Sale to Grantor Trust
As an alternative to the gifting strategies described above, you could consider selling assets, such as limited partnership interests, to trusts that benefit you (if another family member creates a trust for you) or your family members. A sale to a grantor trust is a transfer leveraging technique. The technique shifts income and appreciation above an extremely favorable interest factor to a grantor trust for the benefit of your family members and thus slows the growth of the value of the assets ultimately includible in your gross estate, which also benefits your family members.
Generally, to use this technique, you would establish a trust for your family members and gift certain assets to the trust, while selling some or all of the remaining assets to the trust for the fair market value of the assets sold. Alternatively, another family member could create a trust for you of which you are a beneficiary, and that trust could purchase assets from you. We would need an appraisal of the value of the assets being gifted and sold. Obviously, if a discount is applied in determining fair market value, you would be selling the interest for a price below the underlying asset value. We have been estimating a 34% discount in these types of transactions if limited partnership interest are sold, but the actual sale price would be determined by an appraiser. As consideration for the sale, you will receive back from the trust an interest-bearing promissory note secured by all of the trust’s assets, and may want additional security as well, such as guarantees from your family members.
Transactions between the grantors (you) and a grantor trust are disregarded for income tax purposes, so no gain would be recognized by you on the sale and the interest payments on the note will be neither taxable to you nor deductible by the trust. The trust’s income will be taxed to you even though you will not be a trust beneficiary. The interest rate specified in the note is the “applicable federal rate’’ (“AFR”) in effect as of the date of the sale. There are three sets of AFRs, depending upon the length of the note: (1) short-term AFRs if the term is three years or less; (2) mid-term AFRs if the term is more than three years but not more than nine years; and (3) long- term AFRs if the note term is more than nine years. The AFRs change monthly to reflect U.S. Treasury rates during the prior month. No later than the end of the term, the principal must be paid back to you by the trust, or the note must be renegotiated/renewed.
There is no requirement that interest be paid currently. The only statutory limit on the deferral of interest is the requirement that, to avoid a gift, the interest rate under the note must be at least the appropriate AFR (with semi-annual compounding).
The note should be secured with all of the trust’s assets, and not just the assets sold to the trust. Furthermore, prior to the sale you should make a gift to the trust to provide assets so that previously gifted assets should represent at least 10% of the trust assets immediately following the sale.