you are alive at the point of the trust's termination, whatever remains in the trust passes to the remainder beneficiaries. If structured properly, the trust can significantly reduce the gift tax on the assets that get passed on. And since the value of these assets is no longer in your estate, your estate tax burden is lowered.
Structuring the trust's terms is another topic to carefully address with the tax professional, estate planner and investment advisor. GRATs provide a fixed annuity payment. This is generally a fixed percentage of the original value of the assets transferred in trust. For example, if a $500,000 asset is placed in trust and the annuity payout rate is 5%, the trust would pay $25,000 each year. If there is not enough income earned on the trust assets to cover the annuity payout amount, the payments will be made from principal. This allows steady and consistent payments.
All appreciation in excess of the required annuity payments accumulates for the benefit of the remainder beneficiaries. Therefore, it may be possible at the end of the trust term to deliver assets to the beneficiaries that have a value far exceeding that of the original assets gifted to the trust.
The gift tax value of the assets transferred to the trust is determined at the time the trust is created. The gift tax value is determined by subtracting the discounted value of your future annuity payments from the value of the trust assets contributed. How the annuity interest and any other retained interests are valued depends on the relationship of the remainder beneficiaries and who retains the annuity and other interests relative to the transferor.
A Simple hypothetical illustration can show the value of a GRAT, using the example above. Assume that $500,000 of stock, with a 7% potential growth rate, is gifted to a five-year GRAT when the federal discount rate, IRC section 7520 rate, is 3.8%, reserving a 5% annual annuity for the grantor. The gift, at the transfer to the trust is $116,176. Each year, for five years, the grantor receives $25,000 from the trust as an annuity payment. At the end of the trust term, if the grantor is still alive, the remainder interest of approximately $547,500 passes on to the remainder beneficiaries.
When looking to relocate assets, you can choose between a GRAT, which pays out at a preselected level, and the grantor-retained unitrust, GRUT, which requires a trustee to value the asset every year and to pick an appropriate payout based on investment performance.
Both primary and vacation residences are eligible for qualified personal residence trusts, QPRTs, under which a grantor may reside in a home that has been placed into the trust. Usually, such trusts also may maintain six months of property-related expenses.
In this case, your income interest is going to be the term of years of living in the house.
Spouses who own a home jointly can each put 50% of the home in separate QPRTs so that if one outlives the other, the surviving spouse will still be able to live in the home while enjoying the tax benefits. If the grantors outlive the terms of the trust, they can still rent the home from the trust, but IRS requires that the trust charge a market-rate rent.
Although grantors can set up an unlimited number of GRATs and GRUTs, they can set up only two QPRTs, and only certain residential properties are allowable, including a vacation home.