Rev. Rul. 81-264

ISSUE

For purposes of section 2511 of the Internal Revenue Code, has an individual who permits the statute of limitations to run on recovery of a loan to a family member made a gift, where the debtor had some financial resources available to repay the loan?

FACTS

On January 1, 1978, D loaned $500,000 to D's child, A, and received from A a promissory note payable on demand, bearing interest at the market rate. At the time of the transaction, D and A intended that the note be enforceable. The state statute of limitations on recovery of a demand loan and accrued interest is three years and begins to run on the date of the making of the loan. D did not make demand on the note and the state statute of limitations on recovery of the loan and accrued interest ran on January 1, 1981. When the statute ran, A had some financial resources.

LAW AND ANALYSIS

Section 2511 of the Code provides that the gift tax shall apply whether the transfer is in trust or otherwise, direct or indirect, or whether the property is real or personal, tangible or intangible. However, if property is transferred in exchange for an adequate and full consideration in money or money's worth, there is no gift. Section 2512(b) of the Code. Further, a transfer made in the ordinary course of business (a transfer that is bona fide, at arm's length, and free from any donative intent) is not a gift. Section 25.2512-8 of the Gift Tax Regulations.

If an individual makes a loan and as part of a prearranged plan intends to forgive or not collect on the note, the note will not be considered valuable consideration and the promisee will have made a gift at the time of the loan to the full extent of the loan. Rev. Rul. 77-299, 1977-2 C.B. 343. If there was no such prearranged plan, but the promisee later forgives the debt, the promisee will have made a gift at the time of the forgiveness. The amount of the gift will equal the principal amount forgiven and the interest accrued to the date of the forgiveness. Section 25.2511-1 of the Gift Tax Regulations and Republic Petroleum Corp. v. United States, 397 F. Supp. 900 (E.D. La. 1975).

Here, as in all such familial transactions, there is a presumption that the transfer of wealth from D to A without consideration is not entirely free of donative intent. Estate of Lang v. Commissioner, 64 T.C. 404 (1975), aff'd, 613 F.2d 770 (9th Cir. 1980). A had the resources to pay the debt, and, as D's child, was the natural object of D's bounty. On these facts, D's failing to enforce the debt obligation and permitting it to be barred by the statute has not been shown to be free of donative intent, and thus is not a transaction in the ordinary course of business within the meaning of section 25.2512-8 of the regulations.

It does not matter that the running of the statute of limitations does not extinguish the debt but merely creates an affirmative defense in a collection suit. Control of the debt passes to the debtor when the statute of limitations runs. Thereafter, it is the debtor rather than the creditor who decides whether and under what terms loaned funds will be repaid. The essence of a gift is such relinquishment of control by the donor over the property. Estate of Lang v. Commissioner.

HOLDING

D made a gift to A when the statute of limitations on the collection of the loan ran. The amount of the gift is the unpaid balance of the principal plus accrued interest.