The possibility that there will be major changes in the estate and gift tax laws as a result of November’s election has many people considering planning techniques to lock in the current $11.58 million unified credit. These include outright gifts, sale and notes back to a grantor trust, use of a charitable lead trust, use of a grantor retained annuity trust and more. Each of these techniques involve some form of fixed or variable payments made currently, but what about for property such as artwork that does not generate an income? Then it is good to remember the GRIT.
A grantor retained income trust, or GRIT, is a planning technique that has been often overlooked but is an excellent tool for owners of artwork, farm land and special situations where they want to keep the income or use the property while gifting the remainder tax-free.
You form a GRIT, an irrevocable grantor trust, which keeps the right to use the property (or the income from the property) with you for a certain period of years after the property is transferred to the trust. When the term of years expires, ownership of the property goes to your intended beneficiary or beneficiaries. Your gift to the beneficiary is discounted by the time value of money, so the beneficiary must wait for the trust term to expire before receiving ownership of the trust property, making it worth less than if they received it today.
For example, suppose your 70-year-old aunt wished to make a gift to you of a portfolio of stock worth $10 million. Your aunt transfers the stock to a GRIT, retaining the right to any dividends and income from the trust for ten years. At the end of the ten-year term of the trust, ownership of the stock passes to you.
Your aunt's taxable gift is measured under the subtraction method prescribed in Reg. 25.2512-5(d)(2). Under that Regulation, the taxable gift equals to the total value of the property transferred less the value of the donor's retained interest. The result is that the current value of the gift of the remainder interest in the $10 million is valued at $6.5 million. This applies now, when the unified credit is $11.58 million, and it applies in 2021, even if Biden wins and Congress lowers the unified exemption and raises the estate tax rate.
If your aunt survives the 10-year term, the transferred stock portfolio—and any appreciation on the portfolio—will go to you without any additional gift tax. So, if the $10 million has an after-tax appreciation rate of 4%, the value would be $14.8 million. If the Biden tax changes go through, and the unified credit drops to $1million for gifts and $3.5 million for estates, this is a potential tax savings of $4 million. In the meantime, your aunt gets to keep the dividends and interest generated by the investment portfolio.
So, why is this not a more common technique? Because except for some very specific case (such as a qualified personal residence trust, or QPRT) The GRIT is treated as a current gift of the entire value when transfers of remainder interests are to a “member of the family” of the donor.
A “member of the family” includes 1) your spouse, 2) any of your ancestors 3) any lineal descendants of you or your spouse, 4) your siblings, and 5) any spouse of the foregoing “member of the family. So, if your aunt had gifted the stock to her children, the value of the taxable gift is the full $10 million value of the stock portfolio.
But there are exceptions to this rule, specifically the gift to the GRIT of non-depreciable tangible property such as artwork, vacant land and collectibles.
This “tangible personal property GRIT,” or “TPP-GRIT,” can transfer property to the members of your family without losing the discount on the value of the gift. So if you transfer your art collection or the fields of your ranch to a GRIT, you can keep the right to use the art and receive the income from the crops, leases or even sale of that property. At the end of the term of the GRIT, the art, ranch land or other tangible personal property goes to the beneficiaries and no tax is paid on the appreciation."Under the standard GRIT, a gift to the trust is discounted by the actuarial value of your aunt’s retained use interest, determined by looking at the government’s valuation tables. With a TPP-GRIT, the value of the taxable gift equals the value of the property transferred to the trust less the fair market value of your retained income interest. The fair market value is the rental value of the assets you gave to the trust.
The fair rental value may be difficult to determine because there is not a wide market in such rentals outside of the corporate arena, but this rental market is expanding. The regulations provide that the best evidence of the value of the term interest is actual rentals that are comparable in nature and character with the property and the duration of the term interest and that “[l]ittle weight is accorded to appraisals in the absence of such evidence.” So the first thing I would do is see if there was a strong rental market in the style and quality of the art you have in your collection. There is not much call for rental of Georgian silver tea sets, but there is some call for rental of abstract, impressionist and modern paintings and sculpture, and for productive farmland.
As with any discounting method, there is also a risk that, upon an audit, the IRS will assert a lower rental value than that asserted in the client's appraisal, resulting in a higher taxable gift and interest. Despite this, it is an often neglected, but useful, technique for owners of artwork and vacant land, or if you wish to give to people who are not members of your family.
Matthew Erskine is managing partner of Erskine & Erskine, which provides legal and fiduciary services for unique assets.