Trusts can be effective estate planning tools for high net worth individuals.

Individuals with taxable estates are always looking for efficient ways to plan for the eventual estate tax. Two popular estate planning techniques that provide individuals with the ability to do so are Grantor Retained Annuity Trusts (GRATs) and Qualified Personal Residence Trusts (QPRTs).

As described in more detail below, these techniques provide a taxpayer with the ability to transfer assets outside of his or her estate at their current, or even discounted value. Since the asset will be transferred out of a taxpayer’s estate now, all future appreciation attached to the asset will be exempt from the estate tax. Experienced Southern Florida estate attorneys discuss below.

Grantor Retained Annuity Trusts

A GRAT is a trust by which the person making the contribution (the grantor) makes a transfer of property to the trust and retains an annuity (equal to a fixed percentage of the value of the initial trust assets) for a specified term of years. At the end of the period, the remaining trust property transfers to the beneficiaries which the grantor designates in the trust instrument.

For gift tax purposes, the value of the gift by the grantor would equal the total value of the assets transferred to the GRAT less the present value of the grantor’s retained annuity payment for the period of time that the grantor designates.  The present value of an annuity is based on the amount of the annuity selected, the initial term selected, and the interest rate in effect for the month of the transfer (determined by the IRS). The trust could be established to reduce the taxable gift to zero or close to zero (i.e., a zeroed-out GRAT). 

The benefit of the GRAT is that if the investment return of the GRAT exceeds the interest rate used to determine the value of the grantor’s retained interest and the grantor survives the GRAT term, the investment return in excess of the interest rate will escape gift tax and the future estate tax. The current interest rate set by the IRS. is 2.4% (for September 2017).  This interest rate is relatively low by historical standards and makes the current time a good time to utilize a zeroed-out GRAT.  Thus, the GRAT is particularly beneficial where the assets transferred to the GRAT have the potential to readily appreciate in value over the period of time selected. 

However, a disadvantage of a GRAT is that if the grantor fails to outlive the term of the annuity, the remaining GRAT assets will be included in the grantor’s estate for estate tax purposes, thereby eliminating some or all of the potential estate planning benefits of the GRAT. 

Qualified Personal Residence Trusts

A QPRT is a trust to which the grantor may transfer a residence while retaining the ability to use the residence for a certain term of years. During that term of years, the grantor continues to pay the expenses of the residence (e.g., mortgage, insurance, and property taxes), and gets all available income tax deductions with respect to those payments.  At the end of the selected term, the residence would pass by gift in a manner provided in the trust instrument.

The advantage of a QPRT is that, for gift tax purposes, the grantor can deduct from the value of the gift the value of his or her retained use of the residence for the chosen term of years. This reduction will substantially reduce the amount of the gift. The ultimate value of the taxable gift will be based on the term of the trust, the grantor’s age/s, and the interest rate set by the IRS in effect for the month of the transfer.

After the initial term of the trust has expired, the grantor no longer has the retained right to reside in the residence, and the residence will pass in trust to the beneficiaries. However, the grantor may rent the property from the beneficiaries at fair market value further reducing his or her gross estate without adverse estate or gift tax consequences.

There are, however, some disadvantages to a QPRT. Typically assets transferred on the death of an individual are entitled to a "step-up" in basis to the asset's fair market value on the date of death. The effect of this basis step-up is to eliminate any taxable gain on the property, thereby resulting in substantial income tax savings.  This "step-up" is lost if a residence is transferred to a QPRT and the grantor survives the initial retained term. However, if the grantor dies during the trust term, the transaction is treated for estate tax purposes as if it had never occurred, thereby removing the potential benefit. In that case, the costs of the transaction would be the cost of setting up the trust and any trust administrative expenses.

Additionally, with respect to a QPRT, at the end of the initial retained term (during which the grantor has the right to reside on the property), the property will no longer qualify as a homestead under Florida law, because the grantor is no longer the owner of the property. This will ultimately result in a reassessment of property taxes and the loss of the homestead protection from creditors. 

Contact Top Boca Raton Estate Attorneys Today

If you are looking for creative and efficient ways to reduce your potential estate tax exposure, contact Morris Law Group to discuss if a GRAT and/or a QPRT is the right planning technique for you.

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