California Estate Planning Information
by Jeffrey N. Zisselman
July 2006:
Intentionally Defective Grantor Trusts (IDGT)
An intentionally defective grantor trust or IDGT is a trust which is
drafted so that the grantor will be treated as the owner of the trust
for income tax purposes but not for gift or estate tax purposes. A popular
estate planning freeze technique involves a sale of limited partnership
or membership interests, usually for an installment note, to an IDGT.
The value of the asset is frozenat the value of the note received in
the sale, so that future appreciation in the value of the asset sold
to the IDGT will be transferred to the beneficiaries of the IDGT without
gift or estate tax. Instead of contributing the FLLC Interests to a
Grantor Retained Annuity Trust, you may sell the FLLC Interests to an
IDGT. This will freeze the value of the assets at the time of the sale
and your children and future grandchildren will receive the future appreciation
without gift tax, estate tax, and potentially income taxes. Moreover,
you will be further depleting your estate by the income tax you are
paying on the IDGT on an annual basis; depending on your circumstances
and objectives, this may be viewed as either a great advantage or an
equally great disadvantage. Similar to the GRAT, selling FLLC shares
through an IDGT effectively provides a doublediscount.
June 2006:
Another estate planning instrument to consider is a Qualified Personal
Residence Trust (QPRT). This provides a mechanism through which
you could irrevocably transfer your residence and/or vacation home to
a trust, retaining a term interest, with your children as the ultimate
beneficiaries. During the term period, the house would remain
in your name and under your control; thereafter, it would be given to
the beneficiaries pursuant to the terms of the trust. You could continue
to live there after the term interest has expired; however, you would
be required to pay a reasonable rental sum to the beneficiaries of the
trust.
These trusts contain a number of key advantages. First of all, they can dramatically reduce federal estate and gift taxation. Similar to a CRT, the gift is completed when the residence is placed in the trust; however, the amount of the gift will be discounted due to the term interest that is retained by the grantor. This results in a more efficient use of unified credits and it removes any future appreciation in the residence from your estate. This instrument can become particularly key in certain cases because it provides the flexibility to reduce the estate in an efficient manner without draining investments which might be needed for retirement. Moreover, the grantor of the trust can continue to make the mortgage payments on the residence and still be able to deduct the amount of interest and taxes that are paid. However, any payments of principal during this time period will likely be deemed an additional gift to the beneficiaries. Furthermore, after the retention period expires, the grantor can remain on the property and continue to pay rent to the beneficiaries. Since this payment would be required and would be based on a reasonable sum, this provides a way to designate more funds to the beneficiaries without being burdened by the estate and gift tax.
There are a number of requirements that must be met for a trust to qualify as a QPRT. As a rule, these are not particularly stringent and are relatively easy to meet. A QPRT trust must be irrevocable and cannot contain any assets other than the residence and a nominal amount of cash needed for standard upkeep. Additionally, the property must be available for the grantors to use as a personal residence. This does not require that the property actually be used as a residence, but it must be available to do so. Furthermore, there are restrictions regarding the rental of the property.
There are also some disadvantages to a QPRT that must be considered. After the property is placed in the trust, the basis of the property will not be stepped up upon the death of the grantor. This can be a large issue when the residence in question is highly appreciated. Another disadvantage is that the grantor must survive the term of the retained interest. If the grantor does not survive the term, the property will be fully included in their estate. This would be the result as if there was no QPRT at all. Finally, a QPRT removes the property from your name and places it in the name of the trust and eventually the beneficiaries. As a result, when the term ends, the grantors must pay a reasonable rent to stay there; plus, the beneficiaries are fully entitled to require that they leave if they are not interested in the rental payments.
Despite its disadvantages, a QPRT can be an excellent estate-planning tool under the right circumstances.
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