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Beneficiary Defective Trust

One mechanism to shelter estate taxes on assets with expected rapid appreciation is for a relative of yours (or other third party) to create a beneficiary defective trust with you as the beneficiary. In this type of irrevocable trust, the grantor makes a gift of $5,000 or less to the trust. No other gifts to the trust are made in any given calendar year. To the grantor, this trust is a non- grantor trust. To the beneficiary, this is a grantor trust, on which the beneficiary pays the income tax associated with the trust assets. The beneficiary often has a limited power of appointment over the trust exercisable during the beneficiary’s life or at the beneficiary’s death. The beneficiary may be Trustee and may have investment power over the assets of the trust. The beneficiary may sell to the trust assets that the beneficiary owns in exchange for a note payable to the beneficiary. The appreciation of assets sold to the trust is then outside of the estate of the beneficiary and therefore not subject to estate tax at the death of the beneficiary. This type of trust allows you to be a beneficiary of the trust yourself, rather than just your other family members. This type of trust has not been blessed by the IRS, but has been used for many years. The most significant structuring challenge is providing adequate security for the note since the trust does not have much in the way of assets.

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