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A trust may deduct as qualified residence interest expense, subject to limitations, interest paid on a residence it owns if it is a qualified residence of a beneficiary who has a present or residuary interest in the trust.
My question regards the definition of present and residuary interest.
The residence, a vacation home, is held in a GST trust under which the trustee has discretionary power to distribute income and or principal to the grantor's surviving spouse and or descendants who are then living.
Grantor's spouse has a testamentary power of appointment limited to the descendants of her and grantor or to charity.
If the power is not exercised, the trust estate is divided into separate trusts for each of grantor and spouse's children (the "primary beneficiaries") for their lives with discretionary distributions to the primary beneficiaries and their descendants.
The primary beneficiary has discretionary power, during lifetime, to direct the trustee to distribute principal to his or her descendants and has a testamentary power to appoint assets to persons or entities other than himself, his estate, or his creditors.
If the assets aren't distributed by the above powers, they are divided into separate trusts for each child of a primary beneficiary who has the same powers as the primary beneficiary before him.
I assume that no one here is considered to have a present interest in the trust assets. Am I correct on that?
Under these terms is anybody considered to have a "residuary interest" that would allow, if they used the property as a residence, the trust to deduct mortgage interest as interest on a second residence?
I realize this isn't really an estate or gift tax question but thought It might be appropriate for this board.
Thank you in advance for any advice you have on this.
Richard Cassidy, CPA
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You might look at Cristofani,
http://purdue.giftlegacy.com/giftlaw/glawpro_cases.jsp?WebID=GL2007-1252&ID=31
an example of tax litigation over the issue of present v. future interest. Looks to me like the s/s and the Decedent's issue qualify as present beneficiaries, and the issue of both qualify as future beneficiaries.
John Jacobson
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John,
In Cristofani, wasn't it the fact that the beneficiaries had a right to demand a distribution from the trust that created the present interest? In my case, the beneficiaries have no rights to demand a distribution and no rights to receive a distribution except at the trustee's discretion. That's why I don't think they have a present interest. Am I missing something there?
The fact that no currently living beneficiary ever has a right to a distribution, except at the discretion of the trustee, makes me wonder if they even hold a residuary interest.
Thanks for the reply and your time.
Richard Cassidy
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The "distribution" I am thinking of is use of the vacation home. I'm not sure whether this could be thought of as an "accumulation" under Civil Code Section 722 because the use is a function of time. Does the trustee charge rent for each use?
John Jacobson
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John,
No, the trustee does not charge rent. I agree that the use of the vacation home would be considered a distribution. But there is nothing in the trust telling the beneficiary he has a "right" to use the property. That's why I don't think it fits the definition of a present interest as addressed in Christofani. No right to the immediate use or enjoyment of the property.
Thanks again
Richard Cassidy
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| What's different in your case (from the typical "accumulation" future interest as explained in Cristofani) is that use of the residence is a function of time. In other words, one could look at this as the trustee granting one of the present beneficiaries the right to use the property for a set period (i.e. one month) and for that time, the beneficiary appears to have a "limited present interest," at least under California law. (See Calif. Civil Code Sec. 688 and following.) Without research, I realize this may be untested territory, but if you can't say its investment interest because the trustee is not charging rent ..... I would be curious if any of the tax cases distinguish between limited and perpetual present interests.
John Jacobson
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Just a thought to follow up on John's lastest comment. Holding property for appreciation could give rise to a classification as investment interest. Interest paid on rental proprty would be passive.
Mary Kay Foss
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John,
Thanks again for the time.
Civil code Sec. 689 says that “a present interest entitles the owner to the immediate possession of the property”. I don’t know that the trustee’s discretion to make distributions or allow use of the property would be considered to convey an “entitlement” to possession, immediate or otherwise. I guess that’s my problem. Does the mere fact that the trustee does let the beneficiary use the property create a present interest? I might assume so but wonder if I would be “more likely than not” to prevail on examination.
Mary Kay,
Thanks for the comment. I agree that I might take the interest as investment interest but if the beneficiary does use the property for personal purposes for over 14 days I was thinking that the IRS would argue that it is a residence under 280A(d)(1) and thus not allow it as investment interest expense and also not allow it as residence interest expense because the beneficiary doesn’t have “… a present interest in such estate or trust or an interest in the residuary of such estate or trust” as required by 163(h)(4)(d). Maybe I’m just reading too much into that requirement.
Thanks again,
Richard Cassidy
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That's the $64 question: whether you can find any support for this logic in the tax cases, or alternatively, whether this is an area of first impression. Maybe you can find a case that rests on an interpretation of state law about present and future interests, and extrapolate from there.
John Jacobson
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