2.3.3.1 Losses were permitted to estates (but not trusts) upon a sale or exchange of property with a beneficiary because the relationship between an estate and the beneficiary of an estate were not treated as “related” for purposes of I.R.C. Sec. 267.
2.3.3.1.1 This rule permitted estates (but not trusts) to elect to recognize losses on distribution of depreciated assets to a beneficiary. I.R.C. Sec. 643(e).
2.3.3.1.2 The Taxpayer Relief Act of 1997 amended the law to include an executor of an estate and the beneficiary as related parties under I.R.C. Sec. 267(b)(13).
2.3.3.1.3 The 1997 amendment, however, did not change the rule “in the case of a sale or exchange in satisfaction of a pecuniary bequest.” I.R.C. Sec. 267(b)(13).
2.3.3.1.4 The result of the change to I.R.C. Sec. 267 means that losses upon in-kind distributions are no longer generally available under a Sec. 643(e) election, but are still available if the depreciated property is used to fund a pecuniary bequest.
2.3.3.1.5 “This new restriction effectively revokes the I.R.C. Sec. 643(e) election to treat funding in-kind distributions as a taxable event when this involves a depreciated asset and a deductible loss otherwise would have been created. The realization of a loss can now only occur when the distribution of a passive activity is made in funding a pecuniary bequest, and not as heretofore, upon Sec. 643(e) election in a funding of a fractional share or residuary bequest.” Abbin, “Income Taxation of Fiduciaries and Beneficiaries” (Panel, 1990) at 760.
2.3.3.2 Thus, losses are recognized by estates (but not trusts) when a pecuniary legacy – including, of course, a marital pecuniary bequest – is satisfied by a distribution in kind. I.R.C. Sec. 267 prohibits the trust from recognizing losses upon the distribution of property in kind. [Sec. 267(d) excludes from income of the beneficiary any gain attributable to the disallowed loss in a later sale of the asset.]
2.3.3.3 “A fiduciary who wishes to dispose of an asset with a basis higher than its current market value should usually sell the asset and distribute the proceeds to the beneficiaries, rather than distributing the asset in kind. The fiduciary can then deduct the recognized loss on the sale and use that loss to offset gains it may have or as the basis for a capital loss carryover.” Lane & Zaritsky, Federal Income Taxation of Estates and Trusts, ¶ 4.11[1][c], (Warren, Gorham & Lamont, 2004).
