Section 2056 -- Marital Deduction
UIL Number(s) 2056.01-00
Control No.: TR-32-75-89
Taxpayer's Name: * * *
Taxpayer's Address: * * *
Taxpayer's I.D. No: * * *
Date of Death: * * *
No Conference Held: * * *
ISSUE
In the case of a legal life estate in personalty provided under the will of a 1985 decedent, does the beneficiary have the right to make nonincome producing property productive or convert it to productive property in order to qualify the bequest for the marital deduction under section 2056(b)(7) of the Internal Revenue Code?
FACTS
The decedent died on September 22, 1985. Her will dated March 26, 1966, gave her surviving spouse a bare legal life estate in the residue of her estate, unencumbered by any trust requirements, with the remainder at the surviving spouse's death, to her children. The surviving spouse was named as personal representative with full powers to sell and exchange the assets of the estate. There was no mention of the marital deduction for estate tax purposes. The major portion of her estate at her death consisted of stock in two corporations. Her surviving spouse owns additional stock in the corporations in his individual name. The stock of both corporations is publicly traded on the over-the-counter market. Both corporations use earnings to support growth and have not declared or paid cash dividends in the past.
The estate filed an estate tax return on December 22, 1986. On that return the estate elected under the provisions of section 2056(b)(7) of the Internal Revenue Code to treat the property of the estate, both real and personal, as qualified terminable interest property.
On May 17, 1988, Colorado enacted a statute providing that any devise of a life estate to a surviving spouse entitles the surviving spouse to all of the income for life from the property and the right to make the property productive or to convert it into productive property.
APPLICABLE LAW AND RATIONALE
Section 2056(b)(7)(A) of the Internal Revenue Code provides, that a marital deduction is allowed with respect to the estates of decedents dying after December 31, 1981, for "Qualified Terminable Interest Property." All of the property for which a deduction is allowed shall be treated as passing to the surviving spouse and no part of such property shall be treated as passing to any person other than the surviving spouse.
Section 2056(b)(7)(B)(i) provides that the term "Qualified Terminable Interest Property" means property (1) which passes from the decedent (2) in which the surviving spouse has a "Qualifying Income Interest for Life" and (3) which the executor elected to treat as "Qualified Terminable Interest Property".
Section 2056(b)(7)(B)(ii) provides that the term "Qualifying Income Interest" means that (1) the surviving spouse is entitled for life to all the income from the property, payable annually or at more frequent intervals, and (2) no person (including the surviving spouse) has a power to appoint any part of the property to any person other than the surviving spouse.
In general the principles outlined in 20.2056(b)(5)(f) of the Estate Tax Regulations are applicable in determining whether the surviving spouse is entitled for life to all the income of the property regardless of whether the interest passing to the spouse is in trust.
Section 20.2056(b)(5)(f) of the regulations provides that if an interest is transferred in trust, the surviving spouse is entitled for life to all of income if the affect of the trust is to give substantially that degree of beneficial enjoyment of trust property during her life which the principles or the law of trusts accord to a person who is unqualifiedly designated as the life beneficiary of the trust. An interest passing to such a trust will not qualify unless the applicable rules for the administration require or permit the spouse to require that the trustee provide the required beneficial enjoyment.
Section 15-1-1201 of the Colorado Revised Statutes, enacted in May of 1988, generally provides that a surviving spouse, who is the owner of a life estate in property, shall be entitled to the right to all of the income from the property and shall have the power to make the property productive or convert it into productive property. The exercise of such power is subject to the degree of judgment and care which a prudent person would use if he were owner of the property. The proceeds of any such conversion are to be reinvested by the surviving spouse in a form subject to the life estate and remainder rights created by the decedent. The statute is made retroactive to apply to the estates of decedents dying after December 31, 1981.
The common law originally did not admit of the creation of a life estate in personal property with a reversion or remainder over and a gift for life carried the absolute title or interest. It is now well settled that life estates may be created in personal property including money, and personal property not consumable by use, or of a durable nature with a remainder over to others. See 31 C.J.S. Estates section 133 (1964).
While it has been said that personal property which is subject to a legal life estate cannot generally be reinvested by the person entitled to possession, there is authority for the view that, where there is a life estate in personal property, there must always be a power to make the enjoyment available according to the circumstances, and the life tenant may under proper restrictions, invest or reinvest the money or its equivalent in order that his bequest may be more remunerative. He may convert one kind of property into another or change the character of the investments provided that such acts are in accordance with prudent management and the value of the property as a whole is not diminished. A gift of income with the right to possession of the fund producing it confers on the life tenant implied authority to retain in kind that which the donor confided to his care and to invest the fund to produce that which he [the donor] indicated the life tenant should have 31 C.J.S. Estates section 135 (1964).
In Wing v. Wing, 208 S.W. 2d 776 (ARK 1948) the decedent made his daughter principal devises and legatee of all his property real and personal for life, and then to the heirs of her body but if she should die without issue living at her death, the remainder was to go to nephews and nieces. The primary question before the court was whether the chancery court had power to direct the sale of the real property for reinvestment while there was still a possibility that remaindermen, not in being, might take. Mrs. Wing asserted that as life tenant she was not in a position to devote the necessary attention to rice culture, nor did she have sufficient knowledge of farming to justify further investments and expenditures for maintaining the lands as rice plantations. It was also alleged that current prices had probably reached a market peak. The lower court found that it would be in the best interests of all parties including the contingent remaindermen, not in being, that the lands be converted. The higher court affirmed.
The court in thus holding recognized that unproductive real property can be sold by a life tenant and reinvested in productive property. The fact that the foregoing case involved real property makes a strong case that the sale of personality would have been even more readily allowed. For instance, when the need for liquidity arises during the administration of an estate, probate courts generally authorize the sale of personal property before real property since such property is more readily saleable.
Thus, our research indicates that in Colorado, the common law rule in 1985, prior to enactment of the statute, would permit the life tenant of a legal life estate to sell the corpus of the life estate, whether real property or personal property, in order to make the life estate adequately productive. Although the matter is not entirely free from doubt, no modern case has come to our attention that indicates that Colorado would not permit the sale of personal property in a case such as the present one. The effect of the Colorado statute is little more than to codify the existing common law. Consequently, it appears that no constitutional question of due process is presented in this case.
CONCLUSION
The devise to the surviving spouse of a legal life estate in the residue of the estate gives the surviving spouse a qualifying income interest for life as defined in section 2056(b)(7)(B)(ii) of the Internal Revenue Code. Accordingly, a marital deduction is allowable to the estate under section 2056(b)(7) of the Code for the value of the property passing to the surviving spouse.
A copy of this memorandum should be given to the taxpayer. Section 6110(j)(3) of the Internal Revenue Code provides that it may not be used or cited as precedent. Temporary or final regulations pertaining to one or more of the issues addressed in this technical advice memorandum have not yet been adopted. Therefore, this technical advice memorandum will be modified or revoked by adoption of temporary regulations, to the extent the regulations are inconsistent with any conclusions in the memorandum. See section 11.03 of Rev. Proc 89-2, 1989-1 I.R.B. 19. However, when the criteria in section 11.04 of Rev. Proc. 89-2 are satisfied, a technical advice memorandum is not revoked or modified retroactively, except in rare or unusual circumstances.