Wills and Trusts

Wyatt, Tarrant & Combs, LLP

MAXIMIZING AND MULTIPLYING THE “STEP-UP” IN BASIS – Part II

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MAXIMIZING AND MULTIPLYING THE “STEP-UP” IN BASIS – Part II

Swapping Assets with Existing IDGTs

In 2011 and 2012, many individuals made significant taxable gifts, using all or a significant portion of their Available Exclusion Amounts because of the risk of that the exemptions would “sunset” back to 2001 levels.  Many of those gifts were made to grantor trusts.

A common power used to achieve grantor trust status for the IDGT is one described under section 675(4)(C), namely giving the grantor, the power, in a non-fiduciary capacity, to reacquire the trust corpus by substituting other property of an equivalent value.[1]  For income tax purposes, transactions between the grantor and the IDGT will be disregarded.[2]  As such, grantors may exercise the power to swap high basis assets for low basis assets without jeopardizing the estate tax includibility of the assets and without having a taxable transaction for income tax purposes.

To maximize the benefits of the swap power, it must be exercised as assets appreciate or are sold over time.  When exercised properly, this can ensure that only those assets that benefit the most from the step-up will be subject to estate inclusion.

If grantor does not have sufficient other assets, repurchase will be difficult – although the donor could borrow cash from a third party.

The income tax consequences if a note is used to repurchase property are uncertain because the trust’s basis in note may equal grantor’s original carryover basis in the asset given to the trust and now reacquired so paying off the note may generate gain).

Because the sudden or unexpected death of the grantor may make a repurchase difficult or impossible, estate planners may want to consider drafting “standby” purchase instruments to facilitate fast implementation of repurchase.

The Obama administration has proposed significant limitations on the ability of grantors to prospectively manage assets that would be includible in the grantor’s estate through the use of this swap power.  Pursuant to the proposal:

If a person who is a deemed owner under the grantor trust rules of all or a portion of a trust engages in a transaction with that trust that constitutes a sale, exchange, or comparable transaction that is disregarded for income tax purposes by reason of the person’s treatment as a deemed owner of the trust, then the portion of the trust attributable to the property received by the trust in that transaction (including all retained income therefrom, appreciation thereon, and reinvestments thereof, net of the amount of the consideration received by the person in that transaction) will be subject to estate tax as part of the gross estate of the deemed owner, will be subject to gift tax at any time during the deemed owner’s life when his or her treatment as a deemed owner of the trust is terminated, and will be treated as a gift by the deemed owner to the extent any distribution is made to another person (except in discharge of the deemed owner’s obligation to the distributee) during the life of the deemed owner.[3]

The proposal would apply to pre-existing IDGTs because it would be effective with regard to trusts that engage in a described transaction on or after the date of enactment

Turney P. Berry

Louisville, Kentucky


[1]§ 675(4)(C) and Rev. Rul. 2008-22, 2008-16 I.R.B. 796.

[2] See Rev. Rul. 85-13, 1985-1 C.B. 184 and PLR 9535026.

[3] Department of the Treasury, Coordinate Certain Income and Transfer Tax Rules Applicable to Grantor Trusts, General Explanation of the Administration’s Fiscal Year 2014 Revenue Proposals (April 2013), p. 145.

Leave a reply. Please note that although this blog may be helpful in informing clients and others who have an interest in information privacy and security, it is not intended to be legal advice. The information on this blog also should not be relied upon to form an attorney-client relationship.

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