Freeze the Value of Your Estate

January 18th, 2009

Low interest rates and assets values represent a perfect opportunity to freeze estate values and minimize inheritance taxes. The freeze technique utilizes a grantor trust which takes advantage of even lower interest rates than afforded by the 7520 and avoids revaluation of trust assets on an annual basis. This technique is more attractive than the GRAT application for use with assets that are difficult to value.A grantor creates and funds an irrevocable trust for the benefit of descendants. The initial funding of the trust is usually done with cash in an amount equal to 10 percent of the value of the property that will be included in the sale. This trust is a “grantor trust” making the grantor the owner of the entire trust for income tax purposes, even though the trust is a completed gift for gift and estate tax purposes.

Once the trust is funded, the trustees purchase the assets from the grantor in exchange for a promissory note. Since the trust is not a consideration for income tax purposes, the sale does not result in recognition of a capital gain. The trustees continue to pay down the note using the cash flow generated by the purchased assets, or by borrowing funds from a third-party lender, or by making payments in kind. The note can be structured as an interest-only note with a balloon payment of principal at the end of the term of the note.

The property sold to the trust is removed from the grantor’s estate immediately; with no risk of inclusion should they die during the term of the promissory note. If the grantor dies before the note is paid, any portion of the unpaid balance will be included in the grantor’s estate.

The interest rate used for the promissory note is lower than the 7520, meaning that less value is returned to the grantor via the sale technique than would be the case when using a GRAT. The promissory note is structured as a balloon note in contrast to GRAT annuity payments which must be paid with no more than a 20 percent annual increase. Accordingly, the sale technique has the advantage of allowing the subject property more time to appreciate outside of the grantor’s estate. One of the key advantages of this technique is that it is more appropriate for passing wealth to grandchildren than the GRAT technique.

One of the disadvantages of the sale technique is that it must be funded initially by a gift with sufficient assets to provide security for the promissory note. This strategy also requires some use of the lifetime gift tax exemption and cannot produce a $0 gift like the GRAT strategy. The value of the assets subject to the sale can change upon audit. The GRAT technique is based upon a specific tax statute whereas the sale to a grantor trust is a creative use of several different tax laws. However, if the technique is successful, there is an opportunity to pass on wealth to grandchildren with very minimal use of the life time gift tax exemption and GST tax.

We have one more neat estate freeze technique which we will share with you in the next blog post.