Because of the increases to the income tax rates and the reduction in the estate tax rates in recent years, anyone holding appreciated assets in a grantor trust should consider exchanging high-basis assets that have less appreciation potential for the appreciated assets in the trust.

Many of our clients have created "grantor trusts" for their family and transferred appreciating assets to the grantor trust to attempt to reduce or limit their estate tax exposure. In these cases, the grantor trust was used to avoid estate taxes while retaining the income tax liability for the grantor (or creator) of the trust. This technique has the added advantage of requiring the grantor to further reduce his or her estate by paying the income tax liability on the assets that were transferred to family members without such payments being treated as gifts.

A common technique used to qualify the trust as a grantor trust was to provide the grantor of the trust with the power to take back some or all of the assets that are currently in the trust, so long as the grantor transfers assets to the trust with an equivalent value. For instance, if the grantor transferred closely held business stock or real estate to the trust and now wishes to own those assets in his or her individual name, the trust allows the grantor to transfer other assets to the trust having an equivalent value in return for taking back the stock or real estate. Although there are reasons a grantor may not want to return those assets to his or her estate, such as subjecting them to valuation concerns with the taxing authorities, there may be a significant income tax benefit to doing so.

The general income tax rule is that, when an asset is transferred to a trust during the grantor’s lifetime, the trust receives the grantor’s income tax basis in the transferred asset. Often, the transferred asset has a very low basis. Thus, the sale of the asset will trigger a large capital gain, even if the asset is sold after the grantor’s death. Instead, if the asset were to be owned by the grantor at death, the asset would receive a tax basis equal to the asset’s fair market value at the time of the grantor’s death. As a result, if the recipient sells the asset for its fair market value after the grantor’s death, there will be little or no income or capital gain tax to be paid.

Because of the increases to the income tax rates and the reduction in the estate tax rates in recent years, anyone holding appreciated assets in a grantor trust should consider exchanging high-basis assets that have less appreciation potential for the appreciated assets in the trust. This is of particular concern to clients who do not plan to have the trust assets sold during their lives, but who expect that they will be sold after their deaths. As with all tax planning techniques, this plan is not right for everyone.