Upon the grantor’s death, the trust ceases to be a grantor trust, and IRC § 684 applies. This section triggers a deemed sale of the trust’s assets at fair market value (FMV) immediately before the termination of grantor trust status.
However, this section does only apply to foreign grantor trust. Let’s break this down for both types of trusts:
1. Foreign Grantor Trust
a. Completed Gift to a Foreign Grantor Trust
If the grantor makes a completed gift to a foreign grantor trust, the trust assets are not included in the grantor’s estate at death.
Upon the grantor’s death, the trust ceases to be a grantor trust, and IRC § 684 applies. This section triggers a deemed sale of the trust’s assets at fair market value (FMV) immediately before the termination of grantor trust status.
The trust must recognize any capital gains on the deemed sale, calculated as the difference between the FMV of the assets and their adjusted basis.
The trust (or the grantor’s estate) is responsible for paying the capital gains tax on the deemed sale.
b. Why IRC § 684 Applies to Foreign Grantor Trusts
IRC § 684 specifically applies to foreign trusts that are no longer treated as grantor trusts. The deemed sale rule is designed to prevent the avoidance of U.S. capital gains tax when a foreign trust ceases to be a grantor trust.
Example 1: Foreign Grantor Trust
A grantor establishes a foreign grantor trust and makes a completed gift of $1,000,000 in cash to the trust.
The trust uses the cash to purchase real estate, which appreciates to $1,500,000 by the time of the grantor’s death.
Upon the grantor’s death, the trust ceases to be a grantor trust, and IRC § 684 applies.
The trust is deemed to have sold the real estate for 1,500,000,recognizinga1,500,000,recognizinga500,000 capital gain.
The trust (or the grantor’s estate) pays capital gains tax on the $500,000 gain.
2. Domestic Grantor Trust
a. Completed Gift to a Domestic Grantor Trust
If the grantor makes a completed gift to a domestic grantor trust, the trust assets are not included in the grantor’s estate at death.
Upon the grantor’s death, the trust ceases to be a grantor trust, but IRC § 684 does not apply because it only applies to foreign trusts.
Instead, the trust becomes a separate taxable entity (either a complex trust or a simple trust) and must file Form 1041 to report its income.
The trust does not recognize capital gains on a deemed sale of its assets. Instead, capital gains are recognized only when the trust actually sells the assets.
b. Why IRC § 684 Does Not Apply to Domestic Grantor Trusts
IRC § 684 applies only to foreign trusts. Domestic trusts are not subject to the deemed sale rule when they cease to be grantor trusts.
Example 2: Domestic Grantor Trust
A grantor establishes a domestic grantor trust and makes a completed gift of $1,000,000 in cash to the trust.
The trust uses the cash to purchase real estate, which appreciates to $1,500,000 by the time of the grantor’s death.
Upon the grantor’s death, the trust ceases to be a grantor trust, but IRC § 684 does not apply.
The trust becomes a separate taxable entity and does not recognize capital gains on a deemed sale.
If the trust later sells the real estate for 1,500,000,itwillrecognizea1,500,000,itwillrecognizea500,000 capital gain at that time.
3. Key Differences Between Foreign and Domestic Grantor Trusts
Aspect
Foreign Grantor Trust
Domestic Grantor Trust
Deemed Sale Under IRC § 684
Applies upon termination of grantor trust status. Trust must recognize capital gains.
Does not apply. No deemed sale occurs.
Capital Gains Tax
Triggered on deemed sale at FMV. Trust (or estate) pays tax on appreciation.
Capital gains tax is deferred until the trust actually sells the assets.
Estate Tax Inclusion
Assets are not included in the grantor’s estate if the gift was completed.
Assets are not included in the grantor’s estate if the gift was completed.
Step-Up in Basis
No step-up in basis unless assets are included in the grantor’s estate.
No step-up in basis unless assets are included in the grantor’s estate.
Disclaimers
This explanation is intended for informational purposes only and does not constitute legal, tax, or financial advice. The application of trust and estate tax laws depends on the specific facts and circumstances of each case. Tax laws and regulations are complex and subject to change. You should consult a qualified tax professional or attorney for advice tailored to your situation. The author and the law firm disclaim any liability for actions taken or not taken based on the content of this explanation.
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Cynthia Wu is the Founder and Managing Partner of a law firm, with a strong legal background encompassing complex business litigation, probate, and guardianship cases. She holds a Juris Doctor degree from the University of Arizona and an LLM in Taxation from the University of Florida. Cynthia's experience spans estate planning, probate, and business litigation, and she is admitted to practice law in California, the District of Columbia, Texas, and Florida, as well as before the U.S. Tax Court and the Chinese National Bar.
IRC § 684 (the deemed sale rule) on Foreign Grantor Trust
Upon the grantor’s death, the trust ceases to be a grantor trust, and IRC § 684 applies. This section triggers a deemed sale of the trust’s assets at fair market value (FMV) immediately before the termination of grantor trust status.
However, this section does only apply to foreign grantor trust. Let’s break this down for both types of trusts:
1. Foreign Grantor Trust
a. Completed Gift to a Foreign Grantor Trust
If the grantor makes a completed gift to a foreign grantor trust, the trust assets are not included in the grantor’s estate at death.
Upon the grantor’s death, the trust ceases to be a grantor trust, and IRC § 684 applies. This section triggers a deemed sale of the trust’s assets at fair market value (FMV) immediately before the termination of grantor trust status.
The trust must recognize any capital gains on the deemed sale, calculated as the difference between the FMV of the assets and their adjusted basis.
The trust (or the grantor’s estate) is responsible for paying the capital gains tax on the deemed sale.
b. Why IRC § 684 Applies to Foreign Grantor Trusts
IRC § 684 specifically applies to foreign trusts that are no longer treated as grantor trusts. The deemed sale rule is designed to prevent the avoidance of U.S. capital gains tax when a foreign trust ceases to be a grantor trust.
Example 1: Foreign Grantor Trust
A grantor establishes a foreign grantor trust and makes a completed gift of $1,000,000 in cash to the trust.
The trust uses the cash to purchase real estate, which appreciates to $1,500,000 by the time of the grantor’s death.
Upon the grantor’s death, the trust ceases to be a grantor trust, and IRC § 684 applies.
The trust is deemed to have sold the real estate for 1,500,000,recognizinga1,500,000,recognizinga500,000 capital gain.
The trust (or the grantor’s estate) pays capital gains tax on the $500,000 gain.
2. Domestic Grantor Trust
a. Completed Gift to a Domestic Grantor Trust
If the grantor makes a completed gift to a domestic grantor trust, the trust assets are not included in the grantor’s estate at death.
Upon the grantor’s death, the trust ceases to be a grantor trust, but IRC § 684 does not apply because it only applies to foreign trusts.
Instead, the trust becomes a separate taxable entity (either a complex trust or a simple trust) and must file Form 1041 to report its income.
The trust does not recognize capital gains on a deemed sale of its assets. Instead, capital gains are recognized only when the trust actually sells the assets.
b. Why IRC § 684 Does Not Apply to Domestic Grantor Trusts
IRC § 684 applies only to foreign trusts. Domestic trusts are not subject to the deemed sale rule when they cease to be grantor trusts.
Example 2: Domestic Grantor Trust
A grantor establishes a domestic grantor trust and makes a completed gift of $1,000,000 in cash to the trust.
The trust uses the cash to purchase real estate, which appreciates to $1,500,000 by the time of the grantor’s death.
Upon the grantor’s death, the trust ceases to be a grantor trust, but IRC § 684 does not apply.
The trust becomes a separate taxable entity and does not recognize capital gains on a deemed sale.
If the trust later sells the real estate for 1,500,000,itwillrecognizea1,500,000,itwillrecognizea500,000 capital gain at that time.
3. Key Differences Between Foreign and Domestic Grantor Trusts
Aspect
Foreign Grantor Trust
Domestic Grantor Trust
Deemed Sale Under IRC § 684
Applies upon termination of grantor trust status. Trust must recognize capital gains.
Does not apply. No deemed sale occurs.
Capital Gains Tax
Triggered on deemed sale at FMV. Trust (or estate) pays tax on appreciation.
Capital gains tax is deferred until the trust actually sells the assets.
Estate Tax Inclusion
Assets are not included in the grantor’s estate if the gift was completed.
Assets are not included in the grantor’s estate if the gift was completed.
Step-Up in Basis
No step-up in basis unless assets are included in the grantor’s estate.
No step-up in basis unless assets are included in the grantor’s estate.
Disclaimers
This explanation is intended for informational purposes only and does not constitute legal, tax, or financial advice. The application of trust and estate tax laws depends on the specific facts and circumstances of each case. Tax laws and regulations are complex and subject to change. You should consult a qualified tax professional or attorney for advice tailored to your situation. The author and the law firm disclaim any liability for actions taken or not taken based on the content of this explanation.