Interest rates¹ are particularly low and asset values are depressed. This unique combination creates significant opportunities to make gifts, leverage sales and remove highly appreciable assets out of an individual’s estate.
Here are some estate planning strategies intended to “freeze” currently low-valued assets that have high-appreciation potential:
Grantor Retained Annuity Trusts (“GRAT”)
For an investment portfolio or closely held business interest that is currently experiencing depressed values, a transfer of such property to a GRAT can be beneficial especially when the economy is expected to rebound once the COVID-19 pandemic is contained.
A GRAT is an irrevocable trust, authorized by statute, to which the owner of the property makes a transfer while retaining an annuity interest for a predefined term. At the end of the term, the property remaining in the GRAT vests in the remainder beneficiaries (usually children or a trust for the benefit of children) with no further estate or gift tax obligation. All income and appreciation of the stock or closely held business interest in excess of the annuity payment is transferred to the remainder beneficiaries at
the end of the GRAT term, ultimately removing the appreciated value from the transferor’s estate with minimal gift tax liability. Particularly, a zeroed-out GRAT generates a sizable transfer of value without the use of any estate and gift tax exemption.
Sale to Intentionally Defective Grantor Trusts (“IDGT”)
Sales to IDGTs also work incredibly well with high-growth marketable securities or closely held business interests. This transaction is structured so that the owner of highly appreciable property (such as marketable securities or closely held business interests) sells such
property to the IDGT in exchange for a promissory note with an annual interest rate equal to the Applicable Federal Rate (“AFR”). The owner must first establish an IDGT as a grantor trust² and then fund such trust with “seed money” to ensure the IDGT is respected by the IRS for estate and gift tax purposes. The seed money is generally 10% of the value of the property sold and is treated as a taxable gift.
What drives the success of this transaction is that the currently low-valued property sold to the IDGT will significantly appreciate at a rate greater than the interest rate on the promissory note. Using an IDGT allows the owner to transfer property to a trust benefiting others, removing the property’s future appreciation out of the owner’s gross estate.
Part II of this First Alert will discuss other estate planning opportunities well suited to a low interest rate environment including Charitable Remainder Trusts and Intrafamily Loans.
¹The AFRs for April 2020 are as follows: Short-term Annual AFR is 0.91%; Mid-term Annual AFR is 0.99%; and Long-term Annual AFR is 1.44%.
²IRC § 675.
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