Grantor-retained trusts shift future appreciation to beneficiaries at a discounted or zero gift-tax cost by having the grantor retain a qualified interest for a term. IRC 2702 governs: unless the retained interest is a 'qualified interest' (an annuity, a unitrust interest, or a qualified residence interest), it is valued at zero, making the gift the full value. GRATs and QPRTs are the two workhorse qualified-interest structures.
A grantor retained annuity trust (GRAT) pays the grantor a fixed annuity for a term; the remainder passes to beneficiaries. The gift equals the remainder value, computed by subtracting the present value of the retained annuity (using the IRC 7520 rate) from the contribution. A 'zeroed-out' (Walton) GRAT sets the annuity so the remainder gift is near zero — any appreciation above the 7520 hurdle passes transfer-tax-free.
- Best for volatile, high-growth assets and low-7520-rate environments; success requires the asset to outperform the hurdle rate.
- Mortality risk: if the grantor dies during the term, much or all of the GRAT is pulled back into the estate under IRC 2036 — use shorter terms and rolling/laddered GRATs to mitigate.
- GRATs are grantor trusts; the grantor pays the income tax, effectively making an additional tax-free gift of the tax burden.
- GRATs are poor GST vehicles because of the estate-tax-inclusion-period (ETIP) rule delaying GST allocation.
A qualified personal residence trust (QPRT) transfers a residence while the grantor retains the right to live in it rent-free for a term of years. The retained use interest reduces the taxable gift of the remainder; higher 7520 rates and longer terms shrink the gift further — the opposite of GRAT sensitivity.
- If the grantor survives the term, the residence (and its appreciation) is out of the estate; the grantor must then pay fair-market rent to keep living there — an additional wealth shift.
- If the grantor dies during the term, the residence is fully includible (IRC 2036) — the plan simply fails without penalty beyond wasted costs.
- Limited to one or two residences; not available for the grantor's operating assets.
- Because the grantor cannot repurchase the residence from the QPRT (Treas. Reg. limits), plan the post-term rental and ownership carefully.
Key takeaways
- IRC 2702 zeroes out non-qualified retained interests; GRATs and QPRTs use qualified interests to shift appreciation cheaply.
- Zeroed-out, short, laddered GRATs suit volatile assets and low 7520 rates; mortality during the term causes estate inclusion.
- QPRTs benefit from higher 7520 rates and longer terms; the grantor must pay rent after the term.
- GRATs are weak GST tools due to the ETIP rule — use other vehicles for generation-skipping goals.
Authorities
- IRC 2702, 2036; Treas. Reg. 25.2702-3 (GRAT), 25.2702-5 (QPRT)
- Walton v. Commissioner, 115 T.C. 589 (2000) — Zeroed-out GRAT validated.