently included in the gross
estate, then the nontax portion and the
applicable fraction are determined as of
the date of death.
(d)Examples. The following exam-
ples illustrate the provisions of this
section. In each example T, a NRA, is
the transferor; C is T’s child; and GC
is C’s child and a grandchild of T:
Example 1. Direct transfer to skip person. T
transfers property to GC in a transfer that is
subject to Federal gift tax under chapter 12
within the meaning of §26.2652–1(a)(2). At the
time of the transfer, C and GC are NRAs. T’s
transfer is subject to chapter 13 because the
transfer is subject to gift tax under chapter 12.
Example 2. Transfers of both U.S. and foreign
situs property. (i) T’s will established a testa-
mentary trust for the benefit of C and GC. The
trust was funded with stock in a publicly traded
U.S. corporation having a value on the date of
T’s death of $100,000, and property not situated
in the United States (and therefore not subject to
estate tax) having a value on the date of T’s
death of $400,000.
(ii)On a timely filed estate tax return (Form
706NA), the executor of T’s estate allocates
$50,000 of GST exemption under section 2632(a)
to the trust. The numerator of the applicable
fraction is $450,000, the sum of $50,000 (the
amount of exemption allocated to the trust) plus
$400,000 (the value of the nontax portion of the
trust (4/5 3 $500,000)). The denominator is
$500,000. Hence, the applicable fraction with
respect to the trust is .9 ($450,000/$500,000),
and the inclusion ratio is .1 (1 – 9/10).
Example 3. Inter vivos transfer of U.S. and
foreign situs property to a trust and a timely
allocation of GST exemption. T establishes a
trust providing that trust income is payable to
T’s child for life and the remainder is to be paid
to T’s grandchild. T transfers property to the
trust that has a value of $100,000 and is subject
to chapter 13. T also transfers property to the
trust that has a value of $300,000 but is not
subject to chapter 13. T allocates $100,000 of
exemption to the trust on a timely filed United
States Gift (and Generation-Skipping Transfer)
Tax return (Form 709). The applicable fraction
with respect to the trust is 1, determined as
follows: $300,000 (the value of the nontax
portion of the trust) plus $100,000 (the exemp-
tion allocated to the trust)/$400,000 (the total
value of the property transferred to the trust).
Example 4. Inter vivos transfer of U.S. and
foreign situs property to a trust and a late
allocation of GST exemption. (i) In 1996, T
transfers $500,000 of property to an inter vivos
trust the terms of which provide that income is
payable to C, for life, with the remainder to GC.
The property transferred to the trust consists of
property subject to chapter 13 that has a value of
$400,000 on the date of the transfer and property
not subject to chapter 13 that has a value of
$100,000. T does not allocate GST exemption to
the trust. On the transfer date, the nontax portion
of the trust is .2 ($100,000/$500,000) and the
applicable fraction is also .2 determined as
follows: $100,000 (the value of the nontax
portion of the trust)/$500,000 (the value of the
property transferred to the trust).
(ii)In 1999, when the value of the trust is
$800,000, T allocates $100,000 of GST exemp-
tion to the trust. The applicable fraction of the
trust must be recomputed. The numerator of the
applicable fraction is $260,000 ($100,000 (the
amount of GST exemption allocated to the trust))
plus $160,000 (the value of the nontax portion of
the trust as of the date of allocation (.2 3
$800,000)). The denominator of the applicable
fraction is $800,000. Accordingly, the applicable
fraction with respect to the trust after the
allocation is .325 ($260,000/$800,000) and the
inclusion ratio is .675 (1 – .325).
Example 5. Taxable termination. The facts are
the same as in Example 4 except that, in 2006,
when the value of the property is $1,200,000, C
dies and the trust corpus is distributed to GC.
The termination is a taxable termination. If no
further GST exemption has been allocated to the
trust, the applicable fraction remains .325 and the
inclusion ratio remains .675.
Example 6. Estate Tax Inclusion Period. (i) T
transferred property to an inter vivos trust the
terms of which provided T with an annuity
payable for 10 years or until T’s prior death. The
annuity satisfies the definition of a qualified
interest under section 2702(b). The trust also
provided that, at the end of the trust term, the
remainder will pass to GC or GC’s estate. The
property transferred to the trust consisted of
property subject to chapter 13 that has a value of
$100,000 and property not subject to chapter 13
that has a value of $400,000. T allocated
$100,000 of GST exemption to the trust. If T
dies within the 10 year period, the value of the
trust principal will be subject to inclusion in T’s
gross estate to the extent provided in sections
2103 and 2104(b). Accordingly, the ETIP rule
under paragraph (c)(3) of this section applies.
(ii)In year 6 of the trust term, T died. At T’s
death, the trust corpus had a value of $800,000,
and $500,000 was includible in T’s gross estate
as provided in sections 2103 and 2104(b). Thus,
$500,000 of the trust corpus is subject to chapter
13 and $300,000 is not subject to chapter 13.
The $100,000 GST exemption allocation is
effective as of T’s date of death. Also, the
nontax portion of the trust and the applicable
fraction are determined as of T’s date of death.
In this case, the nontax portion of the trust is
.375, determined as follows: $300,000 (the value
of the trust not subject to chapter 13)/$800,000
(the value of the trust). The numerator of the
applicable fraction is $400,000, determined as
follows: $100,000 (GST exemption previously
allocated to the trust) plus $300,000 (the value of
the nontax portion of the trust). The denominator
of the applicable fraction is $800,000. Thus, the
applicable fraction with respect to the trust is
.50, unless additional exemption is allocated to
the trust by T’s executor or the automatic
allocation rules of §26.2632–1(d)(2) apply.
Example 7. The facts are the same as in
Example 6 except that T survives the termination
date of T’s retained annuity and the trust corpus
is distributed to GC. Since the trust was not
included in T’s gross estate, the ETIP rules do
not apply. Accordingly, the nontax portion of the
trust and the applicable fraction are determined
as of the date of the transfer to the trust. The
n o n t a x p o r t i o n o f t h e t r u s t i s . 8 0
($400,000/$500,000). The numerator of the ap-
plicable fraction is $500,000 determined as
follows: $100,000 (GST exemption allocated to
the trust) plus $400,000 (the value of the nontax
portion of the trust). Accordingly, the applicable
fraction is 1, and the inclusion ratio is zero.
(e)Transitional rule for allocations
for transfers made before December
27, 1995. If a NRA made a GST (inter
vivos or testamentary) after December
23, 1992, and before December 27,
1995, that is subject to chapter 13
(within the meaning of §26.2663–2),
the NRA will be treated as having
made a timely allocation of GST
exemption to the transfer in a calendar
year in the order prescribed in section
2632(c). Thus, a NRA’s unused GST
exemption will initially be treated as

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allocated to any direct skips made
during the calendar year and then to
any trusts with respect to which the
NRA made transfers during the same
calendar year and from which a taxable
distribution or a taxable termination
may occur. Allocations within the
above categories are made in the order
in which the transfers occur. Alloca-
tions among simultaneous transfers
within the same category are made
pursuant to the principles of section
2632(c)(2). This transitional allocation
rule will not apply if the NRA
transferor, or the executor of the
NRA’s estate, as the case may be,
elected to have an automatic allocation
of GST exemption not apply by de-
scribing on a timely-filed Form 709 for
the year of the transfer, or a timely
filed Form 706NA, the details of the
transfer and the extent to which the
allocation was not to apply.
PART 301—PROCEDURE AND
ADMINISTRATION
Par. 2. The authority citation for part
301 continues to read in part as
follows:
Authority: 26 U.S.C. 7805.* * *
Par. 3. Section 301.9100–7T is
amended as follows:
a.Paragraph (a)(1) is amended in
the table by removing both entries for
‘‘1431(a)’’.
b.Paragraph (a)(4)(i) is amended in
the table by removing the entry
‘‘1431(a)’’.
c.Paragraph (a)(4)(iii) is revised to
read as follows:
§301.9100–7T Time and manner of
making certain elections under the
Tax Reform Act of 1986.
(a)* * *
(4)* * *
(iii)Freely revocable election. The
election described in this section under
Act section 311(d)(2) is freely revocable.
******
PART 602—OMB CONTROL
NUMBERS UNDER THE
PAPERWORK REDUCTION ACT
Par. 4. The authority citation for part
602 continues to read as follows:
Authority: 26 U.S.C. 7805.
Par. 5. In §602.101, paragraph (c) is
amended by adding entries in numeri-
cal order in the table to read as
follows:
§602.101 OMB Control numbers.
******
(c)* * *
CFR part or sectionCurrent OMB
where identifiedcontrol number
and described
******
26.2601–1.............. 1545–0985
******
26.2632–1.............. 1545–0985
******
26.2642–1.............. 1545–0985
26.2642–2.............. 1545–0985
26.2642–3.............. 1545–0985
26.2642–4.............. 1545–0985
******
26.2652–2.............. 1545–0985
******
26.2662–2.............. 1545–0985
******
Michael P. Dolan,
Deputy Commissioner of
Internal Revenue.
Approved December 14, 1995.
Leslie Samuels,
Assistant Secretary of
the Treasury.
(Filed by the Office of the Federal Register on
December 26, 1995, 8:45 a.m., and published
in the issue of the Federal Register for
December 27, 1995, 60 F.R. 66898)

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Part III. Administrative, Procedural, and Miscellaneous
Imaging Systems to Retain Books
and Records
Notice 96–10
This notice provides a proposed
revenue procedure that, when finalized,
will provide guidance to taxpayers on
the use of an imaging system to satisfy
the requirement of §6001 of the
Internal Revenue Code to maintain
books and records.
The Service is proposing this reve-
nue procedure as one means of comply-
ing with the requirements of §6001
using electronic technology for records
storage. The Service welcomes public
comments on the proposed revenue
procedure. Comments should be sub-
mitted by March 28, 1996, to the
Internal Revenue Service, P.O. Box
7604, Ben Franklin Station, Wash-
ington, DC 20044, Attn: CC:CORP:T:R
(ITA Branch 4), Room 5228.
Rev. Proc. 96–A
SECTION 1. PURPOSE
This revenue procedure provides
guidance to taxpayers on using an
imaging system (as defined in section
3.01 of this revenue procedure) to
maintain books and records. Records
kept using an imaging system that
complies with the requirements of this
revenue procedure will constitute rec-
ords within the meaning of § 6001 of
the Internal Revenue Code.
SECTION 2. BACKGROUND
.01Section 6001 provides that every
person liable for any tax imposed by
the Code, or for the collection thereof,
must keep such records, render such
statements, make such returns, and
comply with such rules and regulations
as the Secretary may from time to time
prescribe. Whenever necessary, the
Secretary may require any person, by
notice served upon such person or by
regulations, to make such returns,
render such statements, or keep such
records, as the Secretary deems suffi-
cient to show whether or not such
person is liable for tax.
.02Section 1.6001–1(a) of the In-
come Tax Regulations provides that,
except for farmers and wage-earners,
any person subject to income tax or
any person required to file a return of
information with respect to income,
must keep such books and records,
including inventories, as are sufficient
to establish the amount of gross in-
come, deductions, credits, or other
matters required to be shown by such
person in any return of such tax or
information.
.03 Section 1.6001–1(e) provides
that the books or records required by
§ 6001 must be kept available at all
times for inspection by authorized
internal revenue officers or employees,
and shall be retained so long as the
contents thereof may become material
in the administration of any internal
revenue law.
SECTION 3. SCOPE
.01This revenue procedure applies
to all taxpayers that use an imaging
system to maintain books and records.
For purposes of this revenue procedure,
an ‘‘imaging system’’ means an
electronic technology used to prepare,
record, image, index, store, preserve,
retrieve, and reproduce books and
records, the originals of which are in
hardcopy format.
.02A taxpayer’s use of a service
bureau or time-sharing service to
provide the taxpayer with an imaging
system for its books and records does
not relieve the taxpayer of the respon-
sibilities described in this revenue
procedure.
.03The requirements of this revenue
procedure pertain to all matters under
the jurisdiction of the Commissioner of
Internal Revenue including, but not
limited to, income, excise, employment,
and estate and gift taxes, as well as
employee plans and exempt organiza-
tions.
SECTION 4. IMAGING SYSTEM
REQUIREMENTS
.01General Requirements of an
Imaging System.
(1)An imaging system for main-
taining books and records for purposes
of §6001 must create accurate and
complete electronic images of hardcopy
documents, and must index, store,
preserve, retrieve, and reproduce im-
aged documents.
(2) An imaging system must
include:
(a)reasonable controls to en-
sure the integrity, accuracy, and re-
liability of the imaging system, includ-
ing a record of where, when, by whom,
and on what equipment the image was
produced, including the hardware and
software that was used;
(b)reasonable controls to pre-
vent the unauthorized creation of, addi-
tion to, alteration of, deletion of, or
deterioration of any imaged document
(for instance, one control could be the
use of a non-erasable and non-
rewritable media);
(c)an inspection and quality
assurance program evidenced by regu-
lar evaluations of the imaging system
including periodic checks of imaged
documents;
(d)a retrieval system that in-
cludes an indexing system (within the
meaning of section 4.02 of this revenue
procedure); and
(e)the ability to reproduce a
legible and readable hardcopy (within
the meaning of section 4.01(5) of this
revenue procedure) of an imaged
document.
(3)For each imaging system used,
the taxpayer must establish, maintain,
and retain written procedures that de-
scribe in detail the complete imaging
system. Any changes to the imaging
system must be documented in writing.
These written procedures and all modi-
fications must be readily available to
the Service upon request.
(4)The imaging system must pro-
vide support for the taxpayer’s books
and records (including books and rec-
ords in an automated data processing
system). For example, the imaging
system and the taxpayer’s books and
records must be cross-referenced, so
that all imaged documents that support
an entry in the taxpayer’s books and
records can be automatically identified
and retrieved for viewing or printing.
(5)All images reproduced by the
imaging system must exhibit a high
degree of legibility and readability
when displayed on a video display
terminal or reproduced on paper. The
term ‘‘legibility’’ means the observer
must be able to identify all letters and
numerals positively and quickly to the
exclusion of all other letters or nu-
merals. The term ‘‘readability’’ means

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that the observer must be able to
recognize a group of letters or nu-
merals as words or complete numbers.
The taxpayer must ensure that the
reproduction process maintains the legi-
bility and readability of the image
being reproduced. Taxpayers may use
reasonable data compression or format-
ting technologies as part of their
imaging system so long as the require-
ments of this revenue procedure are
satisfied.
(6)The taxpayer must retain im-
aged documents until their contents are
no longer material to the administration
of the Internal Revenue laws under
§ 1.6001–1(e).
(7)The taxpayer must be able to
retrieve and reproduce imaged docu-
ments at the time of a Service examina-
tion. Reproduction includes the ability
to print a legible and readable hardcopy
of any imaged document.
(8)The taxpayer must provide the
Service, at the time of an examination,
or for the tests described in section 5
of this revenue procedure, with the
resources (e.g., appropriate hardware
and software, personnel, documenta-
tion, etc.) necessary for promptly locat-
ing, retrieving, reading, and reproduc-
ing on paper any imaged document.
(9)The taxpayer may use more
than one imaging system. In that event,
each system must meet the require-
ments of this revenue procedure. Im-
aged documents that are contained in a
system with respect to which the
taxpayer ceases to maintain the hard-
ware and the software necessary to
satisfy the conditions of this revenue
procedure will be deemed destroyed by
the taxpayer unless the existing imaged
documents are converted to a format
compatible with an imaging system that
the taxpayer continues to maintain.
(10)An imaging system must not
be subject, in whole or in part, to any
agreement (such as a contract or
license) that would limit or restrict the
Service’s access to and use of the
imaging system on the taxpayer’s
premises (or such other place where the
imaging system is maintained), includ-
ing personnel, hardware, software, files,
indexes and software documentation.
.02Requirements of an Indexing
System.
(1)For purposes of this revenue
procedure, an indexing system is a
system that permits the rapid identifica-
tion and retrieval for viewing or
reproducing of relevant documents
maintained in an imaging system. For
example, an indexing system might
consist of assigning each imaged docu-
ment a unique identification number
and maintaining a separate database
that contains descriptions of each im-
aged document along with that docu-
ment’s identification number. In addi-
tion, any system used to maintain,
organize, or coordinate multiple imag-
ing systems is treated as an indexing
system under this revenue procedure.
The requirement to maintain an index-
ing system will be satisfied if the
indexing system is functionally com-
parable to a reasonable hardcopy filing
system. The requirement to maintain an
indexing system does not require that a
separate imaged document description
database be maintained if comparable
results can be achieved without a
separate description database.
(2)Reasonable controls must be
undertaken to protect the indexing
system against the unauthorized crea-
tion of, addition to, alteration of,
deletion of, or deterioration of any
entries.
.03Recommended Practices. The
implementation of records management
practices is a business decision that is
solely within the discretion of the
taxpayer. Records management prac-
tices may include the labeling of
documents, providing a secure storage
environment, creating back-up copies,
selecting an off-site storage location,
retaining hardcopies of illegible docu-
ments or documents that cannot be ac-
curately or completely imaged or re-
produced under the imaging system,
and testing to confirm records integrity.
SECTION 5. DISTRICT DIRECTOR
TESTING
.01 The District Director may
periodically initiate tests of a tax-
payer’s imaging system. These tests
may include an evaluation (by actual
use) of a taxpayer’s equipment and
software, as well as the procedures
used by a taxpayer to prepare, record,
image, index, store, preserve, retrieve,
and reproduce imaged documents. In
some instances, the District Director
may choose to review the internal
controls, security procedures, and docu-
mentation associated with the tax-
payer’s imaging system.
.02The tests described in section
5.01 of this revenue procedure are not
an ‘‘examination,’’ ‘‘investigation,’’ or
‘‘inspection’’ of the books and records
within the meaning of §7605(b), or a
prior audit for purposes of §530 of the
Revenue Act of 1978, 1978–3 (Vol.1)
C.B. 119, because the evaluation is not
directly related to the determination of
the tax liability of a taxpayer for a
particular taxable period.
.03The District Director must in-
form the taxpayer of the results of any
periodic tests.
SECTION 6. COMPLIANCE
.01A taxpayer’s imaging system
that meets the requirements of this
revenue procedure will be treated as
being in compliance with the rec-
ordkeeping requirements of §6001 and
the regulations thereunder.
.02A taxpayer’s imaging system
that fails to meet the requirements of
this revenue procedure may be treated
as not being in compliance with the
recordkeeping requirements of §6001
and the regulations thereunder. See
section 8 for applicable penalties. How-
ever, even though a taxpayer’s imaging
system fails to meet the requirements
of this revenue procedure, the penalties
described in section 8 may not apply if
the taxpayer maintains its original
books and records, or maintains its
books and records in micrographic
form in conformity with Rev. Proc. 81–
46, 1981–2 C.B. 621.
SECTION 7. DESTRUCTION OF
HARDCOPY DOCUMENTS
This revenue procedure permits the
destruction of hardcopy documents af-
ter the taxpayer:
(1)has completed its own testing
of the imaging system that establishes
that hardcopy documents are being
imaged in compliance with all the
provisions of this revenue procedure;
and
(2)has instituted procedures that
ensure its continued compliance with
all the provisions of this revenue
procedure.
SECTION 8. PENALTIES
The District Director may issue a
Notice of Inadequate Records pursuant
to §1.6001–1(d) if the taxpayer’s
books and records are available only as
imaged documents and the taxpayer’s
imaging system fails to meet the

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requirements of this revenue procedure.
Taxpayers whose imaging systems fail
to meet the requirements of this reve-
nue procedure may also be subject to
applicable penalties under subtitle F of
the Code including the § 6662(a)
accuracy-related civil penalty and the
§ 7203 willful failure criminal penalty.
DRAFTING INFORMATION
The principal author of this notice is
Celia Gabrysh of the Office of the
Assistant Chief Counsel (Income Tax
and Accounting). For further informa-
tion regarding this notice, contact Ms.
Gabrysh on (202) 622-4940 (not a toll-
free call).
Delegation Order No. 232 (Rev. 2)
Delegation of Authority
AGENCY: Internal Revenue Service
(IRS), Treasury
ACTION: Delegation of authority to
rescind TAOs.
SUMMARY: The Commissioner, Internal
Revenue Service is issuing this Delega-
tion Order to limit the modification or
rescission of Taxpayer Assistance
Orders (‘‘TAO’’) to the Commissioner,
Deputy Commissioner or Taxpayer
Ombudsman. The Ombudsman’s Dele-
gation Order 232 (Rev. 1) providing
more expansive rescission authority is
hereby superseded.
EFFECTIVE DATE: January 5, 1996.
FOR FURTHER INFORMATION CONTACT:
Doug Peterson, C:PRP, Room 1027,
1111 Constitution Avenue, NW., Wash-
ington, DC 20224, 202-622-4315 (not a
toll-free call).
Authority to Modify or Rescind
Taxpayer Assistance Orders (TAO)
Section 7811 of the Code states that
TAOs ‘‘may be modified or rescinded
only by the Ombudsman, a district
director, a service center director, a
compliance center director, a regional
director of appeals, or any superior of
any such person.’’ The Commissioner
wishes to reassure taxpayers that TAOs
will be accorded the greatest respect
and consideration by the IRS. This
delegation order accordingly limits the
discretionary modification or rescission
authority under §7811 to only the
Commissioner, Deputy Commissioner
or Taxpayer Ombudsman.
This delegation order supersedes
Ombudsman’s Del. Order 232 (Rev. 1)
which provided more expansive au-
thority to local IRS officials.
Dated: January 5, 1996.
Margaret M. Richardson,
Commissioner.
(Filed by the Office of the Federal Register on
Januare 9, 1996, 8:45 a.m., and published in
the issue of the Federal Register for January
10, 1996, 61 F.R. 764)
Delegation Order No. 239 (Rev. 1)
Delegation of authority
AGENCY: Internal Revenue Service
(IRS), Treasury
ACTION: Delegation of authority.
SUMMARY: The Commissioner, Internal
Revenue Service, amends Delegation
Order 239 to clarify that the Taxpayer
Ombudsman is delegated the authority
to issue Taxpayer Assistance Orders
(‘‘TAO’’) to intervene on behalf of
taxpayers and take positive action with
respect to taxpayer cases.
The Commissioner further amends
Delegation Order 239 to direct the
Ombudsman to prepare an annual re-
port of the most serious problems
taxpayers face when conducting busi-
ness with the IRS and to suggest
administrative and legislative solutions
to these problems, if applicable.
Finally, Delegation Order 239 is
further amended to give the Ombuds-
man the authority to establish a system
to track the response of IRS officials to
the administrative problems identified
in the Ombudsman’s annual report.
EFFECTIVE DATE: January 5, 1996.
FOR FURTHER INFORMATION CONTACT:
Doug Peterson, C:PRP, Room 1027,
1111 Constitution Avenue, NW., Wash-
ington, DC 20224, 202-622-4315 (not a
toll-free call).
Amendment of Delegation Order 239
The Commissioner in Delegation
Order 239 delegated to the Taxpayer
Ombudsman the authority to issue
TAOs in addition to the situations
specified in section 7811 of the Internal
Revenue Code. The Commissioner
wishes to amend Delegation Order 239
to clarify that such authority gives the
Taxpayer Ombudsman the ability to
intervene on behalf of taxpayers to take
positive action with respect to tax-
payers’ cases. Thus, for example, the
Ombudsman may issue a TAO to speed
a refund to a taxpayer to relieve severe
financial hardship on the part of the
taxpayer. Likewise, the Ombudsman
may issue a TAO to stay an enforce-
ment action to ensure review of
whether such action is appropriate.
The Commissioner also amends Del-
egation Order 239 to direct the Om-
budsman to prepare an annual report of
the most serious problems taxpayers
face when conducting business with the
Service and to suggest administrative
and legislative solutions to these prob-
lems, if applicable. The purpose of the
annual report is to provide an inde-
pendent mechanism to identify and
resolve the problems taxpayers may
encounter with the Service.
The Commissioner also hereby dele-
gates to the Ombudsman the authority
to establish a system to track the
Service’s response to administrative
changes suggested in the Ombudsman’s
report. The tracking system should
identify which IRS official ideally
should respond to the suggestion and
how that official responded. Addi-
tionally, the Ombudsman’s annual re-
port should include a section detailing
this information concerning the Serv-
ice’s response to any administrative
changes suggested in the prior year’s
report.
Dated: January 5, 1996.
Margaret M. Richardson,
Commissioner.
(Filed by the Office of the Federal Register on
January 9, 1996, 8:45 a.m., and published in
the issue of the Federal Register for January
10 1996, 61 F.R. 763)

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Part IV. Items of General Interest
Notice of Proposed Rulemaking and
Notice of Public Hearing
Distribution of Marketable Securities
by a Partnership
PS–2–95
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemak-
ing and notice of public hearing.
SUMMARY: This document contains
proposed regulations relating to the
treatment of a distribution of marketa-
ble securities by a partnership under
section 731(c) of the Internal Revenue
Code of 1986, as amended (Code).
These proposed regulations provide
taxpayers with guidance needed to
comply with certain changes made by
the Uruguay Round Agreements Act of
1994. This document also provides
notice of a public hearing on these
proposed regulations.
DATES: Written comments and re-
quests to speak (with outlines of oral
comments) at a public hearing sched-
uled for 10 a.m. on Wednesday, April
3, 1996 must be received by Wednes-
day, March 13, 1996.
ADDRESSES: Send submissions to:
CC:DOM:CORP:R (PS–2–95), Room
5228, Internal Revenue Service, POB
7604, Ben Franklin Station, Wash-
ington, DC 20044. In the alternative,
submissions may be hand delivered
between the hours of 8 a.m. and 5 p.m.
to: CC:DOM:CORP:R (PS–2–95), Cou-
rier’s Desk, Internal Revenue Service,
1111 Constitution Avenue NW., Wash-
ington, DC. The public hearing will be
held in the IRS Auditorium.
FOR FURTHER INFORMATION
CONTACT: Concerning the regula-
tions, Terri A. Belanger or William M.
Kostak, (202) 622-3080; concerning
submissions and the hearing, Christina
Vasquez, (202) 622-7190 (not toll-free
numbers).
SUPPLEMENTARY INFORMATION:
Introduction
This document proposes to add
§1.731–2 to the Income Tax Regula-
tions (26 CFR part 1) under section
731(c) of the Code. Section 731(c) was
amended by section 741(a) of the
Uruguay Round Agreements Act of
1994 (Public Law 103–465).
Background
Section 731(a)(1) of the Code
provides that a partner must recognize
gain on a distribution from a part-
nership to the extent that any money
distributed exceeds the adjusted basis
of the partner’s interest in the part-
nership immediately before the dis-
tribution. Section 737 provides that a
partner must recognize gain on a
distribution of property other than
money in an amount equal to the lesser
of (i) the partner’s net precontribution
gain or (ii) the excess of the fair
market value of the distributed property
over the partner’s basis in the part-
nership interest.
Section 731(c) provides that the term
money includes marketable securities
for purposes of section 731(a)(1) and
section 737. As discussed in the
legislative history accompanying sec-
tion 731(c), treating marketable se-
curities as money for this purpose is
appropriate because marketable se-
curities are economically equivalent to
money. Section 731(c) affects only the
tax consequences to the distributee
partner; section 731(c) does not require
the partnership or any partner other
than the distributee partner to recognize
gain on a distribution of marketable
securities.
Explanation of Provisions
Marketable securities treated as
money
Distributions of marketable securities
are treated as distributions of money
under section 731(c) only for purposes
of sections 731(a)(1) and 737. For
example, a distribution of marketable
securities is not treated as a distribution
of money to the extent it is subject to
section 707 or section 751(b) because
the distribution is not subject to section
731(a)(1) or section 737. In addition,
marketable securities are not treated as
money for purposes of section 731(a)-
(2), so that a partner does not recognize
a loss on a distribution of marketable
securities. Finally, marketable securities
contributed by a partner are treated as
property other than money for purposes
of determining the partner’s net pre-
contribution gain under section 737(b).
Reduction of amount treated as
money
Under section 731(c)(3)(B), the
amount of marketable securities that is
treated as money is reduced by the
excess of (i) the partner’s share of the
net gain of the partnership’s securities
of the same class and issuer as the
distributed securities immediately be-
fore the distribution over (ii) the
partner’s share of such net gain imme-
diately after the distribution. This
provision allows a partner to withdraw
the partner’s share of appreciation in
the partnership’s marketable securities
without recognizing gain on the dis-
tribution. As a result, section 731(c)
generally applies only when a partner
receives a distribution of marketable
securities in exchange for the partner’s
share of appreciated assets other than
marketable securities.
Under the authority of section
731(c)(3)(B), the proposed regulations
provide that all marketable securities
held by a partnership are treated as
marketable securities of the same class
and issuer as the distributed securities.
Treating all marketable securities as a
single asset for this purpose is consis-
tent with the basic rationale of section
731(c) that marketable securities are
the economic equivalent of money. As
a result, the amount of the distribution
that is not treated as money will de-
pend on the partner’s share of the net
appreciation in all partnership se-
curities, not on the partner’s share of
the appreciation in the type of se-
curities distributed.
Definition of marketable securities
In general, the term marketable
securities includes any financial
instruments—such as stocks, options,
and derivatives-that are actively traded
w i t h i n t h e m e a n i n g o f s e c t i o n
1092(d)(1). In addition, section
731(c)(2)(B)(v) provides that an inter-
est in an entity is a marketable security
if substantially all of the assets of the
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or money. The proposed regulations
provide that substantially all of the
assets of an entity consist of marketa-
ble securities or money only if 90
percent or more of the assets of the
entity at the time of the distribution
consist of such assets.
Section 731(c)(2)(B)(vi) provides
that, to the extent provided in regula-
tions, an interest in an entity not
described in section 731(c)(2)(B)(v) is
a marketable security to the extent that
the value of such interest is attributable
to marketable securities or money. The
proposed regulations provide that an
interest in an entity is a marketable
security to the extent that the value of
the interest is attributable to marketable
securities or money that constitute less
than 90 percent but 20 percent or more
of the assets of the entity. The 20
percent threshold means that an interest
in an entity holding only a small
amount of marketable securities will
not be treated as a marketable security.
The proposed regulations also pro-
vide that a marketable security will
continue to be treated as a marketable
security, even if the partnership or its
partners are restricted by agreement or
otherwise from selling or exchanging
the security. This provision is intended
to prevent a partnership from avoiding
section 731(c) by temporarily restrict-
ing the transferability of the distributed
security.
Exceptions
Consistent with the provisions of
section 731(c)(3)(A), the proposed reg-
ulations provide three exceptions to
section 731(c). First, the proposed
regulations provide that if the marketa-
ble security was contributed to the
partnership by the distributee partner,
section 731(c) does not apply to the
distribution of that security.
Second, the proposed regulations
provide that section 731(c) does not
apply to the distribution of a marketa-
ble security to the extent that the
security was acquired by the part-
nership in a nonrecognition transaction
in exchange for property other than
marketable securities or cash and (i)
the security is actively traded as of the
date of distribution and (ii) the security
is distributed by the partnership within
five years of either the date the security
was acquired by the partnership or, if
later, the date the security became
actively traded. For example, if a
partnership contributed substantially all
of its assets to a corporation in a
transaction described in section 351
and the stock of the corporation be-
came marketable, the distribution of the
stock by the partnership within five
years would not be subject to section
731(c). This exception recognizes that
the marketable security in these situa-
tions is simply a substitute for the
underlying assets exchanged in the
nonrecognition transaction.
The proposed regulations also pro-
vide that section 731(c) does not apply
to the distribution of a marketable
security if (i) the security was not
actively traded on the date acquired by
the partnership and the entity to which
the security relates had no outstanding
actively traded securities at the time the
security was acquired by the part-
nership; (ii) the security is actively
traded as of the date of distribution;
and (iii) the security was held by the
partnership for at least six months
before it became actively traded and
the security was distributed by the
partnership within five years of the
date on which the security became
actively traded.
In addition, the proposed regulations
provide a successor security rule that
applies to these exceptions. This rule
provides that the exceptions continue to
apply to a security acquired in a
nonrecognition transaction in exchange
for a security that was already subject
to an exception.
Investment partnerships
Section 731(c) does not apply to the
distribution of marketable securities by
an investment partnership to an eligible
partner. An investment partnership is
defined as a partnership that has never
been engaged in a trade or business and
substantially all of the assets of which
consist of the investment assets de-
scribed in section 731(c)(3)(C)(i). The
proposed regulations provide that a
partner can qualify as an eligible
partner even if the partner contributed
services to the partnership. In addition,
the proposed regulations provide that a
partnership will not be treated as
engaged in a trade or business if the
partnership provides reasonable and
customary management services to a
lower-tier investment partnership. This
exception allows an upper-tier invest-
ment partnership to manage the invest-
ments and other activities of a lower-
tier investment partnership without
disqualifying the upper-tier partnership
as an investment partnership. The ex-
ception does not extend to management
services provided to lower-tier part-
nerships other than investment part-
nerships because, as discussed below,
the tiering rules of section 731(c)(3)-
(C)(iv) treat the upper-tier management
partnership as engaged in the trade or
business of the lower-tier partnership,
thereby preventing the upper-tier part-
nership from qualifying as an invest-
ment partnership.
The proposed regulations also pro-
vide that a partnership will not be
treated as engaged in a trade or
business if the partnership provides
reasonable and customary services in
assisting the formation, capitalization,
expansion, or offering of interests in an
entity in which the partnership holds a
significant equity interest, provided that
the anticipated receipt of compensation
for the services does not represent a
significant purpose for the partnership’s
investment in the entity and is inciden-
tal to the investment in the entity.
Section 731(c)(3)(C)(iv) provides
that, except as otherwise provided in
regulations, a partnership is treated as
engaged in any trade or business
engaged in by (and as holding the
assets of) any partnership in which the
partnership holds an interest. The pro-
posed regulations provide that this
look-through rule does not apply if the
upper-tier partnership does not partici-
pate in the management of the lower-
tier partnership and the interest held by
the upper-tier partnership is less than
10 percent of the total profits and
capital interests in the lower-tier
partnership.
Coordination with other sections
The proposed regulations provide
rules for coordinating section 731(c)
with section 704(c)(1)(B) and section
737. This coordination is necessary
because a distribution of marketable
securities could occur as part of a
larger distribution in which property
contributed by the distributee partner is
distributed to another partner (section
704(c)(1)(B)) or the distributee partner
receives property in addition to mar-
ketable securities (section 737).
Under the proposed regulations, the
basis increase in the partner’s interest
in the partnership as a result of any
gain recognized by the partner under

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section 704(c)(1)(B) is taken into ac-
count in determining the distributee
partner’s gain under section 731(c) and
the partner’s basis in the distributed
securities. Taking the stepped-up basis
into account for purposes of section
731 reflects the fact that the general
effect of section 704(c)(1)(B) is to treat
the contributing partner as having con-
tributed property with a full fair market
value basis at the time of contribution.
The proposed regulations, however,
provide that the basis increase in the
partner’s interest as a result of any gain
recognized by the partner under section
737 is not taken into account for these
purposes. The proposed regulations are
consistent with section 737, which
generally treats a distribution of money
as occurring before, and independent
of, a distribution of other property.
Anti-abuse rule
The proposed regulations provide
that the provisions of section 731(c)
and this section must be applied in a
manner that is consistent with the
purpose of section 731(c) and the
substance of the transaction.
Proposed effective date
This section is proposed to apply to
distributions of marketable securities by
a partnership to a partner on or after
Friday, December 29, 1995.
Special Analyses
It has been determined that this
notice of proposed rulemaking is not a
significant regulatory action as defined
in EO 12866. Therefore, a regulatory
assessment is not required. It also has
been determined that section 553(b) of
the Administrative Procedure Act (5
U.S.C. chapter 5) and the Regulatory
Flexibility Act (5 U.S.C. chapter 6) do
not apply to these regulations, and,
therefore, a Regulatory Flexibility
Analysis is not required. Pursuant to
section 7805(f) of the Internal Revenue
Code, this notice of proposed rulemak-
ing will be submitted to the Chief
Counsel for Advocacy of the Small
Business Administration for comment
on its impact on small business.
Comments and Public Hearing
Before these proposed regulations
are adopted as final regulations, consid-
eration will be given to any written
comments (a signed original and eight
(8) copies) that are timely submitted to
the IRS. All comments will be avail-
able for public inspection and copying.
A public hearing has been scheduled
for Wednesday, April 3, 1996 at 10:00
a.m. in the Auditorium of the Internal
Revenue Building, 1111 Constitution
Avenue NW., Washington, DC. Be-
cause of access restrictions, visitors
will not be admitted beyond the Inter-
nal Revenue Building lobby more than
15 minutes before the hearing starts.
The rules of 26 CFR 601.601(a)(3)
apply to the hearing.
Persons that wish to present oral
comments at the hearing must submit
written comments by Wednesday,
March 13, 1996 and submit an outline
of the topics to be discussed and the
time to be devoted to each topic
(signed original and eight (8) copies)
by Wednesday, March 13, 1996.
A period of 10 minutes will be
allotted to each person for making
comments.
An agenda showing the scheduling
of the speakers will be prepared after
the deadline for receiving outlines has
passed. Copies of the agenda will be
available free of charge at the hearing.
Drafting Information
The principal authors of these reg-
ulations are Terri A. Belanger and
William M. Kostak, Office of Assistant
Chief Counsel (Passthroughs and Spe-
cial Industries), IRS. However, other
personnel from the IRS and Treasury
Department participated in their
development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and rec-
ordkeeping requirements.
Proposed Amendments to the
Regulations
Accordingly, 26 CFR part 1 is
proposed to be amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation
for part 1 is amended by adding an
entry in numerical order to read as
follows:
Authority: 26 U.S.C. 7805. * * *
Section 1.731–2 also issued under 26
U.S.C. 731(c). * * *
Par. 2. Section 1.731–2 is added to
read as follows:
§1.731–2 Partnership distributions of
marketable securities.
(a)Marketable securities treated as
money. Except as otherwise provided in
section 731(c) and this section, for
purposes of section 731(a)(1) and 737,
the term money includes marketable
securities and such securities are taken
into account at their fair market value
as of the date of the distribution.
(b)Reduction of amount treated as
money—(1) Aggregation of securities.
For purposes of section 731(c)(3)(B)
and this paragraph (b), all marketable
securities held by a partnership are
treated as marketable securities of the
same class and issuer as the distributed
security.
(2)Amount of reduction. The
amount of the distribution of marketa-
ble securities that is treated as a
distribution of money under section
731(c) and paragraph (a) of this section
is reduced (but not below zero) by the
excess, if any, of—
(i)The distributee partner’s distribu-
tive share of the net gain, if any, which
would be recognized if all the marketa-
ble securities held by the partnership
were sold (immediately before the
transaction to which the distribution
relates) by the partnership for fair
market value; over
(ii)The distributee partner’s dis-
tributive share of the net gain, if any,
which is attributable to the marketable
securities held by the partnership im-
mediately after the transaction, deter-
mined by using the same fair market
value as used under paragraph (b)(2)(i)
of this section.
(3)Distributee partner’s share of
net gain. For purposes of section
731(c)(3)(B) and paragraph (b)(2) of
this section, a partner’s distributive
share of net gain is determined—
(i)By taking into account any basis
adjustments under section 743(b) with
respect to that partner; and
(ii)Without taking into account any
special allocations adopted with a
principal purpose of avoiding the effect
of section 731(c) and this section.
(c)Marketable securities—(1) Ac-
tively traded. For purposes of section

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731(c) and this section, a financial
instrument is actively traded (and thus
is a marketable security) if it is of a
type that is, as of the date of distribu-
tion, actively traded within the meaning
of section 1092(d)(1). Thus, for exam-
ple, if XYZ common stock is listed on a
national securities exchange, particular
shares of XYZ common stock that are
distributed by a partnership are mar-
ketable securities even if those particu-
lar shares cannot be resold by the
distributee partner for a designated
period of time.
(2)Interests in an entity—(i) Sub-
stantially all. For purposes of section
731(c)(2)(B)(v) and this section, sub-
stantially all of the assets of an entity
consist (directly or indirectly) of mar-
ketable securities, money, or both only
if 90 percent or more of the assets of
the entity (by value) at the time of the
distribution of an interest in the entity
consist (directly or indirectly) of mar-
ketable securities, money, or both.
(ii)Less than substantially all. For
purposes of section 731(c)(2)(B)(vi)
and this section, an interest in an entity
is a marketable security to the extent
that the value of the interest is at-
tributable (directly or indirectly) to
marketable securities, money, or both,
if less than 90 percent but 20 percent
or more of the assets of the entity (by
value) at the time of the distribution of
an interest in the entity consist (directly
or indirectly) of marketable securities,
money, or both.
(d)Exceptions—(1) Previously con-
tributed property. Section 731(c) and
this section do not apply to the dis-
tribution of a marketable security if the
security was contributed to the part-
nership by the distributee partner,
except to the extent that the value of
the distributed security is attributable to
marketable securities or money contrib-
uted (directly or indirectly) by the
partnership to the entity to which the
distributed security relates.
(2)Security acquired in nonrecogni-
tion transaction. Section 731(c) and
this section do not apply to the distri-
bution of a marketable security to the
extent that—
(i)The security was acquired by the
partnership in a nonrecognition transac-
tion in exchange for any property
except money or marketable securities
(including a security that would have
been treated as a marketable security
under paragraph (c)(2) of this section if
distributed at the time of the
exchange);
(ii)The distributed security is ac-
tively traded as of the date of distribu-
tion; and
(iii) The security is distributed
within five years of either the date on
which the security was acquired by the
partnership or, if later, the date on
which the security became actively
traded.
(3)Security not marketable when ac-
quired. Section 731(c) and this section
do not apply to the distribution of a
marketable security if—
(i)The security was not actively
traded as of the date acquired by the
partnership and the entity to which the
security relates had no outstanding
actively traded securities on that date;
(ii)The security is actively traded as
of the date of distribution; and
(iii)The security was held by the
partnership for at least six months
before the date the security became
actively traded and the security was
distributed within five years of the date
on which the security became actively
traded.
(4)Successor security. Section
731(c) and this section do not apply to
the distribution of a marketable security
to the extent that the security was
acquired by the partnership in a non-
recognition transaction in exchange for
a security the distribution of which
immediately prior to the exchange
would have been excepted under this
paragraph (d).
(e)Investment partnerships—(1) In
general. Section 731(c) and this section
do not apply to the distribution of
marketable securities by an investment
partnership (as defined in section
731(c)(3)(C)(i)) to an eligible partner
(as defined in section 731(c)(3)(C)(iii)).
(2)Eligible partner. For purposes of
section 731(c)(3)(C)(iii) and this sec-
tion, a partner is not treated as a
partner other than an eligible partner
solely because the partner contributed
services to the partnership.
(3)Trade or business activities. For
purposes of section 731(c)(3)(C) and
this section, a partnership is not treated
as engaged in a trade or business by
reason of—
(i)Any activity undertaken as an
investor, trader, or dealer in any asset
described in section 731(c)(3)(C)(i),
including the receipt of commitment
fees, break-up fees, guarantee fees,
director’s fees, or similar fees that are
customary in and incidental to any
activities of the partnership as an
investor, trader, or dealer in such
assets;
(ii)Reasonable and customary man-
agement services (including the receipt
of reasonable and customary fees in
exchange for such management serv-
ices) provided to an investment part-
nership (within the meaning of section
731(c)(3)(C)(i)) in which the part-
nership holds a partnership interest; or
(iii)Reasonable and customary serv-
ices provided by the partnership in
assisting the formation, capitalization,
expansion, or offering of interests in a
corporation (or other entity) in which
the partnership holds or acquires a
significant equity interest (including the
provision of advice or consulting serv-
ices, bridge loans, guarantees of obliga-
tions, or service on a company’s board
of directors), provided that the antici-
pated receipt of compensation for the
services, if any, does not represent a
significant purpose for the partnership’s
investment in the entity and is inciden-
tal to the investment in the entity.
(4)Partnership tiers. For purposes
of section 731(c)(3)(C)(iv) and this
section, a partnership (upper-tier part-
nership) is not treated as engaged in a
trade or business engaged in by, or as
holding (instead of a partnership inter-
est) a proportionate share of the assets
of, a partnership (lower-tier part-
nership) in which the partnership holds
a partnership interest if—
(i)The upper-tier partnership does
not participate in the management of
the lower-tier partnership; and
(ii)The interest held by the upper-
tier partnership is less than 10 percent
of the total profits and capital interests
in the lower-tier partnership.
( f )B a s i s r u l e s— ( 1 ) P a r t n e r ’ s
basis—(i) Partner’s basis in distributed
securities. The distributee partner’s
basis in distributed marketable se-
curities with respect to which gain is
recognized by reason of section 731(c)
and this section is the basis of the
security determined under section 732,
increased by the amount of such gain.
Any increase in the basis of the
marketable securities attributable to
gain recognized by reason of section
731(c) and this section is allocated to
marketable securities in proportion to
their respective amounts of unrealized
appreciation in the hands of the partner
before such increase.
(ii)Partner’s basis in partnership
interest. The basis of the distributee

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partner’s interest in the partnership is
determined under section 733 as if no
gain were recognized by the partner on
the distribution by reason of section
731(c) and this section.
(2)Basis of partnership property.
No adjustment is made to the basis of
partnership property under section 734
as a result of any gain recognized by a
partner, or any step-up in the basis in
the distributed marketable securities in
the hands of the distributee partner, by
reason of section 731(c) and this
section.
(g)Coordination with other sec-
tions—(1) Section 704(c)(1)(B). The
basis of the distributee partner’s inter-
est in the partnership for purposes of
determining the amount of gain, if any,
recognized by reason of section 731(c)
(and for determining the basis of the
marketable securities in the hands of
the distributee partner) includes the
increase, if any, in the partner’s basis
that occurs under section 704(c)(1)(B)-
(iii) as a result of a distribution to
another partner of property contributed
by the distributee partner in a distribu-
tion that is part of the same distribution
as the marketable securities.
(2)Section 737—(i) Marketable se-
curities as other property. A distribu-
tion of marketable securities is treated
as a distribution of property other than
money for purposes of section 737 to
the extent that the marketable securities
are not treated as money under section
731(c). In addition, marketable se-
curities contributed to the partnership
are treated as property other than
money in determining the contributing
partner’s net precontribution gain under
section 737(b).
(ii)Basis increase under section
737. The basis of the distributee
partner’s interest in the partnership for
purposes of determining the amount of
gain, if any, recognized by reason of
section 731(c) (and for determining the
basis of the marketable securities in the
hands of the distributee partner) does
not include the increase, if any, in the
partner’s basis that occurs under sec-
tion 737(c)(1) as a result of a distribu-
tion of property to the distributee
partner in a distribution that is part of
the same distribution as the marketable
securities.
(h)Anti-abuse rule. The provisions
of section 731(c) and this section must
be applied in a manner consistent with
the purpose of section 731(c) and the
substance of the transaction. Accord-
ingly, if a principal purpose of a
transaction is to achieve a tax result
that is inconsistent with the purpose of
section 731(c) and this section, the
Commissioner can recast the transac-
tion for federal tax purposes as appro-
priate to achieve tax results that are
consistent with the purpose of section
731(c) and this section. Whether a tax
result is inconsistent with the purpose
of section 731(c) and this section must
be determined based on all the facts
and circumstances. For example, under
the provisions of this paragraph (h)—
(1)A change in partnership alloca-
tions or distribution rights with respect
to marketable securities may be treated
as a distribution of the marketable
securities subject to section 731(c) if
the change in allocations or distribution
rights is, in substance, a distribution of
the securities;
(2)A distribution of substantially all
of the assets of the partnership other
than marketable securities and money
to some partners may also be treated as
a distribution of marketable securities
to the remaining partners if the dis-
tribution of the other property and the
withdrawal of the other partners is, in
substance, equivalent to a distribution
of the securities to the remaining
partners; and
(3) The distribution of multiple
properties to one or more partners at
different times may also be treated as
part of a single distribution if the
distributions are part of a single plan of
distribution.
(i)[Reserved]
(j)Examples. The following exam-
ples illustrate the rules of this section.
Unless otherwise specified, all se-
curities held by a partnership are
marketable securities within the mean-
ing of section 731(c); the partnership
holds no marketable securities other
than the securities described in the
example; all distributions by the part-
nership are subject to section 731(a)
and are not subject to sections
704(c)(1)(B), 751(b), or 737; and no
securities are eligible for an exception
to section 731(c).
Example 1. Recognition of gain. (i) A and B
form partnership AB as equal partners. A
contributes property with a fair market value of
$1,000 and an adjusted tax basis of $250. B
contributes $1,000 cash. AB subsequently pur-
chases Security X for $500 and immediately
distributes the security to A in a current
distribution. The basis in A’s interest in the
partnership at the time of distribution is $250.
(ii)The distribution of Security X is treated as
a distribution of money in an amount equal to
the fair market value of Security X on the date of
distribution ($500). (The amount of the distribu-
tion that is treated as money is not reduced under
section 731(c)(3)(B) and paragraph (b) of this
section because, if Security X had been sold
immediately before the distribution, there would
have been no gain recognized by AB and A’s
distributive share of the gain would therefore
have been zero.) As a result, A recognizes $250
of gain under section 731(a)(1) on the distribu-
tion ($500 distribution of money less $250
adjusted tax basis in A’s partnership interest).
Example 2. Reduction in amount treated as
money—in general. (i) A and B form partnership
AB as equal partners. AB subsequently distributes
Security X to A in a current distribution.
Immediately before the distribution, AB held
securities with the following fair market values,
adjusted tax bases, and unrecognized gain or
loss:
ValueBasisGain (Loss)
Security X1007030
Security Y1008020
Security Z100110(10)
(ii) If AB had sold the securities for fair
market value immediately before the distribution
to A, the partnership would have recognized $40
of net gain ($30 gain on Security X plus $20
gain on Security Y minus $10 loss on Security
Z). A’s distributive share of this gain would have
been $20 (one-half of $40 net gain). If AB had
sold the remaining securities immediately after
the distribution of Security X to A, the part-
nership would have $10 of net gain ($20 of gain
on Security Y minus $10 loss on Security Z). A’s
distributive share of this gain would have been
$5 (one-half of $10 net gain). As a result, the
distribution resulted in a decrease of $15 in A’s
distributive share of the net gain in AB’s
securities ($20 net gain before distribution minus
$5 net gain after distribution).
(iii)Under paragraph (b) of this section, the
amount of the distribution of Security X that is
treated as a distribution of money is reduced by
$15. The distribution of Security X is therefore
treated as a distribution of $85 of money to A
($100 fair market value of Security X minus $15
reduction).
Example 3. Reduction in amount treated as
money—carried interest. (i) A and B form
partnership AB. A contributes $1,000 and
provides substantial services to the partnership in
exchange for a 60 percent interest in partnership
profits. B contributes $1,000 in exchange for a
40 percent interest in partnership profits. AB
subsequently distributes Security X to A in a
current distribution. Immediately before the
distribution, AB held securities with the follow-
ing fair market values, adjusted tax bases, and
unrecognized gain:
ValueBasisGain
Security X1008020
Security Y1009010

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(ii) If AB had sold the securities for fair
market value immediately before the distribution
to A, the partnership would have recognized $30
of net gain ($20 gain on Security X plus $10
gain on Security Y). A’s distributive share of this
gain would have been $18 (60 percent of $30 net
gain). If AB had sold the remaining securities
immediately after the distribution of Security X
to A, the partnership would have $10 of net gain
($10 gain on Security Y). A’s distributive share
of this gain would have been $6 (60 percent of
$10 net gain). As a result, the distribution
resulted in a decrease of $12 in A’s distributive
share of the net gain in AB’s securities ($18 net
gain before distribution minus $6 net gain after
distribution).
(iii)Under paragraph (b) of this section, the
amount of the distribution of Security X that is
treated as a distribution of money is reduced by
$12. The distribution of Security X is therefore
treated as a distribution of $88 of money to A
($100 fair market value of Security X minus $12
reduction).
Example 4. Reduction in amount treated as
money—change in partnership allocations. (i) A
is admitted to partnership ABC as a partner with
a 1 percent interest in partnership profits. At the
time of A’s admission, ABC held no securities.
ABC subsequently acquires Security X. A’s
interest in partnership profits is subsequently
increased to 2 percent for securities acquired
after the increase. A retains a 1 percent interest
in all securities acquired before the increase.
ABC then acquires Securities Y and Z and later
distributes Security X to A in a current
distribution. Immediately before the distribution,
the securities held by ABC had the following fair
market values, adjusted tax bases, and unrecog-
nized gain or loss:
ValueBasisGain (Loss)
Security X1,000500200
Security Y1,000800200
Security Z1,0001,100(100)
(ii) If ABC had sold the securities for fair
market value immediately before the distribution
to A, the partnership would have recognized
$600 of net gain ($500 gain on Security X plus
$200 gain on Security Y minus $100 loss on
Security Z). A’s distributive share of this gain
would have been $7 (1 percent of $500 gain on
Security X plus 2 percent of $200 gain on
Security Y minus 2 percent of $100 loss on
Security Z).
(iii)If ABC had sold the remaining securities
immediately after the distribution of Security X
to A, the partnership would have $100 of net
gain ($200 gain on Security Y minus $100 loss
on Security Z). A’s distributive share of this gain
would have been $2 (2 percent of $200 gain on
Security Y minus 2 percent of $100 loss on
Security Z). As a result, the distribution resulted
in a decrease of $5 in A’s distributive share of
the net gain in ABC’s securities ($7 net gain
before distribution minus $2 net gain after
distribution).
(iv)Under paragraph (b) of this section, the
amount of the distribution of Security X that is
treated as a distribution of money is reduced by
$5. The distribution of Security X is therefore
treated as a distribution of $95 of money to A
($100 fair market value of Security X minus $5
reduction).
Example 5. Basis consequences—distribution
of marketable security. (i) A and B form
partnership AB as equal partners. A contributes
nondepreciable real property with a fair market
value and adjusted tax basis of $100.
(ii)AB subsequently distributes Security X
with a fair market value of $120 and an adjusted
tax basis of $90 to A in a current distribution. At
the time of distribution, the basis in A’s interest
in the partnership is $100. The amount of the
distribution that is treated as money is reduced
under section 731(c)(3)(B) and paragraph (b)(2)
of this section by $15 (one-half of $30 net gain
in Security X). As a result, A recognizes $5 of
gain under section 731(a) on the distribution
(excess of $105 distribution of money over $100
adjusted tax basis in A’s partnership interest).
(iii)A’s adjusted tax basis in Security X is $95
($90 adjusted basis of Security X determined
under section 732(a)(1) plus $5 of gain recog-
nized by A by reason of section 731(c)). The
basis in A’s interest in the partnership is $10 as
determined under section 733 ($100 pre-
distribution basis minus $90 basis allocated to
Security X under section 732).
Example 6. Basis consequences—distribution
of marketable security and other property. (i) A
and B form partnership AB as equal partners. A
contributes nondepreciable real property, with a
fair market value of $100 and an adjusted tax
basis of $10.
(ii)AB subsequently distributes Security X
with a fair market value and adjusted tax basis of
$40 to A in a current distribution and, as part of
the same distribution, AB distributes Property Z
to A with an adjusted tax basis and fair market
value of $40. At the time of distribution, the
basis in A’s interest in the partnership is $10. A
recognizes $30 of gain under section 731(a) on
the distribution (excess of $40 distribution of
money over $10 adjusted tax basis in A’s
partnership interest).
(iii)A’s adjusted tax basis in Security X is $35
($5 adjusted basis determined under section
732(a)(2) plus $30 of gain recognized by A by
reason of section 731(c)). A’s basis in Property Z
is $5, as determined under section 732(a)(2). The
basis in A’s interest in the partnership is $0 as
determined under section 733 ($10 pre-
distribution basis minus $10 basis allocated
between Security X and Property Z under section
732).
(iv)AB’s adjusted tax basis in the remaining
partnership assets is unchanged unless the
partnership has a section 754 election in effect.
If AB made such an election, the aggregate basis
of AB’s assets would be increased by $70 (the
difference between the $80 combined basis of
Security X and Property Z in the hands of the
partnership before the distribution and the $10
combined basis of the distributed property in the
hands of A under section 732 after the distribu-
tion). Under section 731(c)(5), no adjustment is
made to partnership property under section 734
as a result of any gain recognized by A by reason
of section 731(c) or as a result of any step-up in
basis in the distributed marketable securities in
the hands of A by reason of section 731(c).
Example 7. Coordination with section 737. (i)
A and B form partnership AB. A contributes
Property A, nondepreciable real property with a
fair market value of $200 and an adjusted basis
of $100 in exchange for a 25 percent interest in
partnership capital and profits. AB owns marketa-
ble Security X.
(ii)Within five years of the contribution of
Property A, AB subsequently distributes Security
X, with a fair market value of $120 and an
adjusted tax basis of $100, to A in a current
distribution that is subject to section 737. As part
of the same distribution, AB distributes Property
Y to A with a fair market value of $20 and an
adjusted tax basis of $0. At the time of
distribution, there has been no change in the fair
market value of Property A or the adjusted tax
basis in A’s interest in the partnership.
(iii)If AB had sold Security X for fair market
value immediately before the distribution to A,
the partnership would have recognized $20 of
gain. A’s distributive share of this gain would
have been $5 (25 percent of $20 gain). Because
AB has no other marketable securities, A’s
distributive share of gain in partnership securities
after the distribution would have been $0. As a
result, the distribution resulted in a decrease of
$5 in A’s share of the net gain in AB’s securities
($5 net gain before distribution minus $0 net
gain after distribution). Under paragraph (b)(2)
of this section, the amount of the distribution of
Security X that is treated as a distribution of
money is reduced by $5. The distribution of
Security X is therefore treated as a distribution of
$115 of money to A ($120 fair market value of
Security X minus $5 reduction). The portion of
the distribution of the marketable security that is
not treated as a distribution of money ($5) is
treated as other property for purposes of section
737.
(iv)A recognizes total gain of $40 on the
distribution. A recognizes $15 of gain under
section 731(a)(1) on the distribution of the
portion of Security X treated as money ($115
distribution of money less $100 adjusted tax
basis in A’s partnership interest). A recognizes
$25 of gain under section 737 on the distribution
of Property Y and the portion of Security X that
is not treated as money. A’s section 737 gain is
equal to the lesser of (i) A’s precontribution gain
($100) or (ii) the excess of the fair market value
of property received ($20 fair market value of
Property Y plus $5 portion of Security X not
treated as money) over the adjusted basis in A’s
interest in the partnership immediately before the
distribution ($100) reduced (but not below zero)
by the amount of money received in the
distribution ($115).
(v)A’s adjusted tax basis in Security X is
$115 ($100 basis of Security X determined under
section 732(a) plus $15 of gain recognized by
reason of section 731(c)). A’s adjusted tax basis
in Property Y is $0 under section 732(a). The
basis in A’s interest in the partnership is $25
($100 basis before distribution minus $100 basis
allocated to Security X under section 732(a) plus
$25 gain recognized under section 737).
(k)Effective date. This section ap-
plies to distributions of marketable
securities made on or after Friday,
December 29, 1995.
Margaret Milner Richardson,
Commissioner of
Internal Revenue.
(Filed by the Office of the Federal Register on
December 29, 1995, 8:45 a.m., and published
in the issue of the Federal Register for January
2, 1996, 61 F.R. 28)

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561996–22 I.R.B.
Correction to Publication 595, Tax
Guide for Commercial Fishermen
Announcement 96–8
The following correction should be
made to the Capital Construction Fund
(CCF) discussion on page 47 of Pub-
lication 595.
In the discussion of CCF Accounts,
the first item of the numbered list
under the heading ‘‘Capital gain ac-
count’’ should be corrected to read
‘‘more than 6 months.’’ It currently
says ‘‘6 months or less.’’

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57
Announcement of the Disbarment, Suspension, or Consent to Voluntary
Suspension of Attorneys, Certified Public Accountants, Enrolled Agents and
Enrolled Actuaries From Practice Before the Internal Revenue Service
Under 31 Code of Federal Regula-
tions, Part 10, an attorney, certified
public accountant, enrolled agent or en-
rolled actuary, in order to avoid the in-
stitution or conclusion of a proceeding
for his disbarment or suspension from
practice before the Internal Revenue
Service, may offer his consent to
suspension from such practice. The
Director of Practice, in his discretion,
may suspend an attorney, certified
public accountant, enrolled agent or
enrolled actuary in accordance with the
consent offered.
Attorneys, certified public account-
ants, enrolled agents and enrolled actu-
aries are prohibited in any Internal
Revenue Service matter from directly
or indirectly employing, accepting
assistance from, being employed by,
or sharing fees with, any practi-
tioner disbarred or suspended from
practice before the Internal Revenue
Service.
To enable attorneys, certified public
accountants, enrolled agents and en-
rolled actuaries to identify practitioners
under consent suspension from practice
before the Internal Revenue Service,
the Director of Practice will announce
in the Internal Revenue Bulletin the
names and addresses of practitioners
who have been suspended from such
practice, their designation as attor-
ney, certified public accountant, en-
rolled agent or enrolled actuary and
date or period of suspension. This an-
nouncement will appear in the weekly
Bulletin at the earliest practicable date
after such action and will continue to
appear in the weekly Bulletins for five
successive weeks or for as many weeks
as is practicable for each attorney,
certified public accountant, enrolled
agent or enrolled actuary so suspended
and will be consolidated and published
in the Cumulative Bulletin.
The following individuals have been
placed under consent suspension from
practice before the Internal Revenue
Service:
NameAddressDesignationDate of Suspension
Isdaner, Thomas M.Crofton, MDCPAOctober 31, 1995 to October 30, 1996
Cacciola, MarlenePittsburg, CAEnrolled
Agent
November 9, 1995 to May 8, 1996
Goldman, William D.Hot Springs, ARAttorneyNovember 9, 1995 to November 8, 1996
Armstrong, David L.Norman, OKCPAIndefinite from November 10, 1995
Heckathorn, BenRed Oak, TXCPA/
Attorney
Indefinite from November 28, 1995
Tisdel, LindaSeattle, WAEnrolled
Agent
November 28, 1995 to May 27, 1997
Webb, Herbert M.Gainsville, FLAttorneyDecember 21, 1995 to June 20, 1997
Hipp, Robert J.Evanston, ILCPADecember 28, 1995 to April 27, 1996
Ruff, James M.Willmar, MNCPAJanuary 1, 1996 to March 31, 1996
Mulkerin, John J.Wheaton, ILCPAJanuary 5, 1996 to April 4, 1996
Redwitz, RobertIrvine, CACPAFebruary 15, 1996 to May 14, 1996
Lind, Stanley L.Milwaukee, WIAttorneyMarch 1, 1996 to February 28, 1997
Dais, Robert E.Plano, TXCPAMarch 1, 1996 to February 28, 1997
Under Section 330, Title 31 of the
United States Code, the Secretary of
the Treasury, after due notice and
opportunity for hearing, is authorized
to suspend or disbar from practice
before the Internal Revenue Service
any person who has violated the rules
and regulations governing the recogni-
tion of attorneys, certified public ac-
countants, enrolled agents or enrolled
actuaries to practice before the Internal
Revenue Service.
Attorneys, certified public account-
ants, enrolled agents, and enrolled
actuaries are prohibited in any Internal
Revenue Service matter from directly
or indirectly employing, accepting as-
sistance from, being employed by or
sharing fees with, any practitioner
disbarred or under suspension from
practice before the Internal Revenue
Service.
To enable attorneys, certified public
accountants, enrolled agents and
enrolled actuaries to identify such
disbarred or suspended practitioners,
the Director of Practice will announce
in the Internal Revenue Bulletin the
names and addresses of practitioners
who have been suspended from such
practice, their designation as attorney,
certified public accountant, enrolled
agent or enrolled actuary, and the date
of disbarment or period of suspension.
This announcement will appear in the
weekly Bulletin for five successive
weeks or as long as it is practicable for
each attorney, certified public account-
ant, enrolled agent or enrolled actuary
so suspended or disbarred and will be
consolidated and published in the
Cumulative Bulletin.
After due notice and opportunity
for hearing before an administrative
law judge, the following individuals
have been disbarred from further prac-
tice before the Internal Revenue
Service:

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NameAddressDesignationEffective Date
Muraskin, DavidNew York, NYAttorneyNovember 6, 1995
Kelsey, PatrickPoolesville, MDCPANovember 13, 1995
Announcement of the Expedited Suspension of Attorneys, Certified Public
Accountants, Enrolled Agents, and Enrolled Actuaries From Practice Before the
Internal Revenue Service
Under title 31 of the Code of Federal
Regulations, section 10.76, the Director
of Practice is authorized to immediately
suspend from practice before the Inter-
nal Revenue Service any practitioner
who, within five years, from the date
the expedited proceeding is instituted,
(1) has had a license to practice as an
attorney, certified public accountant, or
actuary suspended or revoked for
cause; or (2) has been convicted of any
crime under title 26 of the United
States Code or, of a felony under title
18 of the United States Code involving
dishonesty or breach of trust.
Attorneys, certified public account-
ants, enrolled agents, and enrolled ac-
tuaries are prohibited in any Internal
Revenue Service matter from directly
or indirectly employing, accepting as-
sistance from, being employed by, or
sharing fees with, any practitioner
disbarred or suspended from practice
before the Internal Revenue Service.
To enable attorneys, certified public
accountants, enrolled agents, and en-
rolled actuaries to identify practitioners
under expedited suspension from prac-
tice before the Internal Revenue Serv-
ice, the Director of Practice will an-
nounce in the Internal Revenue Bulletin
the names and addresses of practition-
ers who have been suspended from such
practice, their designation as attorney,
certified public accountant, enrolled
agent, or enrolled actuary, and date or
period of suspension. This announce-
ment will appear in the weekly Bulletin
at the earliest practicable date after
such action and will continue to appear
in the weekly Bulletins for five succes-
sive weeks or for as many weeks as is
practicable for each attorney, certified
public accountant, enrolled agent, or
enrolled actuary so suspended and will
be consolidated and published in the
Cumulative Bulletin.
The following individuals have been
placed under suspension from practice
before the Internal Revenue Service by
virtue of the expedited proceeding
provisions of the applicable regulations:
NameAddressDesignationDate of Suspension
Trebatch, Henry T.Great Neck, NYCPAIndefinite from November 6, 1995
Roomberg, AlanMinersville, PACPAIndefinite from November 10, 1995
Elfenbein, Emanuel B.Miami, FLEnrolled
Agent
Indefinite from November 27, 1995
Cerullo, Louis, J.Boca Raton, FLCPAIndefinite from November 27, 1995
Fogel, HaroldSt. Paul, MNCPAIndefinite from December 13, 1995
Glover, Paul L.Downers Grove, ILAttorneyIndefinite from December 13, 1995
Miller, John R.Akron, OHAttorneyIndefinite from December 13, 1995
Pofahl, CharlesDallas, TXAttorneyIndefinite from December 18, 1995
Walburg, DouglasMahtomedi, MNCPAIndefinite from December 18, 1995
Hibler, Thomas M.Plymouth, MICPA/
Attorney
Indefinite from December 18, 1995
Oringer, RonaldFlanders, NJCPAIndefinite from December 29, 1995
Butcher, FrederickStillwater, NJCPAIndefinite from December 29, 1995
Tokars, FredericAtlanta, GAAttorneyIndefinite from December 29, 1995
Atkins, Sanford I.Moreland Hills, OHAttorneyIndefinite from December 29, 1995

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59
Definition of Terms
Revenue rulings and revenue proce-
dures (hereinafter referred to as ‘‘rul-
ings’’) that have an effect on previous
rulings use the following defined terms
to describe the effect:
Amplified describes a situation where
no change is being made in a prior
published position, but the prior posi-
tion is being extended to apply to a
variation of the fact situation set forth
therein. Thus, if an earlier ruling held
that a principle applied to A, and the
new ruling holds that the same princi-
ple also applies to B, the earlier ruling
is amplified. (Compare with modified,
below).
Clarified is used in those instances
where the language in a prior ruling is
being made clear because the language
has caused, or may cause, some confu-
sion. It is not used where a position in
a prior ruling is being changed.
Distinguished describes a situation
where a ruling mentions a previously
published ruling and points out an
essential difference between them.
Modified is used where the substance
of a previously published position is
being changed. Thus, if a prior ruling
held that a principle applied to A but
not to B, and the new ruling holds that
it applies to both A and B, the prior
ruling is modified because it corrects a
published position. (Compare with am-
plified and clarified, above).
Obsoleted describes a previously
published ruling that is not considered
determinative with respect to future
transactions. This term is most com-
monly used in a ruling that lists
previously published rulings that are
obsoleted because of changes in law or
regulations. A ruling may also be
obsoleted because the substance has
been included in regulations subse-
quently adopted.
Revoked describes situations where
the position in the previously published
ruling is not correct and the correct
position is being stated in the new
ruling.
Superseded describes a situation
where the new ruling does nothing
more than restate the substance and
situation of a previously published
ruling (or rulings). Thus, the term is
used to republish under the 1986 Code
and regulations the same position pub-
lished under the 1939 Code and regula-
tions. The term is also used when it is
desired to republish in a single ruling a
series of situations, names, etc., that
were previously published over a
period of time in separate rulings. If
If the new ruling does more than
restate the substance of a prior ruling, a
combination of terms is used. For
example, modified and superseded de-
scribes a situation where the substance
of a previously published ruling is
being changed in part and is continued
without change in part and it is desired
to restate the valid portion of the
previously published ruling in a new
ruling that is self contained. In this
case the previously published ruling is
first modified and then, as modified, is
superseded.
Supplemented is used in situations in
which a list, such as a list of the names
of countries, is published in a ruling
and that list is expanded by adding
further names in subsequent rulings.
After the original ruling has been
supplemented several times, a new
ruling may be published that includes
the list in the original ruling and the
additions, and supersedes all prior
rulings in the series.
Suspended is used in rare situations
to show that the previous published
rulings will not be applied pending
some future action such as the issuance
of new or amended regulations, the
outcome of cases in litigation, or the
outcome of a Service study.
Abbreviations
The following abbreviations in current use and
formerly used will appear in material published
in the Bulletin.
A—Individual.
Acq.—Acquiescence.
B—Individual.
BE—Beneficiary.
BK—Bank.
B.T.A.—Board of Tax Appeals.
C.—Individual.
C.B.—Cumulative Bulletin.
CFR—Code of Federal Regulations.
CI—City.
COOP—Cooperative.
Ct.D.—Court Decision.
CY—County.
D—Decedent.
DC—Dummy Corporation.
DE—Donee.
Del. Order—Delegation Order.
DISC—Domestic International Sales Corporation.
DR—Donor.
E—Estate.
EE—Employee.
E.O.—Executive Order.
ER—Employer.
ERISA—Employee Retirement Income Security Act.
EX—Executor.
F—Fiduciary.
FC—Foreign Country.
FICA—Federal Insurance Contribution Act.
FISC—Foreign International Sales Company.
FPH—Foreign Personal Holding Company.
F.R.—Federal Register.
FUTA—Federal Unemployment Tax Act.
FX—Foreign Corporation.
G.C.M.—Chief Counsel’s Memorandum.
GE—Grantee.
GP—General Partner.
GR—Grantor
IC—Insurance Company.
I.R.B.—Internal Revenue Bulletin.
LE—Lessee.
LP—Limited Partner.
LR—Lessor.
M—Minor.
Nonacq.—Nonacquiescence.
O—Organization.
P—Parent Corporation.
PHC—Personal Holding Company.
PO—Possession of the U.S.
PR—Partner.
PRS—Partnership.
PTE—Prohibited Transaction Exemption.
Pub. L.—Public Law.
REIT—Real Estate Investment Trust.
Rev. Proc.—Revenue Procedure.
Rev. Rul.—Revenue Ruling.
S—Subsidiary.
S.P.R.—Statements of Procedural Rules.
Stat.—Statutes at Large.
T—Target Corporation.
T.C.—Tax Court.
T.D.—Treasury Decision.
TFE—Transferee.
TFR—Transferor.
T.I.R.—Technical Information Release.
TP—Taxpayer.
TR—Trust.
TT—Trustee.
U.S.C.—United States Code.
X—Corporation.
Y—Corporation.
Z—Corporation.

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Numerical Finding List
1
Bulletins 1996–1 through 1996–6
Announcements:
96–1, 1996–2 I.R.B. 57
96–2, 1996–2 I.R.B. 57
96–3, 1996–2 I.R.B. 57
96–4, 1996–3 I.R.B. 50
96–5, 1996–4 I.R.B. 99
96–6, 1996–5 I.R.B. 43
96–7, 1996–5 I.R.B. 44
Notices:
96–2, 1996–2 I.R.B. 15
96–1, 1996–3 I.R.B. 30
96–4, 1996–4 I.R.B. 69
96–5, 1996–6 I.R.B. 22
96–6, 1996–5 I.R.B. 27
96–7, 1996–6 I.R.B. 22
96–8, 1996–6 I.R.B. 23
96–9, 1996–6 I.R.B. 26
Proposed Regulations:
DL–1–95, 1996–6 I.R.B. 28
EE–20–95, 1996–5 I.R.B. 15
EE–34–95, 1996–3 I.R.B. 49
EE–35–95, 1996–5 I.R.B. 19
EE–53–95, 1996–5 I.R.B. 23
IA–33–95, 1996–4 I.R.B. 99
INTL–3–95, 1996–6 I.R.B. 29
INTL–9–95, 1996–5 I.R.B. 25
Revenue Procedures:
96–1, 1996–1 I.R.B. 8
96–2, 1996–1 I.R.B. 60
96–3, 1996–1 I.R.B. 82
96–4, 1996–1 I.R.B. 94
96–5, 1996–1 I.R.B. 129
96–6, 1996–1 I.R.B. 151
96–7, 1996–1 I.R.B. 185
96–8, 1996–1 I.R.B. 187
96–9, 1996–2 I.R.B. 15
96–10, 1996–2 I.R.B. 17
96–11, 1996–2 I.R.B. 18
96–12, 1996–3 I.R.B. 30
96–13, 1996–3 I.R.B. 31
96–14, 1996–3 I.R.B. 41
96–15, 1996–3 I.R.B. 41
96–16, 1996–3 I.R.B. 45
96–17, 1996–4 I.R.B. 69
96–18, 1996–4 I.R.B. 73
96–19, 1996–4 I.R.B. 80
96–20, 1996–4 I.R.B. 88
96–21, 1996–4 I.R.B. 96
96–22, 1996–5 I.R.B. 27
96–23, 1996–5 I.R.B. 27
96–24, 1996–5 I.R.B. 28
1
A cumulative list of all Revenue Rulings,
Revenue Procedures, Treasury Decisions, etc.,
published in Internal Revenue Bulletins 1995–27
through 1995–52 will be found in Internal
Revenue Bulletin 1996–1, dated January 2, 1996.
Revenue Rulings:
96–1, 1996–1 I.R.B. 7
96–2, 1996–2 I.R.B. 5
96–3, 1996–2 I.R.B. 14
96–6, 1996–2 I.R.B. 8
96–4, 1996–3 I.R.B. 16
96–5, 1996–3 I.R.B. 29
96–7, 1996–3 I.R.B. 12
96–8, 1996–4 I.R.B. 62
96–9, 1996–4 I.R.B. 5
96–10, 1996–4 I.R.B. 27
96–11, 1996–4 I.R.B. 28
96–14, 1996–6 I.R.B. 20
Treasury Decisions:
8630, 1996–3 I.R.B. 19
8631, 1996–3 I.R.B. 7
8632, 1996–4 I.R.B. 6
8633, 1996–4 I.R.B. 20
8634, 1996–3 I.R.B. 17
8635, 1996–3 I.R.B. 5
8636, 1996–4 I.R.B. 64
8637, 1996–4 I.R.B. 29
8638, 1996–5 I.R.B. 5
8639, 1996–5 I.R.B. 12
8640, 1996–2 I.R.B. 10
8641, 1996–6 I.R.B. 4

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Finding List of Current Action on
Previously Published Items
1
Bulletins 1996–1 through 1996–6
*Denotes entry since last publication
Revenue Procedures:
65–17
Modified by
96–14, 1996–3 I.R.B. 41
66–49
Modified by
96–15, 1996–3 I.R.B. 41
88–32
Obsoleted by
96–15, 1996–3 I.R.B. 41
88–33
Obsoleted by
96–15, 1996–3 I.R.B. 41
89–19
Superseded by
96–17, 1996–4 I.R.B. 69
89–48
Superseded in part by
96–17, 1996–4 I.R.B. 69
91–22
Modified by
96–1, 1996–1 I.R.B. 8
91–22
Amplified by
96–13, 1996–3 I.R.B. 31
91–23
Superseded by
96–13, 1996–3 I.R.B. 31
91–24
Superseded by
96–14, 1996–3 I.R.B. 41
91–26
Superseded by
96–13, 1996–3 I.R.B. 31
92–20
Modified by
96–1, 1996–1 I.R.B. 8
92–85
Modified by
96–1, 1996–1 I.R.B. 8
93–16
Superseded by
96–11, 1996–2 I.R.B. 18
93–46
Superseded in part by
96–17, 1996–4 I.R.B. 69
1
A cumulative finding list for previously
published items mentioned in Internal Revenue
Bulletins 1995–27 through 1995–52 will be
found in Internal Revenue Bulletin 1996–1, dated
January 2, 1996.
Revenue Procedures—Continued
Superseded by
96–18, 1996–4 I.R.B. 73
94–18
Superseded in part by
96–17, 1996–4 I.R.B. 69
Superseded by
96–18, 1996–4 I.R.B. 73
94–59
Superseded in part by
96–17, 1996–4 I.R.B. 69
Superseded by
96–18, 1996–4 I.R.B. 73
95–1
Superseded by
96–1, 1996–1 I.R.B. 8
95–2
Superseded by
96–2, 1996–1 I.R.B. 60
95–3
Superseded by
96–3, 1996–1 I.R.B. 82
95–4
Superseded by
96–4, 1996–1 I.R.B. 94
95–5
Superseded by
96–5, 1996–1 I.R.B. 129
95–6
Superseded by
96–6, 1996–1 I.R.B. 151
95–7
Superseded by
96–7, 1996–1 I.R.B. 185
95–8
Superseded by
96–8, 1996–1 I.R.B. 187
95–13
Superseded by
96–20, 1996–4 I.R.B. 88
95–20
Superseded by
96–24, 1996–5 I.R.B. 28
95–50
Superseded by
96–3, 1996–1 I.R.B. 82
96–3
Amplified by
96–12, 1996–3 I.R.B. 30
Revenue Rulings:
66–307
Obsoleted by
96–3, 1996–2 I.R.B. 14
72–437
Modified by
96–13, 1996–3 I.R.B. 31
80–80
Obsoleted by
96–3, 1996–2 I.R.B. 14
82–80
Modified by
96–14, 1996–3 I.R.B. 41
92–19
Supplemented in part
96–2, 1996–2 I.R.B. 5
92–75
Clarified by
96–13, 1996–3 I.R.B. 31
95–10
Supplemented and superseded by
96–4, 1996–3 I.R.B. 16
95–11
Supplemented and superseded by
96–5, 1996–3 I.R.B. 29