If the grantor trust lost its status because the grantor dies, there is no problem.
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What happens if a taxpayer transfers the QOF interest into a grantor trust and the trust later loses its status?
How can I avoid that an “inclusion event” will be triggered in this scenario?
Answers
Honestly, this is a question more appropriate for your CPA and your estate attorney.
It depends on the reason the trust loses its status. A loss of status due to death will avoid inclusion. A loss of status that does not change indirect ownership will not lose status. Be very careful and review trust provisions with legal counsel.
The regulations state that a transfer to a grantor trust will not be an inclusion event. If the trust changes status, not a grantor trust, that will trigger inclusion because the owner of the interest changes for federal tax purposes. No exceptions are provided.
If the grantor trust status change is voluntary, there will be an inclusion event and there's nothing you can do to avoid that. If the grantor trust change is by operation of law (i.e., because the grantor died), there will not be an inclusion event.
It depends on why the trust loses its status as a grantor trust. For example, I believe that if the transfer happens because the grantor passes away, it is a transfer on death, which is not a inclusion event. However, I would need to further research the issue to give a definitive answer on this.
A transfer of a qualifying QOF investment by gift by the taxpayer to a trust that is treated as a grantor trust of which the taxpayer is the deemed owner is not an inclusion event. The rationale for this exception is that, for federal income tax purposes, the owner of the grantor trust is treated as the owner of the property in the trust until such time that the owner releases certain powers that cause the trust to be treated as a grantor trust. Accordingly, the owner's qualifying investment is not reduced or eliminated for federal income tax purposes upon the transfer to such a grantor trust. However, any change in the grantor trust status of the trust (except by reason of the grantor's death) is an inclusion event because the owner of the trust property for federal income tax purposes is changing. Since you did not describe in greater detail how you envision the grantor trust losing its status, I cannot make suggestions as to how to avoid the inclusion event in such scenario, except say that it's unlikely you will be able to avoid the inclusion event.
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