How does a Section 643(e)(3) election affect a trust property distribution?

The beneficiary's basis and the ordinary distribution measure

For property distributions covered by Section 643(e), the beneficiary's basis is the trust's adjusted basis immediately before distribution, adjusted for any gain or loss the trust recognizes on the distribution.

Without the election, the distribution amount under Sections 661(a)(2) and 662(a)(2) is the smaller of that adjusted basis amount and fair market value. This rule also excludes Section 663(a) distributions.

Keep the property's basis records and valuation together when discussing an election with the trust's tax adviser.

The election covers the year's eligible distributions

The election is made on the trust's return for the taxable year and applies to all noncash distributions covered by Section 643(e) during that year.

The Form 1041 instructions direct the fiduciary to check the election box under Other Information, Question 7, and consult the Schedule D instructions.

Prepare a list of the year's property distributions before reviewing the election. Include each asset's basis, fair market value and recipient.

Distributions excluded by Section 663(a)

Section 643(e), including its basis, distribution amount and election rules, does not apply to distributions described in Section 663(a). These include:

• Gifts or bequests of a specific sum of money or specific property under the governing instrument, properly paid or credited all at once or in no more than three installments. An amount payable only from income is not a specific sum.
• Amounts paid, permanently set aside or otherwise qualifying for the charitable deduction under Section 642(c).
• Amounts distributed during the taxable year to which Section 651 or 661 applied in a preceding taxable year because they were credited or required to be distributed then.

Exclusion from Section 643(e) does not itself establish the property's basis or determine whether another rule requires gain or loss recognition.

Fair market value does not remove the income limits

For an estate or complex trust covered by Section 661, the deduction includes income required to be distributed currently and other amounts properly paid, credited or required to be distributed, subject to the Section 663(a) exclusions.

The deduction cannot exceed distributable net income, or DNI. No deduction is allowed for the portion treated as income excluded from the estate's or trust's gross income.

For distributions covered by Section 662, beneficiary inclusion is also generally limited by DNI. If currently required distributions exceed DNI, beneficiaries take proportionate shares, and distributed amounts retain their character, including any tax exempt character.

Recognizing capital gain does not automatically put that gain into DNI. For a domestic trust, Section 643(a)(3) excludes capital gains allocated to corpus when both following conditions apply:

• The gains are not paid, credited or required to be distributed to a beneficiary during the taxable year.
• The gains are not paid, permanently set aside or to be used for Section 642(c) charitable purposes.

The statutory capital gain exclusion does not apply to a foreign trust.

Two related terms

In kind distribution means a distribution of property other than cash from an estate or trust.

Distributable net income is the estate's or trust's taxable income computed with the statutory modifications in Section 643(a).

An Investor Advantage perspective

The conversation below offers a reminder to begin the planning discussion. For this election, bring the property records and proposed distributions to that conversation.

"So I would just encourage all the listeners, if they haven't had a conversation with their estate planning attorney, or they've put off estate planning like most Americans, just 'cause they don't want to think about it,"

Frequently asked questions