Rev. Rul. 78-371

ISSUE

Is an arrangement established to hold title to, conserve and protect, and hold for investment purposes certain undivided interests in a number of contiguous parcels of real estate classified for federal income tax purposes as a trust or as an association taxable as a corporation?

FACTS

The heirs to a number of contiguous parcels of real estate established a real estate trust, T. T is to collect the income from the real estate and to distribute such income to the heirs.

The real estate transferred to T is subject to a net lease, which provides that the lessee will pay all property taxes, betterment assessments, water rates, sewer and utility charges, and fire and general public liability insurance. The lessee is required to manage, maintain, and repair the property under the terms of the lease.

The property transferred to T was allocated on its books in undivided fractional interests, corresponding to each heir's interest in the property contributed.

All the income of T is required to be distributed quarterly. T's governing instrument may be amended by the consent of all the beneficiaries, and T will terminate 30 years from the date of its creation, unless terminated earlier by the consent of all the beneficiaries.

Upon an express determination by the trustees that it is necessary to conserve or protect T's real estate, beneficiaries or members of their families may contribute to T interests in real estate adjacent or contiguous to the real estate held in trust by T, in which event such persons shall become additional beneficiaries.

If necessary to conserve and protect the value of T's real estate, the trustees of T have the power to accept from any source and retain real estate contiguous or adjacent to the trust's real estate. The trustees also have the power to sell any real estate of the trust, and may purchase any real estate adjacent or contiguous to the real estate originally contributed to T, including any tangible personal property located on such real estate. Funds derived from the sale of property held by T and not reinvested in real estate can only be invested in certificates of deposits, or obligations of federal or state governments.

The trustees are further empowered to borrow money, mortgage and lease property, raze or erect any building or other structure, and make any improvements they deem proper.

LAW AND ANALYSIS

Section 301.7701-4(a) of the Procedure and Administration Regulations provides that, in general, the term "trust" as used in the Code refers to an arrangement created by a will or by an inter vivos declaration whereby trustees take title to property for the purpose of protecting or conserving it for the beneficiaries under the ordinary rules applied in chancery or probate courts. Generally speaking, an arrangement will be treated as a trust under the Code if it can be shown that the purpose of the arrangement is to vest in trustees responsibility for the protection and conservation of property for beneficiaries who cannot share in the discharge of this responsibility and, therefore, are not associates in a joint enterprise for the conduct of business for profit.

Section 301.7701-4(b) of the regulations states, in part, that there are other arrangements that are known as trusts because the legal title to property is conveyed to trustees for the benefit of beneficiaries, but which are not classified as trusts for purposes of the Code because they are not simply arrangements to protect or conserve the property for the beneficiaries. These trusts, which are often known as business or commercial trusts, generally are created by the beneficiaries simply as a device to carry on a profit-making business that normally would have been carried on through business organizations that are classified as corporations or partnerships under the Code.

Under section 301.7701-2(a)(2) of the regulations, the determination whether a trust is to be treated for federal tax purposes as a trust or as an association depends on whether there are associates and an objective to carry on business and divide the gains therefrom.

In Wyman Building Trust v. Commissioner, 45 B.T.A. 155 (1941), acq., 1941-2 C.B. 14, the United States Board of Tax Appeals held that a trust created by the heirs of a decedent, who owned a single piece of property under lease, was not a corporation. The Board in Wyman found that the trust's purpose was to provide a convenient authority for executing and extending the lease on behalf of the more cumbersome group of beneficial owners, and for receiving and distributing the income of the property. In Wyman, the trustees were restricted to dealing with a single piece of property and the lessee of the property was required to pay all expenses, including taxes and repairs. The Board found these factors persuasive in determining that the trust was not carrying on a business and sharing the gains therefrom but was performing the functions of a trust by protecting and conserving property. In Sears v. Hassett, 111 F.2d 961 (1st Cir. 1940), the United States Circuit Court of Appeals held that an entity that was created by its beneficiaries as a trust under local law should be classified as an association for federal income tax purposes because the trustees were empowered to engage in extensive real estate operations and to invest and reinvest in securities. The trustees had wide powers to buy and sell real estate, to improve and develop the same by the erection of buildings or otherwise, to repair or rebuild any building damaged by fire or otherwise, and to lease the property. In considering the power to buy and lease property the court quoted from the trust indenture as follows:

The trustees may purchase with such funds as they may from time to time have in their hands any real estate or any interest in real estate encumbered or unencumbered, and may hire and become lessees of any property, easement or right, the use of which is, in their judgment, advantageous to real estate held hereunder.

The taxpayers contended that this provision did not confer an unrestricted power to purchase land, but that the power to purchase as well as the power to become lessees of land was limited by the last clause stating "the use of which is, in their judgement, advantageous to real estate held thereunder." The court did not adopt the taxpayers' interpretation of this provision, but stated that even if it had, its conclusion would not be different.

While the facts in the instant case are similar to the facts in Wyman, the trustees of T also have the power to purchase and sell contiguous or adjacent real estate, and to accept and retain contributions of contiguous or adjacent real estate from the beneficiaries or members of their families. The trustees have the further power to raze or erect any building or other structure and make any improvements they deem proper on the land originally donated to the trust or on any adjacent or contiguous land subsequently acquired by the trust. The trustees are also empowered to borrow money and to mortgage and lease the property. These additional powers taken together indicate that the trustees of T are empowered to do more than merely protect and conserve the trust's property. Thus, the arrangement, in the instant case, is similar to the trust ruled to be an association in the Sears case.

HOLDING

The arrangement is classified as an association taxable as a corporation for federal income tax purposes.