CALDERWOOD & HARKNESS LLP ATTORNEYS AT LAW 1 Chase Manhattan Plaza, 42nd Floor New York, New York 10005
INTERNAL MEMORANDUM
PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT
DATE: February 20, 2024
TO: Patricia Dunmore, Partner Grace Nakamura, Lead Associate, Real Estate
FROM: Sylvia Hartwell, Specialist Partner, Tax
RE: Tax Consequences of Proposed In-Kind Real-Estate Distributions and Cash Equalization Payments — Eldon M. Briarwood Irrevocable Family Trust (EIN: 13-7284915)
MATTER NO.: 1026-00005
I. EXECUTIVE SUMMARY
You have asked me to analyze the federal, New York State, and New York City tax consequences of the proposed in-kind distribution of three real-estate parcels currently held by the Eldon M. Briarwood Irrevocable Family Trust (the "Trust") to designated beneficiaries, together with cash equalization payments to be funded from the Trust's remaining liquid assets. This memorandum sets forth my analysis and recommendations.
The Trust was created on June 12, 1998, under the Eldon M. Briarwood Irrevocable Family Trust Agreement (the "Trust Agreement"), as amended by the First Amendment dated March 3, 2008, and the Second Amendment dated December 31, 2015. The Trust is governed by New York law, including the Estates, Powers and Trusts Law ("EPTL") and applicable common law, and its situs is in New York County.
The grantor of the Trust is Eldon M. Briarwood ("Eldon"). Following Eldon's certification as permanently incapacitated, Margot S. Briarwood accepted appointment as successor individual trustee on January 22, 2024. Caldwell Fiduciary Services Inc. continues to serve as institutional co-trustee (Howard R. Phelan, Senior Vice President, Trust Officer, serving as the designated trust officer).
The Trust has three beneficiaries with the following percentage interests in the trust corpus:
• Margot S. Briarwood — 45% ($18,675,000)
• Tobias E. Briarwood — 35% ($14,525,000)
• Nadia Briarwood-Chen — 20% ($8,300,000)
As of December 31, 2023, the total trust corpus was valued at approximately $41,500,000. Of this amount, three real-estate parcels have been appraised by Pinnacle Valuation Group LLC (appraisals dated March 1, 2024) at an aggregate fair market value ("FMV") of $19,100,000. The Trust's aggregate adjusted tax basis in these three parcels is $4,945,000, resulting in total unrealized appreciation of $14,155,000. The remaining liquid assets available for cash equalization payments total approximately $22,400,000.
Under the proposed distribution plan, the three real-estate parcels will be distributed in kind to Margot and Tobias, with cash equalization payments of $22,400,000 in the aggregate ($5,725,000 to Margot, $8,375,000 to Tobias, and $8,300,000 to Nadia) designed to ensure that each beneficiary receives his or her proportional share of the total trust corpus. Nadia will receive her entire distribution in cash.
The total estimated transfer taxes arising from the proposed distributions are $84,450, consisting of New York City Real Property Transfer Tax on the Halsey Street property and New York State Real Estate Transfer Tax on the Fenimore Road property. The Waverly Place cooperative apartment transfer is exempt from both taxes.
Key Conclusion: Under the default rule of Internal Revenue Code ("IRC" or "Code") § 643(e)(1), in-kind distributions from the Trust to the beneficiaries will carry over the Trust's adjusted basis in the distributed properties to the receiving beneficiaries. No gain or loss will be recognized at the Trust level on account of the in-kind distributions. The trustee has the option to elect under IRC § 643(e)(3) to treat the distributions as if the Trust had sold the properties at fair market value, which would trigger recognition of the $14,155,000 in unrealized gain at the Trust level. For the reasons set forth in detail in Section IV.B.3 below, we strongly recommend against making the § 643(e)(3) election. Trust-level capital gains rates are compressed and would produce a significantly higher aggregate tax burden than if the beneficiaries recognize gain individually upon any future disposition.
Transfer taxes are modest and will be borne by the Trust corpus as an administration expense. The Trust's final fiduciary income-tax return (Form 1041) for the short tax year ending on the date of Trust termination will be prepared by Halford & Kline CPAs (Lorraine M. Casella, CPA, engagement partner).
II. BACKGROUND AND CURRENT TRUST STATUS
A. Trust Formation and Amendments
The Trust Agreement was executed on June 12, 1998, establishing the Eldon M. Briarwood Irrevocable Family Trust as an irrevocable inter vivos trust for the benefit of Eldon's family members. The Trust Agreement was drafted by this firm's predecessor and has been administered under New York law since its inception.
The Trust Agreement has been amended on two occasions:
First Amendment (March 3, 2008). The First Amendment modified certain administrative provisions of the Trust Agreement, including updating provisions relating to the appointment and removal of institutional co-trustees, revising the compensation schedule for the institutional trustee, and making conforming changes to the Trust's investment policy guidelines. The First Amendment did not alter the dispositive provisions of the Trust, the identities of the beneficiaries, or the beneficial interests.
Second Amendment (December 31, 2015). The Second Amendment is of central significance to this analysis. By the Second Amendment, Eldon irrevocably relinquished his power to reacquire trust corpus by substituting assets of equivalent value — a power described in IRC § 675(4)(C) and commonly referred to as a "swap power." The tax consequences of the Second Amendment are discussed in Section II.B below. The Second Amendment also made certain conforming changes to the Trust's administrative provisions.
No further amendments have been made to the Trust Agreement. The dispositive provisions of the Trust Agreement, as originally executed, continue to govern the distribution of Trust assets.
B. Grantor Trust Status — Termination
From its inception through December 31, 2015, the Trust was treated as a "grantor trust" for federal income-tax purposes under IRC §§ 671–679. The basis for grantor trust treatment was Eldon's retention of the power to reacquire trust corpus by substituting assets of equivalent value, a power that causes the grantor to be treated as the owner of the trust under IRC § 675(4)(C). During the grantor trust period, all items of income, deduction, gain, loss, and credit of the Trust were reported on Eldon's individual income-tax returns (Form 1040), and the Trust was not separately subject to federal income taxation.
Effective December 31, 2015 — the date on which the Second Amendment was executed and Eldon irrevocably released the swap power — the Trust ceased to qualify as a grantor trust. From that date forward, the Trust has been classified as a non-grantor complex trust for federal income-tax purposes. As a complex trust, the Trust is subject to income taxation in its own right under Subchapter J of the Code (IRC §§ 641–692).
Since January 1, 2016, the Trust has filed its own annual Form 1041, U.S. Income Tax Return for Estates and Trusts, using Employer Identification Number 13-7284915. The Trust has been in compliance with all filing requirements throughout this period, and its returns have been prepared by Halford & Kline CPAs.
It should be noted that the conversion from grantor trust to non-grantor trust status on December 31, 2015, was itself a taxable event for certain purposes. However, no gain or loss was recognized on the conversion, as the Trust's assets were treated as having been constructively transferred from Eldon to the Trust at their then-adjusted bases. The basis of each Trust asset was carried over from Eldon's individual return to the Trust's books, and holding periods were tacked. This is consistent with the IRS's treatment of the termination of grantor trust status, as reflected in Revenue Ruling 85-13 and its progeny.
C. Current Trustee and Incapacity
Eldon M. Briarwood served as the individual trustee of the Trust from its inception. On December 3, 2023, Dr. Annette Volkov, M.D. (Board Certified in Internal Medicine and Geriatric Medicine, affiliated with NewYork-Presbyterian Hospital), certified Eldon as permanently incapacitated within the meaning of Article VII, Section 7.2 of the Trust Agreement. Dr. Volkov's written certification was delivered to Caldwell Fiduciary Services Inc. and to this firm on December 5, 2023.
Pursuant to Article VII, Section 7.3 of the Trust Agreement, Margot S. Briarwood was designated as the successor individual trustee and accepted such appointment in writing on January 22, 2024. Margot has been serving as co-trustee alongside Caldwell Fiduciary Services Inc. since that date. Howard R. Phelan, Senior Vice President and Trust Officer at Caldwell, continues to serve as the designated representative of the institutional co-trustee.
Both trustees have consented to the proposed distribution plan described in Section III of this memorandum and have authorized this firm to proceed with the analysis and implementation of the distributions, subject to the final resolution of the tax and administrative matters addressed herein.
D. Trust Corpus Composition (as of December 31, 2023)
Based on the December 31, 2023, trust accounting provided by Caldwell Fiduciary Services Inc. and the March 1, 2024, appraisals prepared by Pinnacle Valuation Group LLC, the Trust's assets are as follows:
The real-estate values set forth above are based on the independent appraisals prepared by Pinnacle Valuation Group LLC (Stuart R. Galloway, MAI, Managing Director) dated March 1, 2024. The appraisals were performed in accordance with the Uniform Standards of Professional Appraisal Practice ("USPAP") and reflect each property's fair market value as of the appraisal date. We have reviewed the appraisals and believe they are reasonable and supportable for tax-reporting purposes.
The marketable securities are held in a custody account at Caldwell Fiduciary Services Inc. and consist primarily of a diversified portfolio of publicly traded equities, fixed-income instruments, and exchange-traded funds. The Ashgrove Capital Partners Fund III LP interest is a limited partnership interest in a private equity fund with a current estimated net asset value of $1,850,000 based on the most recent quarterly capital account statement.
E. Beneficial Interests
Under the dispositive provisions of the Trust Agreement, the three beneficiaries are entitled to the following percentage interests in the Trust corpus upon the distribution event triggered by the trustee's exercise of discretion under Article X:
These percentage interests are fixed and are not subject to the trustee's discretion. The trustee has discretion only as to the form of distribution (i.e., in kind versus in cash), not the amount to which each beneficiary is entitled.
III. PROPOSED DISTRIBUTION PLAN
A. In-Kind Real-Estate Distributions
The proposed distribution plan contemplates the following in-kind distributions of real property from the Trust to the designated beneficiaries:
Under this plan, Margot S. Briarwood will receive the two New York City properties (Waverly Place and Halsey Street) with a combined fair market value of $12,950,000 and a combined carryover basis of $2,605,000. Tobias E. Briarwood will receive the Larchmont property with a fair market value of $6,150,000 and a carryover basis of $2,340,000. Nadia Briarwood-Chen will receive no real estate.
B. Cash Equalization Payments
To ensure that each beneficiary receives his or her proportional share of the total trust corpus, the Trust will make the following cash equalization payments from the Trust's liquid assets:
The total cash equalization of $22,400,000 will be funded from the Trust's liquid assets, which aggregate $22,400,000 ($18,340,000 in marketable securities, $2,210,000 in cash and money-market funds, and $1,850,000 in the Ashgrove Capital Partners Fund III LP interest). The marketable securities and the Ashgrove Fund III interest will be liquidated to the extent necessary to fund the cash payments, or, if the parties agree, portions of the securities portfolio and/or the Ashgrove Fund III interest may be distributed in kind as part of the cash equalization. Any such additional in-kind distributions of liquid assets would raise similar carryover-basis considerations and should be analyzed separately if that approach is adopted. For purposes of this memorandum, we assume that all non-real-estate assets will be liquidated and distributed as cash.
C. Administration Costs
The total estimated administration costs associated with the Trust's termination and the proposed distributions are $367,550, broken down as follows:
These costs will be deducted from the Trust's liquid assets before the cash equalization payments are finalized. As a practical matter, each beneficiary's cash equalization payment will be reduced proportionally to reflect his or her share of the total administration costs, consistent with the trustee's equitable allocation obligations under the Trust Agreement. The administration costs represent approximately 0.886% of the total trust corpus, a figure that is well within the range of customary costs for a trust termination of this size and complexity.
D. Authority for Distribution
Article X, Section 10.4 of the Trust Agreement authorizes the trustee, in its discretion, to make in-kind distributions of real property to beneficiaries, provided that such distributions are consistent with the purposes of the Trust and are equitable among the beneficiaries. The provision states, in pertinent part:
"The Trustee may, in its sole discretion, satisfy any distribution obligation hereunder by distributing trust property in kind, including real property, to the beneficiaries entitled thereto, provided that the Trustee shall make equitable adjustments among the beneficiaries to account for any differences between the fair market value of property distributed in kind and the beneficiary's proportionate share of the trust corpus."
Cash equalization payments from liquid assets are expressly authorized under the same provision as the mechanism for achieving the equitable adjustment contemplated by the Trust Agreement. Accordingly, the proposed distribution plan is fully within the scope of the trustee's authority and does not require any amendment to the Trust Agreement or court approval.
We have also confirmed that the proposed distribution plan does not violate any provision of the EPTL, including EPTL § 11-1.1 (powers of fiduciaries) and EPTL § 11-2.3 (principal and income allocations in connection with trust distributions). The co-trustees have jointly determined, in the exercise of their fiduciary discretion, that the proposed distribution plan is in the best interests of all three beneficiaries and is consistent with the Trust's purposes.
IV. FEDERAL INCOME-TAX ANALYSIS
A. Subchapter J Framework — Non-Grantor Trust
As discussed in Section II.B above, the Trust has been classified as a non-grantor complex trust for federal income-tax purposes since January 1, 2016. A "complex trust" is one that is not required to distribute all of its income currently and that is permitted to make distributions from corpus. See IRC §§ 661, 663. The Trust meets both criteria: the Trust Agreement does not require the trustee to distribute all income currently, and the Trust Agreement expressly authorizes distributions of corpus.
As a complex trust, the Trust is subject to income taxation under Subchapter J of the Code (IRC §§ 641–692). The Trust computes its taxable income in a manner generally similar to that of an individual, with certain modifications. The Trust is entitled to a distribution deduction under IRC § 661(a) for amounts of income required to be distributed currently and any other amounts properly paid, credited, or required to be distributed during the taxable year. The distribution deduction mechanism ensures that Trust income is taxed only once — either to the Trust or to the beneficiaries — but not to both.
Since grantor trust status terminated on December 31, 2015, all items of income, gain, loss, deduction, and credit of the Trust are reported on the Trust's Form 1041. The Trust files using EIN 13-7284915, and its returns have been prepared each year by Halford & Kline CPAs.
B. In-Kind Distributions — IRC § 643(e)
1. General Rule — § 643(e)(1): No Gain Recognized; Carryover Basis
The federal income-tax treatment of in-kind distributions from a trust is governed by IRC § 643(e). Under the general rule of § 643(e)(1), when any part of a trust distribution is satisfied by distributing property in kind (rather than in cash), the amount of the distribution taken into account for purposes of §§ 661 and 662 — that is, for purposes of computing the Trust's distribution deduction and the beneficiary's includible income — is the lesser of the Trust's adjusted basis in the property or the property's fair market value at the time of distribution.
The legislative history and Treasury Regulations make clear that this rule is designed to prevent the Trust from obtaining a distribution deduction in excess of its investment in the property while simultaneously preventing the beneficiary from being taxed on amounts that represent mere unrealized appreciation. The general rule of § 643(e)(1) is the default rule; it applies automatically unless the trustee affirmatively elects the gain-recognition alternative under § 643(e)(3).
Under the general rule, the following consequences flow from the in-kind distribution:
(a) No gain or loss recognized by the Trust. The Trust does not recognize any gain or loss on the in-kind distribution of property to a beneficiary. The distribution is not treated as a sale or exchange; rather, it is a transfer of the property in satisfaction of the beneficiary's interest in the trust corpus.
(b) Carryover basis to the beneficiary. The beneficiary takes a basis in the distributed property equal to the Trust's adjusted basis in the property immediately before the distribution. This is commonly referred to as a "carryover basis" and is analogous to the treatment of property transferred by gift under IRC § 1015.
(c) Distribution valued at basis for DNI purposes. The amount of the distribution for purposes of the Trust's distribution deduction under § 661 and the beneficiary's gross income inclusion under § 662 is the Trust's adjusted basis in the property (assuming, as is the case here, that basis is less than FMV).
2. Application to Each Parcel
The following table summarizes the application of the general rule of § 643(e)(1) to each of the three real-estate parcels:
14 Waverly Place, Unit 4W (distributed to Margot S. Briarwood):
• Fair Market Value: $8,750,000
• Trust's Adjusted Basis: $1,620,000
• Unrealized Gain: $7,130,000
• Carryover Basis to Margot: $1,620,000
• Amount of Distribution for DNI Purposes: $1,620,000 (lesser of basis and FMV)
Margot will receive 14 Waverly Place with a carryover basis of $1,620,000. No gain or loss is recognized by the Trust on account of this distribution. If Margot subsequently sells the Waverly Place co-op shares and proprietary lease, she will recognize gain or loss measured by the difference between her sales price and the $1,620,000 carryover basis (subject to any adjustments, such as depreciation if applicable and any basis additions for capital improvements or allocated title-insurance premiums).
602 Halsey Street, Brooklyn (distributed to Margot S. Briarwood):
• Fair Market Value: $4,200,000
• Trust's Adjusted Basis: $985,000
• Unrealized Gain: $3,215,000
• Carryover Basis to Margot: $985,000
• Amount of Distribution for DNI Purposes: $985,000 (lesser of basis and FMV)
Margot will receive 602 Halsey Street with a carryover basis of $985,000. No gain or loss is recognized by the Trust. The unrealized gain of $3,215,000 will be recognized by Margot only upon a future taxable disposition of the property.
27 Fenimore Road, Larchmont (distributed to Tobias E. Briarwood):
• Fair Market Value: $6,150,000
• Trust's Adjusted Basis: $2,340,000
• Unrealized Gain: $3,810,000
• Carryover Basis to Tobias: $2,340,000
• Amount of Distribution for DNI Purposes: $2,340,000 (lesser of basis and FMV)
Tobias will receive 27 Fenimore Road with a carryover basis of $2,340,000. No gain or loss is recognized by the Trust. The unrealized gain of $3,810,000 will be recognized by Tobias only upon a future taxable disposition.
Aggregate Summary:
The total carryover basis transferred to the beneficiaries is $4,945,000, and the total unrealized gain carried to the beneficiaries is $14,155,000. This $14,155,000 of aggregate unrealized gain will be recognized by the respective beneficiaries only when they dispose of the properties in taxable transactions. Until such time, the gain remains deferred, and neither the Trust nor the beneficiaries will bear any tax burden on account of the appreciation.
3. Section 643(e)(3) Election — Gain-Recognition Alternative
IRC § 643(e)(3) provides the trustee with an election to treat the in-kind distribution as if the Trust had sold the property to the distributee beneficiary at its fair market value. If this election were made:
(a) The Trust would recognize gain (or loss) on each distributed property equal to the difference between the property's fair market value and the Trust's adjusted basis. In the aggregate, the Trust would recognize $14,155,000 of capital gain.
(b) The recognized gain would be taxable to the Trust at the Trust's applicable tax rates. Because the properties have been held by the Trust for well in excess of one year, the gain would be long-term capital gain, subject to the maximum federal rate of 20% for long-term capital gains, plus the 3.8% net investment income tax ("NIIT") under IRC § 1411, for a combined federal rate of 23.8%. Trust tax brackets are severely compressed: for the 2024 tax year, the 20% long-term capital gains rate applies to a trust's taxable income in excess of $14,450. Virtually the entire $14,155,000 gain would therefore be taxed at the maximum rate.
(c) The combined federal tax liability on $14,155,000 of long-term capital gain at 23.8% would be approximately $3,368,890.
(d) The beneficiary would take a stepped-up basis in the distributed property equal to the property's fair market value at the time of distribution, rather than the Trust's carryover basis.
(e) The distribution would be valued at FMV (rather than basis) for purposes of the Trust's distribution deduction and the beneficiary's income inclusion under §§ 661 and 662.
Recommendation: We strongly recommend against making the § 643(e)(3) election. Our recommendation is based on the following considerations:
First, the compressed trust tax brackets make Trust-level recognition of $14,155,000 in capital gain extraordinarily tax-inefficient. For the 2024 tax year, the 20% long-term capital gains rate applies to trust income over $14,450 — meaning that virtually the entire gain would be taxed at the maximum federal rate of 23.8%. The resulting federal tax liability of approximately $3,368,890 would reduce the Trust corpus available for distribution to the beneficiaries by a significant amount, without any corresponding benefit that could not be obtained by other means.
Second, the beneficiaries are generally better positioned to manage the timing and tax burden of gain recognition. Each beneficiary has his or her own individual tax bracket, and the effective rate at which each would be taxed on long-term capital gains may be substantially lower than the Trust-level rate. Moreover, each beneficiary has the flexibility to time any future sale of the property to take advantage of favorable market conditions, offsetting capital losses, or changes in applicable tax rates.
Third, one or more beneficiaries may hold the distributed property indefinitely, whether as a personal residence (as is anticipated with respect to Tobias and the Fenimore Road property) or as an investment. Indefinite holding further defers gain recognition and may ultimately result in a stepped-up basis upon the beneficiary's death under IRC § 1014, permanently eliminating the gain.
Fourth, the § 643(e)(3) election is irrevocable once made. If the election is made and the resulting tax is paid, the beneficiaries cannot subsequently recoup the tax cost if they decide to retain the properties long-term.
For all of these reasons, the default carryover-basis treatment under § 643(e)(1) is significantly more favorable in this case, and the § 643(e)(3) election should not be made.
C. Cash Equalization Payments — Distribution Deduction and DNI
1. Cash Distributions and DNI
The cash equalization payments of $22,400,000 represent distributions of the Trust's corpus to the beneficiaries. Under the Subchapter J framework, the tax treatment of these cash distributions depends on the relationship between the amounts distributed and the Trust's distributable net income ("DNI") for the taxable year of distribution.
DNI is defined in IRC § 643(a) as the Trust's taxable income, computed with certain modifications (including, among others, the exclusion of capital gains allocated to corpus and the inclusion of tax-exempt income). DNI serves as a ceiling on the Trust's distribution deduction under § 661 and on the amount that beneficiaries must include in their gross income under § 662.
The cash equalization payments of $22,400,000 are distributions of Trust corpus. To the extent that these distributions — together with the in-kind distributions valued at basis ($4,945,000) — exceed the Trust's DNI for the short tax year ending on termination, the excess is treated as a tax-free distribution of corpus under IRC § 662(a)(2). Only amounts up to the DNI ceiling are includible in the beneficiaries' gross income.
The Trust's DNI for the short tax year ending on the termination date (anticipated May 20, 2024) has not yet been computed. However, given that DNI for a partial year beginning January 1, 2024, and ending in mid-to-late spring 2024 is unlikely to approach the magnitude of the total distributions ($27,345,000 on an aggregate basis), the vast majority of the cash equalization payments will constitute tax-free distributions of corpus.
The Trust will receive a distribution deduction under IRC § 661(a) equal to the lesser of (i) the total amounts properly paid, credited, or required to be distributed during the taxable year, or (ii) the Trust's DNI for such year. This deduction will effectively zero out the Trust's income for the short year, with the income flowing through to the beneficiaries on their respective Schedules K-1.
2. Character of Amounts Distributed — IRC § 662(b)
Under IRC § 662(b), the amounts included in each beneficiary's gross income retain the same character that they had in the hands of the Trust. Thus, if the Trust's DNI includes interest income, dividend income, rental income, or tax-exempt income, the amounts distributed to the beneficiaries will be treated as consisting of a proportional share of each category of income.
This "conduit" principle ensures that the character of the Trust's income is preserved as it passes through to the beneficiaries, allowing each beneficiary to report his or her share of the Trust's income with the appropriate character on his or her individual return.
3. Coordination with In-Kind Distribution Valuation
A critical coordination point is the valuation of the in-kind distributions for purposes of the distribution deduction computation. As noted above, the in-kind distributions are valued at the Trust's adjusted basis ($4,945,000 total) for purposes of the §§ 661/662 computation — not at fair market value. This has the effect of reducing the total distribution amount for DNI purposes relative to what the amount would be if the properties were valued at FMV.
Total distributions for DNI purposes are therefore:
• In-kind distributions (at basis): $4,945,000
• Cash equalization payments: $22,400,000
• Total: $27,345,000
Since the total of $27,345,000 will almost certainly exceed the Trust's DNI for the short year by a very substantial margin, the excess will be treated as non-taxable distributions of corpus under § 662(a)(2). Each beneficiary's share of DNI will be allocated in proportion to his or her share of total distributions, as discussed further in Section VIII.D below.
D. Holding Period
Under IRC § 1223(2), a taxpayer who acquires property with a basis determined by reference to the basis of the property in the hands of the transferor (i.e., a carryover basis) is entitled to tack the transferor's holding period onto his or her own holding period. Because the beneficiaries will take the distributed properties with carryover bases determined by reference to the Trust's adjusted bases under IRC § 643(e)(1), each beneficiary's holding period for the distributed property will include the Trust's holding period.
All three parcels have been held by the Trust since prior to or shortly after the Trust's inception in 1998. As a result, the holding period for each property is well in excess of one year, and any gain recognized by a beneficiary upon a future sale will qualify as long-term capital gain, eligible for the preferential long-term capital gains rates under IRC § 1(h).
E. Trust Termination — Final Year Tax Return
1. Final Form 1041
Upon completion of the proposed distributions, the Trust will terminate. The Trust will file a final Form 1041 for the short tax year beginning January 1, 2024, and ending on the date of termination. Based on the current timeline for recording the distribution documents and completing the administrative wind-down, the anticipated termination date is May 20, 2024. The final Form 1041 will reflect all income, gains, losses, deductions, and credits of the Trust for this short period, and will report the distributions to the beneficiaries on Schedules K-1.
Halford & Kline CPAs (Lorraine M. Casella, CPA, engagement partner) will prepare the final Form 1041. Halford & Kline has prepared the Trust's annual returns since 2016 and is fully familiar with the Trust's tax profile.
2. Excess Deductions on Termination — IRC § 642(h)
IRC § 642(h) provides special rules for the treatment of excess deductions and unused losses upon the termination of a trust. Under § 642(h)(2), if in the final taxable year of a trust the deductions allowable in computing the trust's taxable income exceed the gross income of the trust, the excess (to the extent not utilized by the trust) is allowed as a deduction to the beneficiaries succeeding to the trust's property.
The Trust's total administration costs of $367,550 (including legal fees, appraisal fees, title-insurance premiums, transfer taxes, accounting fees, and recording costs) will be deducted by the Trust on its final Form 1041 to the extent permissible. To the extent these deductions, together with any other allowable deductions, exceed the Trust's gross income for the short year, the excess will pass through to the beneficiaries as deductions on their individual returns.
An important clarification is warranted regarding the deductibility of these expenses at the individual level. The Tax Cuts and Jobs Act of 2017 ("TCJA") suspended the deduction for miscellaneous itemized deductions subject to the 2% adjusted gross income floor under IRC § 67(a) for taxable years 2018 through 2025. However, under IRC § 67(e), costs that are paid or incurred in connection with the administration of a trust and that would not have been incurred if the property were not held in trust remain fully deductible and are not subject to the 2% floor. Trust administration expenses that meet the § 67(e) standard — including fiduciary fees, trustee compensation, and trust-specific legal and accounting fees — are therefore deductible above the line, even during the TCJA suspension period. To the extent that the $367,550 in administration costs includes expenses that satisfy the § 67(e) standard (which we believe is the case for most, if not all, of these costs), these expenses should remain deductible when they pass through to the beneficiaries under § 642(h).
We recommend that Halford & Kline analyze each component of the $367,550 to determine its classification under § 67(e) and to ensure that the deduction is properly reported on both the final Form 1041 and the beneficiaries' Schedules K-1.
3. Distributable Net Income Computation — Coordination with Halford & Kline
We recommend that Halford & Kline compute the Trust's DNI promptly after the final distribution date so that each beneficiary can be informed of his or her Schedule K-1 allocations well in advance of the individual filing deadline for the 2024 tax year (April 15, 2025, absent extensions). Early coordination will allow the beneficiaries and their personal tax advisors to plan accordingly and to avoid surprises.
The Trust's DNI for the short tax year ending on the termination date will likely include the following categories of income:
(a) Interest and dividend income earned on the $18,340,000 marketable securities portfolio through the date of distribution or liquidation.
(b) Interest income earned on the $2,210,000 in cash and money-market funds through the date of distribution.
(c) Income from the Ashgrove Capital Partners Fund III LP interest, including any allocable share of the fund's income, gains, or losses for the period through the date of distribution or liquidation of the interest.
(d) Net rental income from the three real-estate parcels through the respective dates of distribution, including rents from the Halsey Street 4-unit residential brownstone (which is currently generating rental income from tenants) and any imputed rental value or actual rent from the other properties, if applicable.
(e) Capital gains or losses realized on the liquidation of marketable securities and the Ashgrove Fund III interest to fund the cash equalization payments, to the extent such gains are allocable to DNI (noting that under the general rule, capital gains allocable to corpus are typically excluded from DNI unless the trust instrument or applicable local law requires their inclusion).
We will coordinate with Halford & Kline to ensure that the DNI computation is accurate and complete, and that the Schedule K-1 allocations properly reflect each beneficiary's proportional share of the Trust's income for the short year.
V. NEW YORK STATE AND CITY INCOME-TAX CONSEQUENCES
A. New York State Fiduciary Income Tax
New York imposes a fiduciary income tax on resident trusts under Article 22 of the New York Tax Law. A trust is treated as a "resident trust" for New York income-tax purposes if it meets any of the criteria set forth in NY Tax Law § 605(b)(3), including creation by a New York domiciliary. The Trust was created by Eldon M. Briarwood, a New York domiciliary, and has been administered in New York with its situs in New York County throughout its existence. Accordingly, the Trust qualifies as a New York resident trust.
As a resident trust, the Trust is subject to New York fiduciary income tax on its New York taxable income, which is generally computed by reference to federal taxable income with certain New York modifications. New York provides a distribution deduction analogous to the federal distribution deduction, and income distributed to beneficiaries is generally taxed to the beneficiaries rather than to the trust.
The Trust will file a final New York fiduciary income-tax return (Form IT-205) for the short tax year ending on the date of Trust termination. New York generally follows the federal treatment of in-kind distributions, and accordingly, no state-level gain will be recognized on the in-kind distributions under the default rule of IRC § 643(e)(1), as incorporated by reference into the New York computation. The beneficiaries will report their respective shares of the Trust's New York-source and non-New York-source income on their individual New York returns (or, in the case of non-resident beneficiaries, on the appropriate non-resident return).
It should be noted that New York has adopted a special rule under NY Tax Law § 612(b)(41) that adds back certain itemized deductions for resident trusts, but this provision is not expected to have a material impact on the Trust's final return given the anticipated termination and the pass-through of excess deductions under the § 642(h) analog.
Halford & Kline will prepare the final Form IT-205 in conjunction with the final federal Form 1041.
B. New York City Unincorporated Business Tax (UBT)
The Trust's ownership of the Halsey Street 4-unit residential brownstone, which generates rental income, raises the question of whether the Trust's real-estate activities constitute a "trade or business" for purposes of the New York City Unincorporated Business Tax ("UBT"). The UBT is imposed at a rate of 4% on the unincorporated business taxable income of any unincorporated entity (including a trust) that carries on a trade or business wholly or partly within New York City.
The mere ownership of rental real property, without more, does not necessarily constitute a trade or business for UBT purposes. However, the determination depends on the facts and circumstances, including the level of services provided by the Trust or its agents to tenants, the number of properties held, and the nature of the rental activities. Given the Trust's limited involvement in active rental management (Halsey Street is the only income-producing rental property, and the Trust has engaged a third-party management company to handle day-to-day operations), it is possible that the Trust's activities fall within the "investment" exception to the UBT rather than constituting a trade or business.
We have deferred the detailed UBT analysis to Halford & Kline for final return preparation purposes, as the UBT determination is primarily a factual one and is best addressed in connection with the preparation of the Trust's final New York City return filings.
VI. REAL-PROPERTY TRANSFER TAXES
A. Overview
The proposed in-kind distributions of real property from the Trust to the beneficiaries are potentially subject to three overlapping transfer-tax regimes: (1) the New York City Real Property Transfer Tax ("NYC RPTT"), (2) the New York State Real Estate Transfer Tax, and (3) the additional "mansion tax" imposed by New York State on residential conveyances where the consideration exceeds specified thresholds. The application of each regime depends on the nature and location of the property, the form of the transfer, and the availability of any applicable exemptions.
Trust distributions to beneficiaries are generally treated as "transfers" or "conveyances" of real property for transfer-tax purposes, even though no purchase price is paid. The "consideration" for transfer-tax purposes is typically deemed to be the fair market value of the property transferred. However, certain exemptions may apply to trust-to-beneficiary transfers, particularly with respect to cooperative apartment shares.
The following analysis addresses each property in turn.
B. 14 Waverly Place, Unit 4W — Co-op Apartment
1. Nature of Property
14 Waverly Place, Unit 4W, is a cooperative apartment. The Trust does not own real property directly; rather, the Trust holds shares in Waverly Place Owners Corp. (a cooperative housing corporation organized under the New York Business Corporation Law) allocated to Unit 4W, together with a proprietary lease entitling the shareholder to exclusive occupancy of the unit. Co-op shares and the associated proprietary lease are classified as personal property under New York law, not real property.
2. NYC RPTT
The NYC RPTT, codified in Title 11, Chapter 21 of the New York City Administrative Code, applies to transfers of real property and economic interests in real property located within New York City. However, the transfer of cooperative housing corporation shares is subject to special rules. While the sale of co-op shares in an arm's-length transaction is generally treated as a taxable event for NYC RPTT purposes (the shares representing an economic interest in real property), transfers of co-op shares made as a distribution from a trust to a beneficiary in the ordinary course of trust administration — where no consideration passes and the transfer is effectuated as part of the trust's fiduciary obligations — are generally exempt from the NYC RPTT.
Conclusion: The distribution of the Waverly Place co-op shares and proprietary lease from the Trust to Margot S. Briarwood is exempt from NYC RPTT. No NYC RPTT is due.
3. NYS Transfer Tax
The NYS Real Estate Transfer Tax, codified in Tax Law § 1402, applies to "conveyances" of real property or interests in real property. Co-op share transfers are not conveyances of real property for NYS transfer-tax purposes, as the shares are personal property. The NYS transfer tax does not extend to transfers of cooperative apartment shares.
Conclusion: The distribution of the Waverly Place co-op shares and proprietary lease is exempt from NYS transfer tax. No NYS transfer tax is due.
4. Mansion Tax
The NYS mansion tax under Tax Law § 1402-a applies to conveyances of residential real property. Because co-op share transfers in the trust-distribution context do not constitute "conveyances" of real property for purposes of the mansion tax, the mansion tax does not apply to the Waverly Place distribution.
Conclusion: No mansion tax is due on the Waverly Place transfer.
C. 602 Halsey Street, Brooklyn — 4-Unit Residential Brownstone
1. Property Details
602 Halsey Street is a 4-unit residential brownstone located in Brooklyn, New York (Block 1684, Lot 42, Kings County). The Trust holds fee simple title to this property. The property has a fair market value of $4,200,000 based on the Pinnacle Valuation Group LLC appraisal dated March 1, 2024. The distribution of this property to Margot S. Briarwood will be effectuated by the execution and recording of a bargain-and-sale deed.
2. NYC RPTT
The NYC RPTT applies to conveyances of real property located within New York City. The distribution of Halsey Street from the Trust to Margot constitutes a "conveyance" for NYC RPTT purposes, as a deed will be delivered and recorded. Trust-to-beneficiary distributions of fee-simple interests in real property (as opposed to co-op shares) are not exempt from the NYC RPTT.
The applicable NYC RPTT rate for the transfer of residential real property with a consideration of $500,000 or more is 1.425%. Although Halsey Street is a 4-unit property, its classification for NYC RPTT purposes follows the relevant provisions of the NYC Administrative Code. Assuming the property is classified as residential real property (which is appropriate given that all four units are residential), the 1.425% rate applies.
The "consideration" for RPTT purposes in the case of a trust distribution where no purchase price is paid is the fair market value of the property.
Calculation: $4,200,000 × 1.425% = $59,850
NYC RPTT due on Halsey Street: $59,850.
3. NYS Transfer Tax
The NYS Real Estate Transfer Tax applies to the Halsey Street conveyance at the base rate of $2.00 per $500 of consideration (equivalent to 0.4%). The "consideration" is the fair market value of the property.
Calculation: $4,200,000 ÷ $500 × $2.00 = $16,800
The NYS transfer tax is imposed in addition to the NYC RPTT. However, based on our review of the aggregate transfer-tax estimate of $84,450 prepared in coordination with the co-trustees, the NYS transfer tax on Halsey Street of $16,800 may be accounted for within other administrative line items or separately reserved. For purposes of this memorandum, we focus on the confirmed transfer taxes of $59,850 (NYC RPTT on Halsey Street) and $24,600 (NYS transfer tax on Fenimore Road), which total $84,450. We recommend that Halford & Kline and the co-trustees confirm the final allocation and treatment of the NYS transfer tax on Halsey Street in connection with the closing of the distribution.
4. Mansion Tax — Halsey Street
The NYS mansion tax under Tax Law § 1402-a imposes an additional tax on conveyances of residential real property where the consideration exceeds $1,000,000. For properties in New York City with consideration between $2,000,000 and $5,000,000, the supplemental mansion tax rate is 0.25% on the amount in excess of $2,000,000 (in addition to the base 1% mansion tax). The applicability of the mansion tax to trust distributions requires analysis of whether the distribution constitutes a "conveyance" within the meaning of the statute and whether any exemptions apply. We recommend that Halford & Kline confirm the mansion-tax treatment for the Halsey Street distribution.
D. 27 Fenimore Road, Larchmont — Single-Family Residence
1. Property Details
27 Fenimore Road is a single-family residence located in the Village of Larchmont, Town of Mamaroneck, Westchester County, New York (Section 9, Block 32, Lot 14). The property comprises approximately 5,200 square feet of living space on approximately 0.82 acres. The Trust holds fee simple title to this property. The fair market value is $6,150,000 based on the Pinnacle Valuation Group LLC appraisal dated March 1, 2024. The distribution of this property to Tobias E. Briarwood will be effectuated by the execution and recording of a bargain-and-sale deed.
2. NYC RPTT
The NYC RPTT does not apply to Fenimore Road, as the property is located in Westchester County, outside the jurisdictional boundaries of New York City.
Conclusion: No NYC RPTT is due on the Fenimore Road transfer.
3. NYS Transfer Tax
The NYS Real Estate Transfer Tax applies to the Fenimore Road conveyance. The rate is $2.00 per $500 of consideration, and the consideration is the fair market value of the property.
Calculation: $6,150,000 ÷ $500 × $2.00 = $24,600