The opinion of the court was delivered by: Mills, District Judge:
The Trustees of the Scully Trusts filed this action against the
United States, seeking refunds of alleged overpayments of tax
resulting from a re-valuation of property sold by the trusts. The
parties filed cross motions for summary judgment pursuant to
On May 23, 1985, United States Magistrate Charles H. Evans
entered a recommendation that the Trustees' motion for summary
judgment be denied, and that the Government's motion for summary
judgment be granted. In accordance with Fed.R.Civ.P. 72,
objections of the Trustees to the recommendation and the
Government's response are now before the Court, both supported by
the well prepared memoranda of the parties.
The trustees and the Commissioner are in agreement as to the
broad outline of the facts. The cause concerns the sale of
portions of large tracts of farmland over which the Scully family
has exercised ownership and careful stewardship for several
generations. In 1959, Thomas A. Scully created two trusts, one
for the benefit of his lineal descendants per stirpes through his
son, Peter, and one for the benefit of his lineal descendants per
stirpes through his son, Michael. Mr. Scully endowed each trust
with tracts of farmland and named his two sons co-trustees of
both trusts. The trust agreement essentially grants a life estate
to all of Mr. Scully's grandchildren with the corpus to be
distributed per stirpes ten years after the death of the last
person to die among those listed in the trust agreement. The
Court will refer to these trusts as the "family trusts." Upon Mr.
Scully's death (approximately two years after the creation of the
family trusts), Mr. Scully created by his will two more trusts, a
"marital trust" and a "residuary trust." His will named his two
sons trustees of these two trusts as well.
The disposition of the marital trust is directly at issue here.
Mr. Scully's will provided that his wife, Violet (Mrs. Scully),
should receive the income from the marital trust's assets for
life and should have the power to appoint the disposition of the
assets upon her death. In default of appointment by Mrs. Scully,
the assets were to be added to the residuary trust and, in
accordance with that trust's provision, distributed eventually to
Mr. Scully's lineal descendants per stirpes.
Mrs. Scully died in 1976. She exercised her power of
appointment by directing the trustees of the marital trust to
donate a relatively small amount of land to the Lincoln County
Park and Trails Foundation and to divide the remainder of the
trust corpus equally between her sons' families, then evenly
among her grandchildren in each of the two families. She further
directed that her sons, Peter and Michael, serve as co-trustees
for each of the resulting nine trusts. The Court will refer to
these trusts as the "individual trusts."
This litigation concerns two sets of trusts: the two "family
trusts" (one trust for each of the two sons' children as a group)
arising during Mr. Scully's lifetime and one set of nine
individual trusts (one trust for each of the nine grandchildren)
arising at the time of Mrs. Scully's death.
In her will, Mrs. Scully directed the executors of her estate,
her sons Peter and Michael, to pay or arrange for payment of
administrative expenses, cash bequests, and estate tax
liabilities. Mrs. Scully's estate, however, lacked liquid assets
sufficient to satisfy the bequests and charges. In order to raise
the necessary funds, the executors, acting in their capacity as
trustees of the individual trusts, sold land held by the
individual trusts to the two family trusts for which they also
acted as trustees. The individual trusts sold and the family
trusts purchased the farm real estate
for the value shown in Mrs. Scully's federal estate tax return.
A subsequent review and settlement of the estate taxes resulted
in an increase in the valuation of the farmland.
The Trustees claim that the increase in the valuation
demonstrates that the individual trusts actually sold the land to
the family trusts at a loss. They seek to apply the alleged loss
against ordinary income and to recover resulting tax refunds. The
Internal Revenue Service has disallowed the claim with respect to
all nine of the individual trusts. Having adequately exhausted
their rights to administrative redress, the Trustees seek this
Court's review of their claim for a refund.
This Court is asked to determine whether the trusts involved in
this dispute have a common grantor. If the family and individual
trusts are found to have separate grantors, the Court must
further determine whether the farmland sold was real property
used in a trade or business such that a loss on the sale may be
deducted against income. I.R.C. § 165(a).
In pertinent part, section 267 of the Internal Revenue Code
provides that "no deduction shall be allowed . . . [i]n respect
of losses from sales or exchanges of property . . . between . . .
[a] fiduciary of a trust and a fiduciary of another trust, if the
same person is a grantor of both trusts . . ." I.R.C. §
267(a)(1), (b)(5). The litigants agree that Mr. Scully was the
grantor of the family trusts; they ask this Court to decide
whether, in light of the undisputed facts of this case, Mrs.
Scully's exercise of her power of appointment establishes her as
the grantor of the individual trusts.
In deciding whether Mr. Scully was the grantor of the
individual trusts, the Magistrate, citing three United States
Supreme Court cases, initially determined that the Illinois law
of estates and trusts controlled. See Helvering v. Stuart,
317 U.S. 154, 63 S.Ct. 140, 87 L.Ed. 154 (1942); Morgan v.
Commissioner, 309 U.S. 78, 60 S.Ct. 424, 84 L.Ed. 1035 (1940);
Blair v. Commissioner, 300 U.S. 5, 57 S.Ct. 330, 81 L.Ed. 465
(1937). The gravamen of the Trustees' objection is that the
Magistrate erred in resolving under Illinois law the question of
whether, for the purposes of section 267 of the Internal Revenue
Code, Mr. Scully was the "grantor" of the trusts created by Mrs.
Scully's exercise of her general power of appointment. Rather,
the Trustees contend, the construction of the term "grantor"
should have been determined under a uniform federal law concept
of the term, so that the taxability of the transaction in issue
is not dependent upon the vagaries of local property law.*fn2
The Result Under Illinois Law
As ably pointed out by the Magistrate, Illinois has generally
recognized that upon the exercise of a power of appointment, the
appointment of assets relates back to the time of the power's
creation "as if [the appointment] had been originally contained
in the donor's will." Restatement (First) of Property, p. 1811
(1940). "Property passing pursuant to the exercise of the power
passes under the instrument creating the power, just as though
the appointment were read into the original instrument." In re
Estate of Breault, 29 Ill.2d 165, 174, 193 N.E.2d 824 (1963). In
light of these precedents, Mrs. Scully's exercise of her general
testimentary power of appointment would relate back to Mr.
Scully's creation of the Marital Trust, and Mr. Scully would be
denominated the grantor of the individual trusts.
There is, however, one exception,*fn3 relevant here, to the
general rule that the
exercise of a power of appointment relates back to the donor of
the power: "[P]roperty subject to a general power of appointment
may pass as a part of the estate of the donee of the power if the
donee shows an intention to take such property `out of the
instrument creating the power,' and `to make it his own for all
purposes' . . ." Breault at 174, 193 N.E.2d 824, quoting Cary and
Schuyler, Illinois Law of Future Interests, Sec. 364, p. 491
(1941). The question for this Court is, therefore, whether Mrs.
Scully's will evinces an intention to make the property her own
for all purposes.
In determining whether the testator treated appointive and
personal assets as his own for all purposes, the Breault court
emphasized the treatment of the assets for the purpose of
satisfying charges against the testator's estate. Breault at 177.
The testator in Breault clearly intended to commingle the assets
he held personally and the assets over which he held appointive
power, but his will did not treat the two sets of assets in the
same manner. This difference in treatment, the Breault court
found, prevented the appointive assets from becoming a part of
the testator's personal ...