The recent downturn in the economy has resulted in tax planning opportunities for persons with taxable estates.

The downturn in the real estate market results in the outright gift, split purchase, or gift of real estate to a Qualified Personal Residence Trust (“QPRT”) becoming more attractive. Depressed prices for real estate mean that more property can be given away free of gift tax than just a few years ago. When the real estate market recovers in the future, the appreciation of the property will accrue to the beneficiaries of these strategies. An example of the savings might be a property that was worth $1,500,000 in January 2007, when the IRC § 7520 rate was 5.6%. Contribution of the property by a 75-year-old taxpayer to a ten-year QPRT would have resulted in a gift of $661,260. Assuming the property had declined in value to $1,000,000 in January 2009, the gift of the property to a ten-year QPRT would have resulted in a gift of $599,680. If the real estate market recovers and the property is worth $2,000,000 ten years from now, the taxpayer would have removed a $2,000,000 property from his or her estate while using up only $599,680 of gift tax exemption – a discount of approximately 70% from fair market value.

In an effort to stimulate the economy, the Federal Reserve has lowered interest rates. The lowering of interest rates also makes certain planning strategies more viable. Assume the taxpayer has an asset, such as a business, that he believes will appreciate at 12% per annum for the next several years. The taxpayer could contribute the stock of the business valued at $1,000,000 to a two-year, zeroed-out Grantor Retained Annuity Trust or “GRAT.” If the contribution is made in January 2009 and the business does in fact appreciate at the 12% rate, the residual for the beneficiaries at the end of the two year period would be $156,068. Because the GRAT is zeroed-out for gift tax purposes, that amount passes to the beneficiaries estate and gift tax free. This strategy results in a gift or estate tax savings of $70,231 under current law (the tax on $156,068). Had the same strategy been pursued a few years ago when the IRC § 7520 rate was 5.6%, the remainder left to pass to beneficiaries would have only been $104,539.

Another estate freezing strategy that works particularly well when interest rates are low is a Sale to an Intentionally Defective Grantor Trust. A taxpayer sells an asset that he or she expects to appreciate in the future to a special type of trust known as an Intentionally Defective Grantor Trust (“IDGT”). The IDGT is referred to as being intentionally defective because it is the alter-ego of the taxpayer for income tax purposes. For example, the taxpayer sells an appreciating asset with a current value of $1,000,000 to the IDGT. The IDGT is the alter-ego of the taxpayer for income tax purposes, so there is no recognition of gain on the sale of the asset to the IDGT. The sale of the asset is in exchange for a twenty-year promissory note. The long-term Applicable Federal Rate for January 2009 is 3.57%, so the promissory must have an interest rate of that amount or greater. If the asset that was sold to the IDGT were to appreciate at 8% annually for the twenty-year lifespan of the transaction, there would be $1,479,609 left in the trust after paying off the note in twenty years. This strategy removes that amount from the taxpayer’s estate, for a savings of $665,824 in gift or estate taxes under current law.

One final strategy that works better in a low interest rate environment is a Charitable Lead Annuity Trust or CLAT. A CLAT is a planning strategy whereby a charity or charities are paid a fixed amount every year from a trust for a period of years or for life, with the remainder to be distributed to children or other named beneficiaries at the end of the term. If properly structured, a CLAT can be used to eliminate all estate taxes at death while also benefiting charity. When interest rates are low the annual installment payments that need to be paid to the charity in order to eliminate the estate tax are also quite low.