Marital trusts and the Sec. 754 election.

• Author: Day, Sally E.

If either a qualified terminable interest property (QTIP) trust or a marital general power of appointment (GPA) owns a partnership interest at the time a surviving spouse dies, the partnership will not be eligible to adjust its assets' "inside" basis as a result of the death under Sec. 754, even though the value of the interest will be included in the spouse's taxable estate under Sec. 2044. This is because the QTIP is the partner, not the surviving spouse, and a trust cannot die.

Background

Under Secs. 754 and 743, a partnership can adjust the inside basis of its assets on the sale or exchange of a partnership interest or on a partner's death.

Example: Partnership P is owned 60% by J and 40% by K. P owns marketable securities with a $100,000 basis and a $1 million fair market value (FMV). When--J dies, his partnership interest is worth $600,000, creating an additional $540,000 "asset" ($600,000 FMV at death--J's 60% portion of the $100,000 inside basis). Thus, a Sec. 754 election increases the total basis of the marketable securities (in P's hands) from $100,000 to $640,000. The marketable securities are later sold for $1.1 million. As a result, P incurs only $460,000 in gain ($1,100,000--$640,000), rather than $1 million.

The QTIP trust provisions were enacted in 1981 for decedents dying after 1981. They included Sec. 2044, under which the assets transferred to a QTIP trust on the first spouse's death are included in the surviving spouse's estate, as long as the latter had a qualifying income interest for life, even if he or she had no power or control over the trust property. If the marital trust is a GPA trust, the surviving spouse has the power to appoint the entire trust interest in favor of himself or herself, his or her estate, his or her creditors, or the creditors of his or her estate. A GPA trust is includible in the surviving spouse's estate under Sec. 2041.

The Marital Trust Dilemma

The triggering event in the example above is the partner's death. If the partnership interest had instead been owned by a marital trust, there would have been no trigger, because the partner (i.e., the trust) cannot die. This is true even though the surviving spouse (as the marital trust's beneficiary) will have to include the property in his or her taxable estate under Sec. 2044 or 2041 .Thus, the partnership may not be eligible to make a Sec. 754 adjustment to basis, because there has not been either a transfer of a partnership interest by a sale...