Rev. Rul. 77-299

Advice has been requested with respect to the Federal gift tax consequences of a transfer of property under the circumstances described below.

G had given A and B, G's grandchildren, $3,000 per year at Christmas since each grandchild was 10 years old. When A and B were, respectively, 21 and 22 years old and enrolled in graduate school, G proposed to give Blackacre, with a fair market value of $27,000, to A and Whiteacre, with a fair market value of $24,000, to B. Both Blackacre and Whiteacre were unimproved tracts of nonincome-producing real property. A and B had spent the money previously given them by G, did not have any other funds, and did not have an independent source of income. When informed of G's intent, G's attorney, in order to minimize G's Federal gift tax on the transfer, suggested a sale of the property to each grandchild in return for installment notes that would be payable in yearly amounts equal to the annual gift tax exclusion.

The plan was implemented in July 1972, at which time A and B each received a package of instruments in the mail from G's attorney. A's package contained a check from G for $50, a deed to Blackacre, a mortgage on the property, one note with a face amount of $2,950 and eight notes each in the amount of $3,000. B's package contained a check from G for $50, a deed to Whiteacre, a mortgage on the property, one note with a face amount of $2,950 and seven notes each in the amount of $3,000. A letter also accompanied each package explaining the transaction to A and B and indicating that G did not intend to collect on the notes, but intended to forgive each payment as it became due. A and B did not have prior knowledge of the transaction. There were no negotiations concerning the transaction, and G's attorney represented all of the parties to the transaction.

The notes were noninterest-bearing and nonnegotiable. The notes provided that A owed $26,950 on Blackacre and B owed $23,950 on Whiteacre. The first note of each grandchild in the amount of $2,950 matured on January 1, 1973, and each additional note in the amount of $3,000 matured on January 1 of each succeeding year. Each of the deeds recited that it was given in consideration of a cash payment of $50 and the notes. Additionally, each deed described the notes and recited that the mortgages on the property were taken to secure the payment of the notes. The deeds, mortgage, and notes were executed on July 15, 1973, and at the same time A and B each transferred $50 to G. Thereafter, the deeds (but not the mortgages) were recorded with the proper county authorities.

On December 25, 1972, G forgave the $2,950 due from A and B on January 1, 1973. On December 25 of 1973 and 1974, G forgave the $3,000 due from A and B on January 1 of the following years.

The specific question presented is whether the transfer of the property in return for the notes secured by a purchase money mortgage was a bona fide sale between the parties or whether the transaction was in substance a gift of the transferor's entire interest in the property structured to avoid the Federal gift tax.

Section 2501 of the Internal Revenue Code of 1954 imposes a tax on the transfer of property by gift. The gift tax applies, under the provisions of section 2511 of the Code and section 25.2511-1(a) of the Gift Tax Regulations, whether the transfer is in trust or otherwise and whether the gift is direct or indirect. Thus, the gift tax applies to all transactions whereby property or property rights or interests are gratuitously passed or conferred upon another, regardless of the means or device employed. See section 25.2511-1(c) of the regulations.

In the case of present interests, section 2503 of the Code excludes $3,000 of gifts per calendar year for each donee from gifts subject to the gift tax.

Section 2512 of the Code provides that when property is transferred for less than an adequate and full consideration in money or money's worth, the amount by which the value of the property exceeds the value of the consideration shall be deemed a gift and shall be included in computing the amount of gift made during the calendar year.

Section 25.2512-8 of the regulations states:

Transfers reached by the gift tax are not confined to those only which, being without a valuable consideration, accord with the common law concept of gifts, but embrace as well sales, exchanges, and other dispositions of property for a consideration to the extent that the value of the property transferred by the donor exceeds the value in money or money's worth of the consideration given therefor. However, a sale, exchange, or other transfer of property made in the ordinary course of business (a transaction which is bona fide, at arm's length, and free from any donative intent), will be considered as made for an adequate and full consideration in money or money's worth.

In Minnie E. Deal, 29 T.C. 730 (1958), the taxpayer transferred in trust a remainder interest in unimproved, nonincome-producing property to the taxpayer's children in return for noninterest-bearing, unsecured demand notes. The taxpayer cancelled $3,000 of each child's indebtedness each year until the balance due was completely cancelled. The Tax Court held the notes executed by the children were not intended as consideration for the transfer and, rather than a bona fide sale, the taxpayer made a gift of the remainder interest to the children. A similar result was reached in Estate of Pearl Gibbons Reynolds, 55 T.C. 172, 202 (1970), and a similar rationale was applied in Marie-Anne De Goldschmidt-Rothschild, 9 T.C. 325 (1947), aff'd 168 F. 2d 975 (2d. Cir. 1948).

Thus, in the instant case, whether the transfer of property was a sale or a gift depends upon whether, as part of a prearranged plan, G intended to forgive the notes that were received when G transferred the property.

It should be noted that the intent to forgive notes is to be distinguished from donative intent, which, as indicated by section 25.2511-1(g)(1) of the regulations, is not relevant. A finding of an intent to forgive the note relates to whether valuable consideration was received and, thus, to whether the transaction was in reality a bona fide sale or a disguised gift. Therefore, such an inquiry is necessary in situations such as the one described here. See 5 Mertens, Law of Federal Gift and Estate Taxation, section 34.03 (1959). "Nothing can be treated as consideration that is not intended as such by the parties." Fire Insurance Association v. Wickham, 141 U.S. 579 (1891). Donative intent, on the other hand, rather than relating to whether a transaction was actually a sale or a gift, relates to whether the donor intended the transaction to be a sale or a gift. Although the same facts would be used in determining either type of intent, they relate to two entirely different inquiries.

In the instant case, the facts clearly indicate that G, as part of a prearranged plan, intended to forgive the notes that were received in return for the transfer of G's land. Therefore, the transaction was merely a disguised gift rather than a bona fide sale.

The Service will not follow the decisions in Selsor R. Haywood, 42 T.C. 936 (1964), acq. in result, 1965-1 C.B. 4, nonacq., 1977-2 C.B. 2, and J.W. Kelley, 63 T.C. 321 (1974), nonacq., 1977-2 C.B. 2, that held that forgiveness of notes constituted a gift of a present interest, under circumstances similar to the present ruling.

Accordingly, for Federal gift tax purposes, G made a transfer by gift to A in 1972 in the amount of $27,000. In addition, G made a transfer by gift to B in 1972 in the amount of $24,000.