SECTION 3. BACKGROUND -

TRUSTS

.01 Section 301.7701-2(a) defines a “business entity” as an entity recognized for Federal tax purposes (including an entity with a single owner that may be

disregarded as an entity separate from its owner under § 301.7701-3) that is not properly classified as a trust under § 301.7701-4 or otherwise subject to special treatment under the Code.

.02 Section 301.7701-4(a) provides generally that an arrangement is treated as a trust if the purpose of the arrangement is to vest in trustees the responsibility to protect or conserve 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.

.03 Section 301.7701-4(b) provides that there are other arrangements known as trusts because the legal title to property is conveyed to trustees for the benefit of beneficiaries, but that are not classified as trusts for Federal tax purposes 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 a business organization classified as a corporation or partnership.

.04 Section 301.7701-4(c) provides that an “investment” trust is not classified as a trust if there is a power under the trust agreement to vary the investment of the certificate holders. An investment trust with a single class of ownership interests, representing undivided beneficial interests in the assets of the trust, is classified as a trust if there is no power under the trust agreement to vary the investments of the certificate holders.

.05 A power to vary the investment of the certificate holders exists where there is a managerial power under the trust instrument that enables a trust to take advantage of variations in the market to improve the investments of the certificate holders. See Comm’r v. North American Bond Trust, 122 F.2d 545 (2d Cir. 1941), cert. denied, 314 U.S. 701 (1942). .06 Rev. Rul. 75-192, 1975-1 C.B. 384, discusses the situation where a provision in the trust agreement requires the trustee to invest cash on hand between quarterly distribution dates. The trustee is required to invest the money in short-term obligations of (or guaranteed by) the United

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States, or any agency or instrumentality thereof, and in certificates of deposit of any bank or trust company having a minimum stated surplus and capital. The trustee is permitted to invest only in obligations maturing before the next distribution date and is required to hold such obligations until maturity. Rev. Rul. 75-192 concludes that, because the restrictions on the types of permitted investments limit the trustee to a fixed return like that earned on a bank account and eliminate any opportunity to profit from market fluctuations, the power to invest in the specified kinds of shortterm investments is not a power to vary the trust’s investment.

.07 Rev. Rul. 78-371, 1978-2 C.B. 344, concludes that a trust established by the heirs of a number of contiguous parcels of real estate is an association taxable as a corporation for Federal income tax purposes where the trustees have the power to purchase and sell contiguous or adjacent real estate, accept or retain contributions of contiguous or adjacent real estate, raze or erect any building or structure, make any improvements to the land originally contributed, borrow money, and mortgage or lease the property.

.08 Rev. Rul. 79-77, 1979-1 C.B. 448, concludes that a trust formed by three parties to hold a single parcel of real estate is classified as a trust for Federal income tax purposes when the trustee was authorized to sign a long-term net lease for the property, with options to renew the lease with recomputed rent; to hold title to the land and building and to proceeds and income of the property; to distribute all trust income and otherwise to protect or conserve the property. See Wyman Build- ing Trust v. Commissioner, 45 B.T.A. 155 (1941), acq., 1941-2 C.B. 14 (trust not treated as association taxable as a corporation where trust held a single property, the trustee executed and extended net leases to the same tenant at the same rental, and collected and distributed the rents).

.09 Rev. Rul. 81-238, 1981-2 C.B. 248, establishes that an automatic reinvestment plan in which trust interest holders elect to use distributions to purchase interests in

new fixed investment trusts does not constitute a power to vary. The plan does not involve reinvestment in the original trust and there is no change in, or addition to, the assets of the original trust.

.10 Rev. Rul. 90-63, 1990-2 C.B. 270, holds that the power to consent to changes in the credit support for debt obligations held in an investment trust is not a “power to vary the investment” within the meaning of § 301.7701-4(c) if that power is exercisable only to the extent that the trustee reasonably believes the change is advisable to maintain the value of trust property by preserving the credit rating of the bonds.

.11 Rev. Rul. 2004-86, 2004-2 C.B. 191, concludes that a Delaware statutory trust is classified as an investment trust where the trust holds a single property subject to a mortgage and net lease, the trustee is permitted to renegotiate the lease or enter into leases with other tenants in the event of the tenant’s bankruptcy or insolvency, and otherwise has very limited powers.

.12 Section 671 provides that, where the grantor or another person is treated as the owner of any portion of a trust (commonly referred to as a “grantor trust”), there shall be included in computing the taxable income and credits of the grantor or the other person those items of income, deductions, and credits against tax of the trust which are attributable to that portion of the trust to the extent that the items would be taken into account under chapter 1 of the Code in computing taxable income or credits against the tax of an individual.

.13 Section 677(a) provides that the grantor is treated as the owner of any portion of a trust whose income without the approval or consent of any adverse party is, or, in the discretion of the grantor or a nonadverse party, or both, may be distributed, or held or accumulated for future distribution, to the grantor or the grantor’s spouse.

.14 A person that is treated as the owner of an undivided fractional interest in a trust under subpart E of part I, sub

chapter J of chapter 1 of the Code (sections 671 and following), is considered to own the trust assets attributable to that undivided fractional interest of the trust for Federal income tax purposes. See Rev. Rul. 88-103, 1988-2 C.B. 304; and Rev. Rul. 85-13, 1985-1 C.B. 184; see also § 1.1001-2(c), Example 5.