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Intentionally defective grantor trusts: a unique planning possibility

Under the Tax Relief Act of 2010, the federal lifetime gift exemption was increased to $5 million per person, or $10 million per married couple. That number applies to estate, lifetime gifts, and generation skipping transfer tax. As a recent article in Forbes points out, with such a generous increase in the lifetime gift exemption amount, and with the uncertainty about when that number will change, many are now taking advantage of the ability transfer assets with little or no federal gift tax consequences.

Illiquid assets, such as personal real estate, are a prime area estate planning advisors are advising wealthy couples to transfer from their estates in order to take advantage of the currently generous lifetime gift tax exemption. Oftentimes couples are counseled to place their real property in a trust, which can be an excellent way maintain the property’s value while using up some or all of one’s exemption amount.

The decision to transfer real property into a trust is a big one, no doubt, and should be carefully considered as part of one’s long-terms estate planning goals. The trust itself can be titled in the name of a family member or even a company if that fits within one’s unique goals.

If engaging in such a transfer does fit one’s goals, one possibility is to place the real property in an “Intentionally Defective Grantor Trust,” which effectively removes the real property from one’s estate for estate and gift tax purposes, but not for income tax purposes. Doing so opens up multiple estate planning possibilities not otherwise possible because of tax issues. Such a trust will allow one to bring in rental income without tax liability or real estate taxes. In addition, any mortgage interest deductions will benefit the grantor. Rental payments to the trust are both income-tax-free and gift-tax-free. Multiple other possibilities exist with such a trust.

Of course, it is also important to get an independent appraisal of the property prior to placing it in trust, and not a bad idea to find out the fair market rental value as well.

If such a move is within one’s estate planning goals, now could be an excellent time to explore the possibilities with an estate planning attorney.

Source: Forbes, “Your Smartest Estate Planning Move Ever: Give Away Your House-Now!,” Rob Clarfeld, 22 June 2011.