Rev. Rul. 81-286

ISSUE

What amounts are includible under sections 2033 and 2035(a) of the Internal Revenue Code in the gross estate of an individual who transferred cash to the individual's child within 3 years of death in exchange for a term promissory note having a fair market value less than the amount of the transferred cash?

FACTS

On January 1, 1978, D made a loan of $1,000,000 to D's child, A, taking back a note that falls due December 31, 1988. The fair market value of the note on January 1, 1978, was $270,000. On January 1, 1980, D died. Under the terms of D's will, the promissory note was canceled. The estate did not elect to value D's property as of the alternate valuation date under section 2032 of the Code. The fair market value of the note as of the date of D's death was $305,000.

LAW AND ANALYSIS

The value of a promissory note owned by a decedent at death is includible in the decedent's gross estate. Notes are included even if they are canceled by a decedent's will. Section 20.2033-1(b) of the Estate Tax Regulations.

Section 2035(a) of the Code generally provides that a decedent's gross estate includes the value of all property interests that were transferred for less than an adequate and full consideration in money or money's worth within 3 years of the decedent's death. If a decedent made a transfer of cash, not in trust, the amount includible under section 2035(a) is the amount of the cash transferred, no matter how the donee used the cash. Humphrey's Estate v. Commissioner, 162 F.2d 1 (5th Cir.), cert. denied, 332 U.S. 817 (1947).

Section 2043(a) of the Code provides that if a transfer described in section 2035 is made for a partial consideration in money or money's worth, the gross estate must include only the excess of the fair market value of the property at the time of death (or alternate valuation date) over the value of the consideration the decedent received. The consideration the decedent received is valued as of the date of the transfer rather than as of the date of the decedent's death (or alternate valuation date). Section 20.2043-1(a) of the regulations; United States v. Righter, 400 F.2d 344 (8th Cir. 1968); Estate of Davis v. Commissioner, 51 T.C. 269 (1968), rev'd on other grounds, 440 F.2d 896 (3rd Cir. 1971); McDonald v. Commissioner, 19 T.C. 672, 690 (1953), aff'd sub nom., Chase National Bank v. Commissioner, 225 F.2d 621 (8th Cir. 1955), cert. denied, 350 U.S. 965 (1956).

For gift tax purposes, if a cash loan is made in a transaction that is not bona fide, at arm's length, and free from donative intent in exchange for a promissory note payable in a certain term, the promisee makes a completed gift in cash in the amount (if any) by which the amount of the loan exceeds the value of the promissory note on the date of the exchange. Section 2512(b) of the Code. This excess amount is the value of the right to use the money loaned. The right to use property, including money, is itself an interest in property, and the transfer of the interest is a gift for gift tax purposes. Rev. Rul. 73-61, 1973-1 C.B. 408. See Estate of Berkman v. Commissioner, T.C.M. 1979-46.

The fair market value of a promissory note is a factual question determined by taking into account all relevant circumstances, including the note's rate of interest, its date of maturity, and the financial responsibility of the maker of the note. In valuing a note, a comparison should be made between the interest rate on the note and the prevailing rate of interest for similar transactions in the market place. Blackburn v. Commissioner, 20 T.C. 204 (1953). However, if an individual makes a loan with the intention to forgive or not to collect on the note, the note is not considered valuable consideration and the transfer is considered a gift at the time of the loan to the full extent of the loan. Rev. Rul. 77-299, 1977-2 C.B. 343.

The value of the promissory note on the date of D's death is includible in D's gross estate under section 2033 of the Code.

D made a gift to A when D transferred cash to A in exchange for A's promissory note, which was of less value than the amount of D's cash transfer. Because this gift was made within 3 years of D's death, the gift is includible in D's gross estate under section 2035(a) of the Code. Because D received partial consideration for the transfer under section 2043, the amount of the cash gift includible under section 2035(a) is the difference between the amount of the loan and the fair market value of the promissory note on the date of the gift. Section 20.2043-1(a) of the regulations; United States v. Righter, cited above.

HOLDING

The value of the note on the date of death, $305,000, is includible in the decedent's gross estate under section 2033 of the Code. The amount includible under section 2035(a), $730,000, is the difference between the amount of the loan and the fair market value of the note on the date of the gift.