Many wealthy clients use an effective wealth transfer technique known as a gift and sale to a grantor trust.  A grantor trust is treated, for income tax purposes, as entirely owned by the person who transfers property to the trust (the grantor). Accordingly, there is no tax consequence arising from a sale by you to a grantor trust created by you for the benefit of your descendants. If the sales price is equal to the full fair market value of the property, then the property would be removed from your estate without gift tax. The sale is usually in exchange for a promissory note from the trust, in which case the trust property (including both property given to the trust and property sold to the trust) should include sufficient cash or provide a sufficient income stream (such as dividends) to support the required payments on the promissory note. Further, to ensure that the loan is respected for tax purposes, it should have reasonable terms (including a rate of interest at or above the IRS published rate), so that it would be agreed to by the parties even if they were unrelated persons, such as in a commercial setting.


Sam creates an irrevocable grantor trust for the benefit of his son and daughter, and makes a gift to the trust of an interest in a limited partnership. For gift tax purposes, the value of the limited partnership interest is $200,000, but if the partnership was dissolved, the interest is worth $250,000 ($250,000 discounted by 20 percent is $200,000). Sam sells the trust an interest in the partnership for $600,000, which would have an “underlying” value of $750,000 (again, this assumes a 20 percent discount). Sam takes back a note from the trust with a term of 10 years and a 5 percent interest rate, and provides for a balloon principal payment at the end of the ten-year period. The trust is required to pay interest of $30,000 to Sam per year. The hope would be that the trust property would generate sufficient income to pay the interest annually and would appreciate significantly over time to enable the trust to eventually pay the principal at the end of the ten-year period. At that time, the note is paid off and the trust property is distributed to Sam’s son and daughter, Jack and Jill. In this hypothetical, assuming the trust property generates income of 3% a year and principal growth of 7% a year, Sam’s children will receive assets with an “underlying value” of approximately $1,260,000 (or, $630,000 for each of Jack and Jill).


This is just one example, of course: the amounts could be adjusted to reflect your wishes and expectations. It is important to remember that this technique utilizes grantor trusts, so that you would be taxed on all of the income and capital gains generated by the trusts, even though you are not a beneficiary of the trusts. You would have to use other assets to pay the taxes; the trust property would not be available to you for this purpose.