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Residence (and nonresidence) GRITs.

Residence GRITS

Qualified personal residence grantor retained income trusts (residence GRITs) are perhaps the most universally applicable and attractive gift planning device currently available for clients. Unfortunately, some planners have put off establishing a GRIT, since Sec. 7520 rates are at a historically low level (6.8% for November 1992); as rates decline, the relative value of the income interest decreases and the value of the remainder increases, thereby increasing the taxable gift. However, it is possible that the benefits of the residence GRIT will be narrowed or repealed by Congress in light of the fact that it is the one exception to the general framework of Sec. 2702. On balance, it is probably advisable to complete GRITs now without waiting to see if Congress decides to repeal residence GRITs or reduce the unified credit.

A GRIT gift is particularly suited to a younger homeowner. There is no limit on the term of the trust and Sec. 1034 house rollovers are available, provided the trust is a grantor trust as to income and corpus. This will occur under Sec. 673 if the grantor retains a reversion contingent on his death during the GRIT term and its value exceeds 5% of the value of the transferred home. A young healthy grantor could set up a GRIT for a very long term and obtain a substantial reduction in transfer tax while potentially sheltering a very large amount of appreciation.

An older homeowner also should consider a GRIT, since the ability to take the contingent reversion into account in valuing the remainder makes the GRIT a worthwhile technique even for an elderly grantor not likely to live much beyond three years. The final Sec. 2702 regulations (published Jan. 28, 1992) permit the trust to continue as a qualified personal residence trust even if the grantor must move to a nursing home, as long as the residence remains available for the grantor's use.

Although mortgaged property can be transferred to a residence GRIT, it will inevitably complicate the transaction and possibly reduce the transfer tax benefits. The fair market value of the residence on which the taxable gift is based will be reduced by the outstanding mortgage balance if the donee has no rights of subrogation against the grantor and the debt is recourse (as will generally be the case). In this event, all or an actuarially calculated portion (depending on local law and the trust document) of the principal part of each mortgage payment made by the grantor will be a gift to the remainderman. Assuming the GRIT is in fact set up as a grantor trust, Rev. Rul. 85-13 should prevent the recognition of any gain, even if the grantor is relieved of the mortgage obligation and the mortgage balance exceeds the grantor's basis in the house.

Clients tend to have a fair amount of understandable anxiety about "losing their house to the kids" on termination of a GRIT. This concern usually diminishes once the client realizes he can repurchase the house from the trustee, and the trustee can be the grantor himself. The purchase of the residence just prior to the expiration of the term converts the GRIT to a grantor retained annuity trust (GRAT). Rev. Rul. 85-13 prevents any gain or loss recognition on the purchase of the residence by the grantors, as long as the GRIT is a grantor trust either because of the contingent reversion on death during the trust term (see IRS Letter Rulings 9046026 and 9048027 relying on Sec. 673) or by virtue of a similar contingent general power of appointment over the trust corpus under Sec. 674 (see IRS Letter Ruling 9112007).

Vacation homes are ideally suited for transfers to residence GRITs because clients generally intend to transfer them to the children anyway. The anxiety associated with the principal residence does not exist.

If a residence is owned by the grantors as joint tenants with right of survivorship (or tenants by the entirety), the couple must make a decision. The spouses may choose to set up one GRIT for each spouse, a joint GRIT, or if one spouse is much younger or healthier, or has a family history of longevity, they could have the other spouse transfer his interest to the young/healthy spouse before the transfer of the residence to the GRIT. Most planners prefer to set up a GRIT for each spouse rather than create a joint GRIT.

Nonresidence GRITs

The requirement of Sec. 2709. that the grantor's retained interest be an annuity or unitrust interest or that the trust hold a personal residence only applies when the transfer is to a trust for a member of the transferor's family (as defined in Sec. 2704(c)(2)). Because this definition includes only lineal descendants, a "prior-law" GRIT can be set up for a niece or nephew with marketable securities or closely held stock.

The taxable gift should be determined by using the actuarial tables to value the remainder, taking into account the values of both the income interest and the contingent reversion. However, if the property placed in trust has a history of not producing income and the trustee is permitted to hold the asset, the grantor's ability to use the actuarial tables may be challenged on the theory that using the assumed rate of return in the tables would produce an unrealistic value. See the recent case of O'Reilly, 6th Cir., 1992, in which the taxpayer was denied the use of the tables to value a GRIT transfer of closely held stock that had a history of producing a 0.2% return.

It may still be possible to use the tables even with nonproductive property, by providing the grantor with a power to require the trustee to convert the property to income-producing property. In any event, the property should be made to produce a stated standard level of income during the trust term to prevent the IRS from arguing under Dickman that a gift occurs each year to the extent income falls short of the actuarially assumed rate of return. See, e.g., IRS Letter Ruling 9112007.

From Robert B Coplan, Esq., Washington, D.C.
COPYRIGHT 1993 American Institute of CPA's
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Title Annotation:grantor retained income trusts
Author:Coplan, Robert B.
Publication:The Tax Adviser
Date:Jan 1, 1993
Previous Article:Deferred like-kind exchanges of a target corporation.
Next Article:IRS takes position that GRATs cannot be zeroed out.

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