Sale to Grantor Trust (Asset Freeze): Best Kept Secrets of the Rich (part 3 of 3)
In the last two articles, we talked about (1) the step up basis rule and (2) how a properly structured grantor trust can give you the best of both worlds assuming you have the right asset mix to utilize it.
In this article, we are going to take it one step further by explaining how you can use an intentionally defective grantor trust (an “IDGT”) to perform what is known as an “asset freeze” on property or investments (including privately held businesses) that you expect to appreciate at a high growth rate. The idea being that you want such appreciation to occur outside your estate (to avoid estate taxes), but instead of relying on the swap or substitution power (mentioned in the prior article), you are going to sell the property/investment/business to your irrevocable trust in consideration of a promissory note (i.e., a loan).
Here’s the best part - because of the way the trust is structured, you will not pay any income taxes on the sale of your asset to the trust, nor will you pay any income taxes on the interest payments made to you from the trust (under current tax law as of the time of this writing).
Given the benefits of intentionally defective trusts, you see them more commonly used for business owners or those holding a business interest in a company that they expect to have a high growth rate. This trust could also be used for real estate if you believe such real estate will appreciate at a relatively high rate. If you do not own a private company, then you may want to transfer shares of publicly traded companies in the trust - for example, shares of tech companies like Airbnb would have done quite well under this structure (ignoring hindsight bias).
The only downside is that this trust is so powerful that the government is likely to eventually remove it from being a possibility at some point in the future. There have already been proposals to get rid of this benefit. So if you happen to be in a situation where this type of trust could work for you, then you likely have a limited time window to do so (assuming it’s grandfathered in if/when the tax laws change).
So here’s the mechanics of how this trust typically works:
It’s an irrevocable trust and you are the grantor (the one contributing an asset to the trust).
Someone other than yourself is the beneficiary (usually your children and/or grandchildren).
You have an independent third-party serving as trustee - either a trusted friend or CPA would be ideal.
You “gift” seed capital to the trust - generally 10% of the anticipated sale price of the asset you plan on selling to the trust
You then structure a sale to the trust of the asset (generally a business or a portion of the ownership interest in the business) to the trust in return for an interest only promissory note with a balloon payment on the backend of the loan. The 10% seed capital acts as collateral to show the legitimacy of the transaction.
You should have a competent tax accountant to make sure the trust and the promissory note complies (and continues to comply) with current tax laws and that such records are properly kept to be in compliance with such tax laws.
The end result is that when you die, your business (or whatever high growth asset placed in trust) will completely avoid estate taxes. Given the complexity of this trust, it is typically only recommended to wealthy individuals who want to provide for not only their children, but their grandchildren.
Interested in creating your own estate plan? Give me a call at 781 202 6368, email jlento@perennialtrust.com, or click here to schedule your free personal consultation.
I’m always happy to help,
Joseph M. Lento, J.D.
Your Local Estate Planning Attorney
For client testimonials, please visit: www.PerennialEstatePlanning.com
Conveniently located at 477 Main Street, Stoneham, MA 02180
Other helpful links:
https://www.natlawreview.com/article/sales-to-grantor-trusts?amp
https://www.kitces.com/blog/idgt-installment-sale-to-intentionally-defective-grantor-trust-rules/
