# Revenue Ruling 85-13: Tax-Free Installment Sales to Grantor Trusts

**Citation**: Rev. Rul. 85-13, 1985-1 C.B. 184  
**Core Principle**: Transactions between a grantor and an Intentionally Defective Grantor Trust (IDGT / IDIT) are not recognized for federal income tax purposes because the grantor and the trust are treated as the same tax entity.

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### Key Legal Mechanics

1. **Nonrecognition of Gain or Loss on Sale**:
   - When a grantor sells appreciated assets (e.g., pre-IPO stock, real estate, or private business interests) to an IDGT in exchange for a promissory note, no capital gain or loss is recognized under IRC § 1001.
   - The transfer is ignored for federal income tax purposes pursuant to Rev. Rul. 85-13.

2. **Non-Taxable Interest Income & Amortization**:
   - Interest paid on the installment note by the IDGT back to the grantor is not taxable income to the grantor.
   - The trust cannot deduct interest payments, and the grantor does not report interest income.

3. **Tax-Free Estate Burn (Compounding Advantage)**:
   - The grantor continues to pay all federal and state income taxes on trust earnings from outside funds.
   - Under Rev. Rul. 2004-64, paying the trust's tax liability is not treated as a taxable gift to the trust beneficiaries, creating a tax-free compounding mechanism for trust growth.

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### Historical Context: IRS vs. *Rothstein*

- ** *Rothstein v. United States* (2d Cir. 1984)**: The Second Circuit held that a sale to a grantor trust was a transaction between separate entities, giving the trust a new cost basis.
- **IRS Non-Acquiescence (Rev. Rul. 85-13)**: The IRS rejected the *Rothstein* decision and established Rev. Rul. 85-13, confirming that a grantor cannot engage in a taxable sale with a trust of which they are treated as the owner under IRC §§ 671-679.

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### Administrative Requirements for IDGT Sales

1. **Bona Fide Note Documentation**: The sale must be evidenced by a written, enforceable promissory note bearing interest at or above the applicable Applicable Federal Rate (AFR) under IRC § 7872.
2. **Economic Substance & Seed Equity**: The purchasing trust should hold independent seed capital (typically 10%+ of note value) to ensure the note is respected as bona fide debt rather than a retained interest under IRC §§ 2036 or 2702.