What if you paid a significant amount of money to buy something and it was defective? In one instance, you would be getting exactly what you bargained for. The intentionally defective grantor trust, sometimes referred to as a grantor defective trust (GDT), is an estate planning tool for the wealthy.
Normally when a grantor establishes a trust for other beneficiaries, the grantor wants to avoid being taxed on the trusts income; however, in the case of the GDT, the grantor intends to pay the tax on the trust’s income.
The GDT is an irrevocable trust. The trust is set up to accomplish the following 3 goals. First, the grantor wants to make completed gifts to the trust for gift tax purposes. Next, the grantor wants to remove the trust assets from the grantor’s estate for estate tax purposes. Lastly, the grantor wants to intentionally set the trust up in a manner where the grantor continues to pay the income taxes on the assets (in effect making additional gifts).
A Wall Street Journal article, Unusual Trusts Gain Appeal in Unusual Time, reports that this strategy currently has appeal due to the depreciation of many assets and the historically low interest rates. The article provides an example where a married couple set up a GDT and loaned the trust money to buy their office building. The couple will receive interest payments for 9 years.Today’s low interest rates mean that the trust repays the couple less, further benefitting the heirs. When the loan is repaid, the asset’s appreciation should pass to the heirs both estate and gift tax-free.