Like a grantor retained annuity trust, an installment sale to a grantor trust may be an effective means for a individual to transfer part of the future income or appreciation from a high-income or rapidly-appreciating asset with little or no gift or estate tax cost.
A “grantor trust” is a trust of which the grantor is considered the owner for federal income tax purposes. This means that the grantor must report, on the grantor’s individual income tax return, all of the income, deductions, and credits of the trust, just as if the grantor was the owner of the trust grantor assets. The IRS has also ruled that a sale or other transactions between an income trust and the grantor does not result in any capital gain or loss, or any other tax consequences. The trust is ignored for federal income tax purposes and the grantor is still the owner. In this way, the trust is viewed as intentionally defective for income tax purposes but quite effective for estate tax purposes. This type of trust is known as an “intentionally defective grantor trust” or “IDGT”.
The IDGT can purchase substantially appreciated property for a small downpayment and a promissory note, with interest only being payable for up to 9.9 years and the principal being due in a balloon payment at the end of the note term. This essentially freezes the value of the property being purchased by the trust at the value on the date of the initial sale. If interest rates are low (i.e., and the appreciation on the asset being sold is significantly higher than the interest rate on the note), you could transfer significant wealth out of your estate to the purchasing trust. This benefit can be leveraged further if the trust purchases a minority interest or partial interest in property that may be capable of being discounted for gift and estate tax valuation purposes. And, if the trust is treated as a grantor trust, your payment of taxes on the trust’s income will increase the amount of assets being transferred to your heirs without additional gift tax being incurred