Intentionally Defective Grantor Trusts (IDGT) can be highly effective tools to avoid heavy capital gains and estate tax burdens for anyone who owns high-value assets. While we already dove into the specifics of what these types of trusts are, it’s important to understand how to properly utilize them once established.
Grantors of these trusts get the most out of them by selling expensive assets that have greatly appreciated over time into the trusts. This avoids the triggering of capital gains taxes and allows the asset(s) to be excluded from the estate of the grantor at the time of their death.
Selling Assets Into the Trust
The grantor will take advantage of the estate and capital gains tax savings by selling assets at fair market value to the trust in exchange for promissory notes bearing interest at the federal rate at the time of the sale. This prevents the owner of the asset from having to pay the capital gains tax on the asset that has appreciated over time.
For example, if Grant owns a home he purchased in 2005 for $350,000 that has since appreciated to a total value of $850,000, he would sell the home at a value of $850,000 to the IDGT. The trust gives Grant a promissory note for the total value plus the applicable federal interest rate. This removes the home from Grant’s estate but does not trigger the capital gains tax Grant would owe had he sold the property to a third party. Grant, as the grantor of the IDGT, would be required to pay the trust’s interest which would often be either covered by the income generated by assets within the trust or by Grant gifting the necessary cash to the trust to cover these costs.
Gifting Assets Into the Trust
Assets can also be gifted to the trust, though this requires consideration of the gift tax. However, grantors often gift cash to the IDGT in order to cover the interest payments required by the promissory note. This would only be necessary if the assets in the trust are not generating income or are not generating enough income to cover the interest payments.
Tread Carefully in Executing an IDGT
These tools can help you and your beneficiaries realize significant tax savings. However, a failure to properly establish the trust and conduct sales into the trust could result in significant tax and legal liability for everyone involved.
The team at The Law Offices of Tyler Q. Dahl can assist you in setting up an Intentionally Defective Grantor Trust as well as properly selling assets into the trust for tax purposes. Contact our team and ensure your estate plan is working in lockstep with an effective tax strategy.
Dahl Law Group
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