Swap powers within intentionally defective grantor trusts (IDGTs) are critical estate planning tools that may help you improve tax efficiency today while allowing you to preserve wealth for future generations.
An IDGT is an irrevocable trust that you, the grantor, can create during life to pass assets and wealth to your named beneficiaries outside your taxable estate. Although the assets you transfer to the IDGT are considered completed gifts for gift and estate tax purposes, you retain certain powers for which you are responsible for paying taxes on all of the trust’s income and gains. This means that the income tax you pay each year on trust income comes out of your estate free of gift and estate taxes rather than from the trust, which may continue to grow at a tax-free rate of return. However, the challenge with this strategy is that assets held in the trust will not receive a step up in cost basis when you pass away, as would be the case if the assets remained in your taxable estate. To help mitigate this risk, you may employ swap powers.
Swap powers allow grantors to exchange or substitute low-cost-basis assets held in a grantor trust for high-basis assets of equal value included in their taxable estates. With this type of swap, low-cost-basis assets transferred outside a trust receive a step up to the fair market value on the date of the grantor’s death, thereby eliminating asset appreciation during the grantor’s life and beneficiaries’ exposure to capital gains tax on the sale of those assets in the future. Similarly, grantors may swap assets that have declined in value into a trust to help preserve the loss in their taxable estates.
While swaps are not taxable events, grantors and trustees must take care to properly document all exchanges and ensure that the value of substituted property is equivalent. It is essential to work with experienced advisors, including financial planners, accountants and valuation specialists, to ensure you properly establish your trust to allow for swap powers and accurately valuate assets to avoid any risks of unintended tax exposure.
About the Author: Eric Zeitlin is managing director of Provenance Wealth Advisors (PWA), an Independent Registered Investment Advisor affiliated with Berkowitz Pollack Brant Advisors + CPAs and a registered representative with PWA Securities, LLC. He can be reached at the firm’s Fort Lauderdale, Fla., office at (954) 712-8888 or email@example.com.
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Eric Zeitlin is a registered representative of and offers securities through PWA Securities, LLC, Member FINRA/SIPC.
This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct.
Any opinions are those of the advisors of PWA and not necessarily those of PWA Securities, LLC. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of PWAS, we are not qualified to render advice on tax or legal matters. You should discuss any tax or legal matters with the appropriate professional. Prior to making any investment decision, please consult with your financial advisor about your individual situation.
Updated on October 16, 2023