Expatriation Notice 2009-85: Section 4 (Other Provisions)
Expatriation Notice 2009-85 Section 4 Other Provisions: Part of what makes Expatriation difficult is the fact that the expatriation tax laws — which are unique for the exit tax process — must also coincide with other provisions of Internal Revenue Code. In reality, the mark-to-market exercise is just a pretend equation, because you are not actually selling the items associated with the exercise. Therefore, the IRS has to make sure that the expatriation process coordinates with other tax provisions in the code, to make sure the tax process is smooth (take that with a grain of salt) for the covered expatriate.
Let’s go through some of the other code section to keep in mind regarding expatriation.
Termination of Deferrals
“Termination of deferrals. Section 877A(h)(1)(A) provides that, notwithstanding any other provision of the Code, any time period for acquiring property that would result in the reduction of gain recognized with respect to property disposed of by a covered expatriate terminates on the day before the expatriation date.
This rule applies to certain incomplete transactions such as deferred like-kind exchanges and involuntary conversions. In addition, section 877A(h)(1)(B) provides that, notwithstanding any other provision of the Code, any extension of time for payment of tax ceases to apply on the day before the expatriation date, and the unpaid portion of such tax becomes due and payable at the time and in the manner prescribed by the Secretary.
Accordingly, the tax shall be due and payable on the earlier of the date the tax would become due and payable without regard to section 877A and the due date of the covered expatriate’s return for the taxable year that includes the day before the expatriation date.”
What is a Termination of Deferral?
The termination of deferrals refers to other tax deferred treatment the covered expatriate may be receiving on other property and assets.
For example 1031 exchange allows for the deferral of income tax.
When expatriation happens, it is considered a “triggering event” and the tax deferral is lost
IRC 367 (a) Gain Recognition Agreement
Regulations under section 367(a) regarding gain recognition agreements (GRAs) provide that if an individual U.S. transferor loses U.S. citizenship or ceases to be a lawful permanent resident of the United States, the individual shall be treated as disposing of all the stock of the transferee foreign corporation received in the initial transfer as of the day before the loss of such status.
This disposition shall constitute a triggering event with respect to the GRA and require the recognition of gain under the GRA (and the payment of applicable interest with respect to any additional tax due); this disposition shall not terminate or reduce the amount of gain subject to the GRA.
Gain recognized under the GRA as a result of this disposition, and any basis adjustments resulting from such gain recognition, shall be taken into account prior to any gain or loss that is required to be taken into account under section 877A on the deemed sale of the stock of the transferee foreign corporation under section 877A(a).”
What is a Gain Recognition Agreement Termination?
When a company transfers certain assets to another company, it can trigger sale or exchange treatment.
To avoid this outcome, an IRC 367 may be entered into, in order to avoid the outcome for a certain period of time.
Expatriation will deemed a triggering event that will result in having to include the stock in a mark-to-market calculation (and require immediate recognition)
IRC 684 Recognition of Gain on Transfer to a Foreign Trust
Section 877A(h)(3) provides that if the expatriation of any individual would result in recognition of gain under section 684, the provisions of section 684 apply before the provisions of section 877A.
Section 684(a) and the regulations thereunder generally require immediate recognition of gain when a U.S. person directly, indirectly, or constructively transfers appreciated property to a foreign trust of which the U.S. person is not treated as the owner under the grantor trust rules (sections 671 through 679). Section 672(f) limits the circumstances in which a foreign person may be treated as the owner of a trust under the grantor trust rules.
A covered expatriate’s expatriation may cause a domestic trust of which the covered expatriate was treated as the owner on the day before the expatriation date to become a foreign trust under the rules of section 7701(a)(31)(B) and § 301.7701-7.
If a covered expatriate’s expatriation also causes the covered expatriate to cease to be treated as the owner of the trust, appreciated property held by the trust will generally be subject to the gain recognition rules of section 684. Gain that is subject to tax under the rules of section 684 will not also be subject to tax under the mark-to-market regime.”
Gain Recognition on Foreign Trust Transfers
This can be a very complex scenario.
It usually occurs when a U.S. person transfers (directly, indirectly or constructively) appreciated property to a foreign trust.
Before expatriation, the U.S. person may not be considered an owner of the trust.
But, in a situation in which a Covered Expatriate, expatriates, and it would result in in the trust becoming foreign it may result in the immediate recognition of gain.
And, this gain recognition precedes 877A (but it is not double-taxed).
Section 897 Gain in Sale of US Real Estate Property (USRPI)
If a covered expatriate holds a USRPI on the day before the expatriation date, the USRPI is generally subject to tax under the mark-to-market regime in the same manner as other property of the covered expatriate.
As provided in section 3.C of this notice, the covered expatriate’s basis in the USRPI will be adjusted to reflect the gain or loss taken into account under the mark-to-market regime.
Section 897 will not apply to the gain or loss recognized as a result of the mark-to-market regime, because the covered expatriate will not be a nonresident alien within the meaning section 7701(b) on the day before the expatriation date.
However, as illustrated in Example 3, above, section 897 will apply when the covered expatriate subsequently disposes of the USRPI.”
Sale of USRPI
When a Covered Expatriate owns property the day before expatriation, it is subject to the mark-to-market analysis.
As a result, the A/B (Adjusted Basis) will increase to the value of the MTM amount, so as to not be taxed on the same gain twice.
So, if the property has further appreciated, there may be additional future gain on the same item.
Notice 2009-85, Example 3 & IRS Explanation
“The facts are the same as in Example 1.
Assume that Assets X and Z are United States real property interests within the meaning of section 897(c) (“USRPIs”). On October 15, 2013, A, now a resident of country B, sells Asset X for $3,000,000 and Asset Z for $700,000.
A’s taxable gain is determined as follows: 14 Asset X: A’s basis of $200,000 in Asset X is adjusted by $1,800,000 (the amount of gain taken into account under section 877A(a)(2) by reason of the deemed sale under section 877A(a) without regard to the amount excluded under section 877A(a)(3)), resulting in a basis of $2,000,000.
The $1,800,000 adjustment to basis is determined without regard to the $563,400 exclusion amount allocated to asset X.
A recognizes $1,000,000 of gain ($3,000,000 amount realized – $2,000,000 basis) on this subsequent actual disposition of Asset X. Because A is now a nonresident alien individual as defined under section 7701(b), and because Asset X is a USRPI, that gain is subject to section 897.
Asset Z: A’s basis of $800,000 in Asset Z is adjusted downward by $300,000 (the amount of loss taken into account under section 877A(a)(2) by reason of the deemed sale under section 877A(a)), resulting in a basis of $500,000.
A recognizes $200,000 of gain ($700,000 amount realized – $500,000 basis) on this subsequent actual disposition. Because A is now a nonresident alien individual as defined under section 7701(b), and because Asset Z is a USRPI, that gain is subject to section 897.”
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