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Foreign Trusts - Gain on Transfers to the Trust

Question or Topic

Must I recognize gain on certain transfers to certain foreign trusts and estates?

The Answer

TD 8956, 26 CFR Part 1, July 9, 2001

[4830-01-P]

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8956]

RIN 1545-AY25

Recognition of Gain on Certain Transfers to Certain Foreign Trusts and

Estates

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations under section 684 of

the Internal Revenue Code relating to recognition of gain on certain

transfers to certain foreign trusts and estates. The regulations affect

United States persons who transfer property to foreign trusts and estates.

DATES: Effective Date: These regulations are effective July 20, 2001.

APPLICABILITY DATE: These regulations are applicable to transfers of

property to foreign trusts and foreign estates after August 7, 2000.

FOR FURTHER INFORMATION CONTACT: Karen A. Rennie-Quarrie, (202) 622-

3880 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

BACKGROUND

This document contains final regulations relating to the Income Tax

Regulations (CFR part 1) under section 684 of the Internal Revenue Code

(Code). On August 7, 2000, Treasury and the IRS published a notice of

proposed rulemaking (REG-108522-00) in the Federal Register (65 FR 48198)

under section 684 of the Code relating to gain recognition on transfers of

property by U.S. persons to foreign trusts and estates. Comments

responding to the notice of proposed rulemaking were received and a public

hearing was held on November 8, 2000. After consideration of all

comments, the proposed regulations are adopted as final regulations as

revised by this Treasury decision.

Explanation of Provisions

I. COMMENTS AND CHANGES TO section 1.684-1: RECOGNITION OF GAIN ON

TRANSFERS TO CERTAIN FOREIGN TRUSTS AND ESTATES

Under the proposed regulations, a U.S. person who transfers property to

a foreign trust or estate generally must recognize gain immediately even

if deferral might otherwise be permitted under another provision of the

Code.

One commenter questioned the authority for the conclusion in section

1.684-1(d) Example 4 that a U.S. person must recognize gain immediately

upon the transfer of appreciated property to a foreign trust in exchange

for a private annuity. The general rule in section 684(a) provides, in

part, that the transfer to the foreign trust is treated as a sale or

exchange for an amount equal to the fair market value of the property

transferred and the transferor must recognize the gain in the property,

except as provided in regulations. The language of section 684(a) does

not provide for any deferral of this gain. Moreover, the legislative

history of former section 1491 (the predecessor of section 684 regarding

transfers of property by U.S. persons to foreign trusts) makes it clear

that Congress did not look favorably upon deferral in the context of

transfers to foreign trusts in exchange for private annuities: “The

committee believes that any policy in favor of permitting deferral of tax

in private annuity transactions should not apply to a private annuity

transaction with a foreign trust.” S. Rep. No. 94-938, at 217, n.5

(1976). Therefore, Treasury and the IRS do not believe it would be

appropriate to adopt regulations that would permit deferral in such a

case. The final regulations retain Example 4 without modification.

II. COMMENTS AND CHANGES TO SECTION 1.684-2: TRANSFERS

The proposed regulations define the term transfer broadly to mean any

direct, indirect, or constructive transfer. Section 1.684-2(e) of the

proposed regulations provides that if any portion of a foreign trust is

treated as owned by a U.S. person and such portion ceases to be treated as

owned by such U.S. person, the U.S. person is treated as having

transferred the assets of such portion to a foreign trust immediately

before the trust is no longer treated as owned by the U.S. person.

Section 1.684-2(e)(2) Example 2 illustrates this rule in the case of the

death of the grantor.

One commenter questioned the authority for the position that death is a

transfer to which section 684 applies. Section 684(a) expressly applies

to “any transfer of property by a United States person to a foreign estate

or trust” (emphasis added). Section 679 also generally applies to

transfers of property by U.S. persons to foreign trusts. In the case of

section 679, however, section 679(a)(2)(A) specifically excepts transfers

by reason of death from the application of the general rule of section

679. This exception implies that Congress believed that, unless otherwise

excepted, a transfer by reason of death would be a transfer to which

section 679 applied. Because Congress provided no exception in section

684 for transfers by reason of death, it follows that section 684 applies

to such transfers. Additional support for this conclusion is found in the

information reporting rules in section 6048(a)(3)(A)(ii), which provides

that a “reportable event” includes “the transfer of any money or property

(directly or indirectly) to a foreign trust by a United States person,

including a transfer by reason of death” (emphasis added). Although

section 684 generally applies to transfers by reason of death, section

1.684-3(c) provides an exception to the general rule of gain recognition

in the case of certain transfers at death.

One commenter requested guidance concerning a transfer of property by a

domestic trust (that is not treated as owned by another person) to a

foreign trust as a result of the testamentary exercise of a limited power

of appointment with respect to the domestic trust. Treasury and the IRS

believe that, under general principles regarding limited powers of

appointment, the domestic trust, and not the holder of the limited power

of appointment, is the transferor of the property. Accordingly, the

domestic trust must recognize gain under the general rule of section 1.684-

1(a) unless an exception applies. The final regulations do not include

any special rules for such transfers.

One commenter asked about the interaction of section 1.684-2(d) and

section 1.684-2(e) in the context of an actual transfer of property from a

foreign trust that is treated as owned by a U.S. person to either a

foreign charitable organization or a U.S. charity. Under section 1.684-

2(d) of the proposed regulations, if any portion of a trust is treated as

owned by a U.S. person, a transfer of property from that portion of the

trust to a foreign trust is treated as a transfer from the owner. Under

section 1.684-2(e) of the proposed regulations, if a portion of a foreign

trust that is treated as owned by a U.S. person ceases to be treated as

owned by the U.S. person, the U.S. person is treated as having transferred

the assets of that portion of the trust to a foreign trust immediately

before such portion is no longer treated as owned by the U.S. person.

The commenter noted that section 1.684-2(e) of the proposed regulation

could be read to apply in situations where a portion of a foreign trust

ceases to be treated as owned by a U.S. person because of an actual

transfer of property from the trust. The final regulations clarify that

section 1.684-2(e) does not apply (and that section 1.684-2(d) may apply)

when any portion of a trust ceases to be owned by a U.S. person by reason

of an actual transfer of property from the trust. As a result, the

general rule of gain recognition under section 1.684-1(a) would not apply

to an actual transfer by a foreign trust that is treated as owned by a

U.S. person to a foreign charitable trust that meets the requirements of

section 1.684-3(b), or to a U.S. charity, even if the transfer causes the

portion of the trust to cease to be owned by the U.S. person.

III. COMMENTS AND CHANGES TO SECTION 1.684-3: EXCEPTIONS TO THE GENERAL

RULE OF GAIN RECOGNITION

Section 1.684-3(a) of the proposed regulations provides that a U.S.

person who transfers property to a foreign trust is not required to

recognize gain on the transfer to the extent that any person is treated as

the owner of the trust under section 671. One commenter questioned

whether the term any person includes foreign persons. Although not

specifically addressed in the final regulations, it is understood that the

term any person includes foreign as well as U.S. persons.

Section 1.684-3(b) of the proposed regulations provides an exception

for transfers to a foreign trust that has already received a ruling or

determination letter from the IRS recognizing the trust’s tax exempt

status under section 501(c)(3), provided that the letter has been neither

revoked nor modified. Commenters questioned the requirement that a

foreign trust obtain a ruling or determination letter from the IRS

recognizing the trust’s tax exempt status under section 501(c)(3). They

assert that the requirement may interfere with a U.S. person’s ability to

make contributions to a foreign charitable entity that may not be familiar

with U.S. tax laws and may not have any reason to obtain a determination

letter from the IRS. They suggest that the final regulations require only

that the U.S. transferor disclose to the IRS, at such time and in such

manner as the IRS may provide, that the transfer has been made and that

the U.S. transferor believes the transferee is an organization described

in section 501(c)(3).

In response to commenters’ concerns, the final regulations eliminate

the requirement that the foreign trust receive a ruling or determination

letter from the IRS recognizing the trust’s tax exempt status under

section 501(c)(3). The final regulations provide, instead, that the

general rule of gain recognition does not apply to any transfer of

property to a foreign trust that is described in section 501(c)(3)(without

regard to the requirements of section 508(a)). However, taxpayers should

be aware that, under Notice 97-34 (1997-1 C.B. 422), the U.S. transferor

has a reporting obligation on Form 3520 with respect to such a transfer,

unless the foreign trust has received a ruling or determination letter

from the IRS recognizing the trust’s tax exempt status under section

501(c)(3). Moreover, if the IRS subsequently determines that the foreign

trust is not described in section 501(c)(3), the exception will not apply

and the U.S. transferor will be required to recognize gain as of the time

of the original transfer, and may be subject to interest and penalties, if

applicable.

Section 1.684-3(c) of the proposed regulations provides an exception

for transfers of property by reason of the death of the U.S. transferor if

both of the following requirements are satisfied: (1) the property is

included in the U.S. transferor’s gross estate for Federal estate tax

purposes, and (2) the basis of the property in the hands of the foreign

trust is determined under section 1014(a). One commenter questioned

whether section 684 would apply in the case of an individual who is a U.S.

person for income tax purposes, but a non-domiciliary for estate tax

purposes, with the result that the property of the individual would be

entitled to a step-up in basis, but would not be included in the

individual’s gross estate. The final regulations eliminate the

requirement that the property be included in the U.S. transferor’s gross

estate and allow the exception to apply as long as the basis of the

property in the hands of the foreign trust is determined under section

1014(a).

Another commenter requested that the final regulations confirm that

section 1032 applies to provide for nonrecognition of gain on issuer stock

transferred to a foreign trust. The commenter noted that under former

section 1491, no excise tax was imposed on a transfer of stock by a

foreign corporation to a foreign trust if the corporation was not required

to recognize gain on the transfer under section 1032. See Notice 97-18

(1997-1 C.B. 389, Sec. II.A.1). In response to this comment, section

1.684-3(e) of the final regulations provides a new exception for transfers

of stock (including treasury stock) by a domestic corporation to a foreign

trust if the domestic corporation is not required to recognize gain on the

transfer under section 1032.

Commenters also suggested that contributions by U.S. persons to foreign

compensatory trusts described in sections 402(b), 404(a)(4), or 404A

should be exempt from gain recognition under section 684. Treasury and

the IRS have considered the proposed exception but do not believe it is

consistent with the intended purpose of section 684. Accordingly, the

final regulations do not include an exception for transfers to foreign

compensatory trusts. However, the exception for transfers of stock to

which section 1032 would apply may be available in appropriate cases for

transfers of stock of a domestic parent company to a foreign compensatory

trust set up by a foreign subsidiary.

Another commenter requested an exception for transfers of life

insurance contracts to foreign trusts. The commenter noted that the

proceeds of life insurance contracts do not generally give rise to any

taxable gain if held by a U.S. individual or trust. Congress has

recognized that life insurance contracts might be used to effectuate

inappropriate outbound transfers of property. As part of the repeal of

section 1491 in 1997, Congress enacted section 1035(c), which provides

regulatory authority to deny the nonrecognition treatment given to

exchanges of life insurance contracts under section 1035(a) where the

exchange has the effect of transferring property to any person other than

a U.S. person. Public Law 105-34, section 1131(b)[(c)](1). Because of

the potential for abuse and the lack of a compelling reason for creating

an exception for offshore transfers of life insurance contracts, Treasury

and the IRS have concluded that such an exception is not warranted.

IV. COMMENTS AND CHANGES TO SECTION 1.684-4: OUTBOUND MIGRATION OF

DOMESTIC TRUSTS

Section 1.684-4 of the proposed regulation provides that if a U.S.

person transfers property to a domestic trust and, for any reason, the

domestic trust becomes a foreign trust, the domestic trust will be deemed

to have transferred all of its assets to a foreign trust and the domestic

trust must immediately recognize gain. The proposed regulations do,

however, incorporate the relief for inadvertent migrations that is set

forth in section 301.7701-7(d)(2).

One commenter suggested that the final regulations should extend the

inadvertent migration rules of section 301.7701-7(d)(2) to apply to

section 301.7701-7(f), which deals with the election by certain trusts to

remain domestic trusts. Under section 301.7701-7(d)(2), in the event of

an inadvertent change in any person that has the power to make a

substantial decision of the trust that would cause the domestic or foreign

residency of the trust to change (e.g., an inadvertent change from a U.S.

trustee to a foreign trustee by reason of the U.S. trustee's death), the

trust is allowed 12 months to make necessary changes to avoid a change in

the trust's residency (e.g., the replacement of the foreign successor

trustee with a U.S. successor trustee).

The commenter suggests that a trust with an election in force under

section 301.7701-7(d)(2) should be allowed a similar amount of time to

make necessary changes if a U.S. trustee is inadvertently replaced by a

foreign trustee.

The final regulations do not include such a rule. Under section

301.7701-7(f), a trust generally can elect to remain a domestic trust if

it was in existence on August 20, 1996, and it was treated as a domestic

trust on August 19, 1996. Section 301.7701-7(f)(4)(ii) provides that such

an election terminates if subsequent changes are made to the trust that

result in the trust no longer having any reasonable basis for being

treated as a domestic trust under section 7701(a)(30) prior to its

amendment by the Small Business Job Protection Act of 1996 (SBJP Act),

Pub. L. 104-188, 110 Stat. 1755. Whereas the "control test" of section

7701(a)(30)(E)(ii), as enacted by the SBJP Act, contains a relatively

bright-line test for purposes of determining a trust's status, thereby

necessitating the inadvertent migration rule of section 301.7701-7(d)(2),

the determination of domestic or foreign status prior to the SBJP Act was

governed by less objective criteria.

Under pre-SBJP Act law, an inadvertent short-term replacement of a

domestic trustee by a foreign trustee would not necessarily cause a change

in the trust's status. Accordingly, a specific inadvertent migration rule

for section 301.7701-7(f) is not appropriate. Instead, as set forth in

section 301.7701-7(f)(4)(ii), an election under section 301.7701-7(f) will

not be terminated unless the trust has no reasonable basis for being

treated as a domestic trust under pre-SBJP Act law.

SPECIAL ANALYSES

It has been determined that this Treasury decision is not a significant

regulatory action as defined in Executive Order 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)

does not apply to these regulations and, because the regulations do not

impose a collection of information on small entities, the Regulatory

Flexibility Act (5 U.S.C. chapter 6) does not apply. Therefore, 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 submitted to the Chief Counsel for

Advocacy of the Small Business Administration for comment on its impact on

small businesses.

DRAFTING INFORMATION

The principal author of these regulations is Karen A. Rennie-Quarrie of

the Office of Associate Chief Counsel (International). 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 recordkeeping requirements.

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

entries in numerical order to read in part as follows:

Authority: 26 U.S.C. 7805 ? ? ?

Section 1.684-1 also issued under 26 U.S.C. 643(a)(7) and 684(a).

Section 1.684-2 also issued under 26 U.S.C. 643(a)(7) and 684(a).

Section 1.684-3 also issued under 26 U.S.C. 643(a)(7) and 684(a).

Section 1.684-4 also issued under 26 U.S.C. 643(a)(7) and 684(a).

Section 1.684-5 also issued under 26 U.S.C. 643(a)(7) and 684(a). * * *

Par. 2. Sections 1.684-1, 1.684-2, 1.684-3, 1.684-4 and 1.684-5 are

added under the undesignated centerheading “Miscellaneous” to read as

follows:

SECTION 1.684-1 RECOGNITION OF GAIN ON TRANSFERS TO CERTAIN FOREIGN

TRUSTS AND ESTATES.

(a) Immediate recognition of gain--

(1) In general. Any U.S. person who transfers property to a foreign

trust or foreign estate shall be required to recognize gain at the

time of the transfer equal to the excess of the fair market value of

the property transferred over the adjusted basis (for purposes of

determining gain) of such property in the hands of the U.S.

transferor unless an exception applies under the provisions of

section 1.684-3. The amount of gain recognized is determined on an

asset-by-asset basis.

(2) No recognition of loss. Under this section a U.S. person may not

recognize loss on the transfer of an asset to a foreign trust or

foreign estate. A U.S. person may not offset gain realized on the

transfer of an appreciated asset to a foreign trust or foreign estate

by a loss realized on the transfer of a depreciated asset to the

foreign trust or foreign estate.

(b) Definitions. The following definitions apply for purposes of this

section:

(1) U.S. person. The term U.S. person means a United States person

as defined in section 7701(a)(30), and includes a nonresident alien

individual who elects under section 6013(g) to be treated as a

resident of the United States.

(2) U.S. transferor. The term U.S. transferor means any U.S. person

who makes a transfer (as defined in section 1.684-2) of property to a

foreign trust or foreign estate.

(3) Foreign trust. Section 7701(a)(31)(B) defines foreign trust.

See also section 301.7701-7 of this chapter.

(4) Foreign estate. Section 7701(a)(31)(A) defines foreign estate.

foreign trust or foreign estate must comply with the reporting

requirements under section 6048.

(d) Examples. The following examples illustrate the rules of this

section. In all examples, A is a U.S. person and FT is a foreign trust.

The examples are as follows:

Example 1. Transfer to foreign trust. A transfers property that has

a fair market value of 1000X to FT. A’s adjusted basis in the

property is 400X. FT has no U.S. beneficiary within the meaning of

section 1.679-2, and no person is treated as owning any portion of

FT. Under paragraph (a)(1) of this section, A recognizes gain at the

time of the transfer equal to 600X.

Example 2. Transfer of multiple properties. A transfers property Q,

with a fair market value of 1000X, and property R, with a fair market

value of 2000X, to FT. At the time of the transfer, A’s adjusted

basis in property Q is 700X, and A’s adjusted basis in property R is

2200X. FT has no U.S. beneficiary within the meaning of section

1.679-2, and no person is treated as owning any portion of FT. Under

paragraph (a)(1) of this section, A recognizes the 300X of gain

attributable to property Q. Under paragraph (a)(2) of this section,

A does not recognize the 200X of loss attributable to property R, and

may not offset that loss against the gain attributable to property Q.

Example 3. Transfer for less than fair market value. A transfers

property that has a fair market value of 1000X to FT in exchange for

400X of cash. A’s adjusted basis in the property is 200X. FT has no

U.S. beneficiary within the meaning of section 1.679-2, and no person

is treated as owning any portion of FT. Under paragraph (a)(1) of

this section, A recognizes gain at the time of the transfer equal to

800X.

Example 4. Exchange of property for private annuity. A transfers

property that has a fair market value of 1000X to FT in exchange for

FT’s obligation to pay A 50X per year for the rest of A’s life. A’s

adjusted basis in the property is 100X. FT has no U.S. beneficiary

within the meaning of section 1.679-2, and no person is treated as

owning any portion of FT. A is required to recognize gain equal to

900X immediately upon transfer of the property to the trust. This

result applies even though A might otherwise have been allowed to

defer recognition of gain under another provision of the Internal

Revenue Code.

Example 5. Transfer of property to related foreign trust in exchange

for qualified obligation. A transfers property that has a fair

market value of 1000X to FT in exchange for FT’s obligation to make

payments to A during the next four years. FT is related to A as

defined in section 1.679-1(c)(5). The obligation is treated as a

qualified obligation within the meaning of section 1.679-4(d), and no

person is treated as owning any portion of FT. A’s adjusted basis in

the property is 100X. A is required to recognize gain equal to 900X

immediately upon transfer of the property to the trust. This result

applies even though A might otherwise have been allowed to defer

recognition of gain under another provision of the Internal Revenue

Code. Section 1.684-3(d) provides rules relating to transfers for

fair market value to unrelated foreign trusts.

SECTION 1.684-2 TRANSFERS.

(a) In general. A transfer means a direct, indirect, or constructive

transfer.

(b) Indirect transfers--

(1) In general. Section 1.679-3(c) shall apply to determine if a

transfer to a foreign trust or foreign estate, by any person, is

treated as an indirect transfer by a U.S. person to the foreign trust

or foreign estate.

(2) Examples. The following examples illustrate the rules of this

paragraph (b). In all examples, A is a U.S. citizen, FT is a foreign

trust, and I is A’s uncle, who is a nonresident alien. The examples

are as follows:

Example 1. Principal purpose of tax avoidance. A creates and

funds FT for the benefit of A's cousin, who is a nonresident

alien. FT has no U.S. beneficiary within the meaning of section

1.679-2, and no person is treated as owning any portion of FT.

In 2004, A decides to transfer additional property with a fair

market value of 1000X and an adjusted basis of 600X to FT.

Pursuant to a plan with a principal purpose of avoiding the

application of section 684, A transfers the property to I. I

subsequently transfers the property to FT. Under paragraph (b)

of this section and section 1.679-3(c), A is treated as having

transferred the property to FT.

Example 2. U.S. person unable to demonstrate that intermediary

acted independently. A creates and funds FT for the benefit of

A’s cousin, who is a nonresident alien. FT has no U.S.

beneficiary within the meaning of section 1.679-2, and no person

is treated as owning any portion of FT. On July 1, 2004, A

transfers property with a fair market value of 1000X and an

adjusted basis of 300X to I, a foreign person. On January 1,

2007, at a time when the fair market value of the property is

1100X, I transfers the property to FT. A is unable to

demonstrate to the satisfaction of the Commissioner, under

section 1.679-3(c)(2)(ii), that I acted independently of A in

making the transfer to FT. Under paragraph (b) of this section

and section 1.679-3(c), A is treated as having transferred the

property to FT. Under paragraph (b) of this section and section

1.679-3(c)(3), I is treated as an agent of A, and the transfer

is deemed to have been made on January 1, 2007. Under section

1.684-1(a), A recognizes gain equal to 800X on that date.

if a transfer to a foreign trust or foreign estate is treated as a

constructive transfer by a U.S. person to the foreign trust or foreign

estate.

(d) Transfers by certain trusts--

(1) In general. If any portion of a trust is treated as owned by a

U.S. person, a transfer of property from that portion of the trust to

a foreign trust is treated as a transfer from the owner of that

portion to the foreign trust.

(2) Examples. The following examples illustrate the rules of this

paragraph (d). In all examples, A is a U.S. person, DT is a domestic

trust, and FT is a foreign trust. The examples are as follows:

Example 1. Transfer by a domestic trust. On January 1, 2001, A

transfers property which has a fair market value of 1000X and an

adjusted basis of 200X to DT. A retains the power to revoke DT.

On January 1, 2003, DT transfers property which has a fair

market value of 500X and an adjusted basis of 100X to FT. At

the time of the transfer, FT has no U.S. beneficiary as defined

in section 1.679-2 and no person is treated as owning any

portion of FT. A is treated as having transferred the property

to FT and is required to recognize gain of 400X, under section

1.684-1, at the time of the transfer by DT to FT.

Example 2. Transfer by a foreign trust. On January 1, 2001, A

transfers property which has a fair market value of 1000X and an

adjusted basis of 200X to FT1. At the time of the transfer, FT1

has a U.S. beneficiary as defined in section 1.679-2 and A is

treated as the owner of FT1 under section 679. On January 1,

2003, FT1 transfers property which has a fair market value of

500X and an adjusted basis of 100X to FT2. At the time of the

transfer, FT2 has no U.S. beneficiary as defined in section

1.679-2 and no person is treated as owning any portion of FT2.

A is treated as having transferred the property to FT2 and is

required to recognize gain of 400X, under section 1.684-1, at

the time of the transfer by FT1 to FT2.

(e) Deemed transfers when foreign trust no longer treated as owned by a

U.S. person--

(1) In general. If any portion of a foreign trust is treated as

owned by a U.S. person under subpart E of part I of subchapter J,

chapter 1 of the Internal Revenue Code, and such portion ceases to be

treated as owned by that person under such subpart (other than by

reason of an actual transfer of property from the trust to which

section 1.684-2(d) applies), the U.S. person shall be treated as

having transferred, immediately before (but on the same date that)

the trust is no longer treated as owned by that U.S. person, the

assets of such portion to a foreign trust.

(2) Examples. The following examples illustrate the rules of this

paragraph (e). In all examples, A is a U.S. citizen and FT is a

foreign trust. The examples are as follows:

Example 1. Loss of U.S. beneficiary.

(i) On January 1, 2001, A transfers property, which has a

fair market value of 1000X and an adjusted basis of 400X,

to FT. At the time of the transfer, FT has a U.S.

beneficiary within the meaning of section 1.679-2, and A is

treated as owning FT under section 679. Under section

1.684-3(a), section 1.684-1 does not cause A to recognize

gain at the time of the transfer.

(ii) On July 1, 2003, FT ceases to have a U.S. beneficiary

as defined in section 1.679-2(c) and as of that date

neither A nor any other person is treated as owning any

portion of FT. Pursuant to section 1.679-2(c)(2), if FT

ceases to be treated as having a U.S. beneficiary, A will

cease to be treated as owner of FT beginning on the first

day of the first taxable year following the last taxable

year in which there was a U.S. beneficiary. Thus, on

January 1, 2004, A ceases to be treated as owner of FT. On

that date, the fair market value of the property is 1200X

and the adjusted basis is 350X. Under paragraph (e)(1) of

this section, A is treated as having transferred the

property to FT on January 1, 2004, and must recognize 850X

of gain at that time under section 1.684-1.

Example 2. Death of grantor.

(i) The initial facts are the same as in paragraph (i) of

Example 1.

(ii) On July 1, 2003, A dies, and as of that date no other

person is treated as the owner of FT. On that date, the

fair market value of the property is 1200X, and its

adjusted basis equals 350X. Under paragraph (e)(1) of this

section, A is treated as having transferred the property to

FT immediately before his death, and generally is required

to recognize 850X of gain at that time under section 1.684-

1. However, an exception may apply under section 1.684-

3(c).

Example 3. Release of a power.

(i) On January 1, 2001, A transfers property that has a

fair market value of 500X and an adjusted basis of 200X to

FT. At the time of the transfer, FT does not have a U.S.

beneficiary within the meaning of section 1.679-2.

However, A retains the power to revoke the trust. A is

treated as the owner of the trust under section 676 and,

therefore, under section 1.684-3(a), A is not required to

recognize gain under section 1.684-1 at the time of the

transfer.

(ii) On January 1, 2007, A releases the power to revoke the

trust and, as of that date, neither A nor any other person

is treated as owning any portion of FT. On that date, the

fair market value of the property is 900X, and its adjusted

basis is 200X. Under paragraph (e)(1) of this section, A

is treated as having transferred the property to FT on

January 1, 2007, and must recognize 700X of gain at that

time.

(f) Transfers to entities owned by a foreign trust. Section 1.679-3(f)

provides rules that apply with respect to transfers of property by a U.S.

person to an entity in which a foreign trust holds an ownership interest.

SECTION 1.684-3 EXCEPTIONS TO GENERAL RULE OF GAIN RECOGNITION.

(a) Transfers to grantor trusts. The general rule of gain recognition

under section 1.684-1 shall not apply to any transfer of property by a

U.S. person to a foreign trust to the extent that any person is treated as

the owner of the trust under section 671. Section 1.684-2(e) provides

rules regarding a subsequent change in the status of the trust.

(b) Transfers to charitable trusts. The general rule of gain recognition

under section 1.684-1 shall not apply to any transfer of property to a

foreign trust that is described in section 501(c)(3) (without regard to

the requirements of section 508(a)).

under section 1.684-1 shall not apply to any transfer of property by

reason of death of the U.S. transferor if the basis of the property in the

hands of the foreign trust is determined under section 1014(a).

(d) Transfers for fair market value to unrelated trusts. The general rule

of gain recognition under section 1.684-1 shall not apply to any transfer

of property for fair market value to a foreign trust that is not a related

foreign trust as defined in section 1.679-1(c)(5). Section 1.671-

2(e)(2)(ii) defines fair market value.

(e) Transfers to which section 1032 applies. The general rule of gain

recognition under section 1.684-1 shall not apply to any transfer of stock

(including treasury stock) by a domestic corporation to a foreign trust if

the domestic corporation is not required to recognize gain on the transfer

under section 1032.

(f) Certain distributions to trusts. For purposes of this section, a

transfer does not include a distribution to a trust with respect to an

interest held by such trust in an entity other than a trust or an interest

in certain investment trusts described in section 301.7701-4(c) of this

chapter, liquidating trusts described in section 301.7701-4(d) of this

chapter, or environmental remediation trusts described in section 301.7701-

4(e) of this chapter.

(g) Examples. The following examples illustrate the rules of this

section. In all examples, A is a U.S. citizen and FT is a foreign trust.

The examples are as follows:

Example 1. Transfer to owner trust. In 2001, A transfers property

which has a fair market value of 1000X and an adjusted basis equal to

400X to FT. At the time of the transfer, FT has a U.S. beneficiary

within the meaning of section 1.679-2, and A is treated as owning FT

under section 679. Under paragraph (a) of this section, section

1.684-1 does not cause A to recognize gain at the time of the

transfer. See section 1.684-2(e) for rules that may require A to

recognize gain if the trust is no longer owned by A.

Example 2. Transfer of property at death: Basis determined under

section 1014(a).

(i) The initial facts are the same as Example 1.

(ii) A dies on July 1, 2004. The fair market value at A’s death

of all property transferred to FT by A is 1500X. The basis in

the property is 400X. A retained the power to revoke FT, thus,

the value of all property owned by FT at A’s death is includible

in A’s gross estate for U.S. estate tax purposes. Pursuant to

paragraph (c) of this section, A is not required to recognize

gain under section 1.684-1 because the basis of the property in

the hands of the foreign trust is determined under section

1014(a).

Example 3. Transfer of property at death: Basis not determined

under section 1014(a).

(i) The initial facts are the same as Example 1.

(ii) A dies on July 1, 2004. The fair market value at A’s death

of all property transferred to FT by A is 1500X. The basis in

the property is 400X. A retains no power over FT, and FT’s

basis in the property transferred is not determined under

section 1014(a). Under section 1.684-2(e)(1), A is treated as

having transferred the property to FT immediately before his

death, and must recognize 1100X of gain at that time under

section 1.684-1.

Example 4. Transfer of property for fair market value to an

unrelated foreign trust. A sells a house with a fair market value of

1000X to FT in exchange for a 30-year note issued by FT. A is not

related to FT as defined in section 1.679-1(c)(5). FT is not treated

as owned by any person. Pursuant to paragraph (d) of this section, A

is not required to recognize gain under section 1.684-1.

SECTION 1.684-4 OUTBOUND MIGRATIONS OF DOMESTIC TRUSTS.

(a) In general. If a U.S. person transfers property to a domestic trust,

and such trust becomes a foreign trust, and neither trust is treated as

owned by any person under subpart E of part I of subchapter J, chapter 1

of the Internal Revenue Code, the trust shall be treated for purposes of

this section as having transferred all of its assets to a foreign trust

and the trust is required to recognize gain on the transfer under section

1.684-1(a). The trust must also comply with the rules of section 6048.

(b) Date of transfer. The transfer described in this section shall be

deemed to occur immediately before, but on the same date that, the trust

meets the definition of a foreign trust set forth in section

7701(a)(31)(B).

defined in section 301.7701-7(d)(2) of this chapter, a trust may avoid the

application of this section by complying with the procedures set forth in

section 301.7701-7(d)(2) of this chapter.

(d) Examples. The following examples illustrate the rules of this

section. In all examples, A is a U.S. citizen, B is a U.S. citizen, C is

a nonresident alien, and T is a trust. The examples are as follows:

Example 1. Migration of domestic trust with U.S. beneficiaries. A

transfers property which has a fair market value of 1000X and an

adjusted basis equal to 400X to T, a domestic trust, for the benefit

of A’s children who are also U.S. citizens. B is the trustee of T.

On January 1, 2001, while A is still alive, B resigns as trustee and

C becomes successor trustee under the terms of the trust. Pursuant

to section 301.7701-7(d) of this chapter, T becomes a foreign trust.

T has U.S. beneficiaries within the meaning of section 1.679-2 and A

is, therefore, treated as owning FT under section 679. Pursuant to

section 1.684-3(a), neither A nor T is required to recognize gain at

the time of the migration. Section 1.684-2(e) provides rules that

may require A to recognize gain upon a subsequent change in the

status of the trust.

Example 2. Migration of domestic trust with no U.S. beneficiaries.

A transfers property which has a fair market value of 1000X and an

adjusted basis equal to 400X to T, a domestic trust for the benefit

of A’s mother who is not a citizen or resident of the United States.

T is not treated as owned by another person. B is the trustee of T.

On January 1, 2001, while A is still alive, B resigns as trustee and

C becomes successor trustee under the terms of the trust. Pursuant

to section 301.7701-7(d) of this chapter, T becomes a foreign trust,

FT. FT has no U.S. beneficiaries within the meaning of section 1.679-

2 and no person is treated as owning any portion of FT. T is

required to recognize gain of 600X on January 1, 2001. Paragraph (c)

of this section provides rules with respect to an inadvertent

migration of a domestic trust.

SECTION 1.684-5 EFFECTIVE DATE

Sections 1.684-1 through 1.684-4 apply to transfers of property to

foreign trusts and foreign estates after August 7, 2000.

/s/ Robert E. Wenzel

Deputy Commissioner of Internal Revenue

Approved: July 9, 2001

/s/ Mark Weinberger

Assistant Secretary of the Treasury

(Tax Policy)

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