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what is degrantorizing of a trust

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what is degrantorizing of a trust ?
Submitted: 8 years ago.Category: Tax
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6/27/2010
Tax Professional: Stephen G., Sr Income Tax Expert replied 8 years ago
Stephen G.
Stephen G., Sr Income Tax Expert
Category: Tax
Satisfied Customers: 7,473
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Hi & thanks for using our service. I'll do my best to give you a complete & accurate answer. Please ask me to clarify anything you don't understand.

 

A grantor trust by definition is usually disregarded for income tax purposes; the grantor usually uses his/her social security number for income tax reporting purposes.

 

The only impact comes when the grantor dies; the trust is "degrantorized" when the successor trustee takes over & the grantor trust becomes a "real" trust.

 

The grantor trust avoids the probate process for the heirs as there is title transfer necessary; there's no termination of the trust, merely a chance in administration of the trust; ie. the trust in degrantorized, as the grantor is no longer available to act as his/her own trustee, so the successor trustee, not being a grantor, is now the trustee of a "real" trust.

 

Please remember to click on the green 'ACCEPT" "ICON" & thanks again for using our service.

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Customer reply replied 8 years ago

I am interested in knowing how this (de-grantorizing) works for a New York Trust prior to the sale of property held by a grantor trust so that the grantor pays capital gains at 15% vs. the trust capital gains at 28%; and then are the net proceeds deposited into the trust or are the proceeds now part of the grantor's estate and the grantor trust is unfunded or no longer in existence?

 

The above is the heart of my question .... your answer is a general answer to very specific additional questions which I could not fit into the one line question but only in the more detail section asking what have I done so far. So what you have provided me thus far is what I already learned on the internet. However, what is being proposed is de-grantorizing prior to death of grantor for capital gain tax purposes, unless you are telling me that a grantor trust shifts capital gains tax to the grantor upon sale for a gain of property held by a trust. If so that is contrary to what a top estate attorney in this area is saying. However, he is not explaining how this works ... so I am asking you.

Tax Professional: Stephen G., Sr Income Tax Expert replied 8 years ago

 

Ok, look, we can approach this 2 ways.............the first, why don't you explain exactly what you are trying to do, including using the actual numbers involved & I can either explain how to do it or tell you whether or not what you're proposing will have the result you desire.

 

The second way is basically what I already explained; for tax purposes a grantor trust is disregarded as long as the grantor is alive the grantor has the ability to terminate the trust, withdraw whatever is in the trust without tax implications; any tax effect is flows to the grantor for income tax purposes.

 

If the grantor dies before the property is sold, but the trust is terminated properly, then the beneficiaries will pay the capital gains tax on their respective tax returns. There are too many if's and's or but's to comment further, without you being more specific as to what you're asking, including the figures involved.

 

Tell me what the fact pattern is that the "top estate attorney" is considering & I'll tell you what he means or if he's right or wrong..........Attorneys seldom get the income tax questions correct, in my experience anyway.

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Customer reply replied 8 years ago

My client is selling his business. Two pieces of the business are owned by two grantor trusts. The estate attorney is saying that he recommends de-grantorizing the trust to shift the capital gain tax from the Trust (@ 28%) back to my client (@ 15% or 20% depending on the closing being this year or next). Frankly I have never heard of de-grantorizing a Grantor Trust prior to the grantor's death or the transfer of trust assets to a foreign domiciled trust. At this point I am not questioning the estate attorney's statement that this can be done but operating on the assumption that it can be done. However, I do not know how it works nor what it means. Therefore my questions:

 

1) How does de-grantorizing a Trust work in shifting the assets back to the grantor for capital gains tax purposes?

2) Does that mean the original gift is no longer valid?

3) Which tax entity owns the assets - The trust or the client?

4) Assuming that a de-grantorizing as he describes can take place, do the net after tax proceeds go into the Trust as the way the assets are removed from the estate or is the Trust dissolved?

 

The Grantor Trusts were formed just after the formation of these particular parts of the business as an estate planning move. Specifically as the business grew in value, the growth was outside the estate. Asset book values are about $3.5 million each. The possible sales price averages $10 mill per unit so shifting from 28% to 15% make a lot of financial sense. I just have never run across this before and nor sure how such a de-grantorizing works or the longer term ramifications of such a move.

 

I am, this afternoon, doing some work on the level of this vis-a-vis the entire business network being sold. These are the smaller pieces of my client's holdings so in the grander scheme of things it may not be as important as the estate attorney things given that he is thinking in transaction mode vs. strategic planning mode which is my mode.

 

Nope - at this point I am not prepared to ask these questions of the estate attorney because until I get a better understanding for myself. Otherwise I am not serving as the advisor my client has hired me to be. If this estate attorney is blowing smoke up my dress to protect his own turf, then I am certainly not going to add wind to the blow at this point. Unfortunately what I find on the Internet deals with the death of the grantor or the transfer of assets to a foreign domiciled trust.

 

Maybe this is way too specific and complicated a question for this forum. I was trying something I have never tried before by asking this question via this type of forum.

Tax Professional: Stephen G., Sr Income Tax Expert replied 8 years ago

 

Look, let's understand one thing, perhaps we aren't on the same wave length in terms of what a "grantor trust" is; or perhaps what you're dealing with aren't grantor trusts;

 

There are no estate or income tax savings which accrue to a grantor trust; the reason, the grantor retains 100% control over the trust (as the Trustee & the current income beneficiary) while he/she is alive; the advantage of a grantor trust is that the assets avoid the probate process upon the death of the grantor;

 

the assets are fully includable in the grantor's estate for estate tax purposes; they are just not in the probate estate for settlement purposes; the terms of the trust determines their disposition at the grantor's death;

 

So if these assets are indeed in a grantor trust, and they were to be sold while the grantor is alive, the related capital gain is reportable on the grantor's income tax return;

 

If the idea was to remove appreciation of these assets from the estate, a grantor trust is not the vehicle to accomplish this; If that was the principal purpose of forming these trusts, then perhaps you aren't dealing with grantor trusts; what you call them (or what an attorney calls them) is not important; naturally, the terms of the trust control; for example, there's really no such thing as a "real estate trust", there are any number of various trusts which only hold title to real estate & are called "real estate trusts" for that reason; grantor trusts, living trusts, irrevocable trusts, nominee trusts, generation skipping trusts, may all hold title to real estate & be referred to as "real estate trusts", when in fact that does nothing to indicate what type of trust you're dealing with in actuality.

 

So, if you follow this along, you can see why your last set of questions don't really apply to grantor trusts...............so.........

 

1. There's no shifting of capital gains in a grantor trust because the grantor never transferred the income tax burden to the trust, by definition.......

 

2. There was no gift, just a change in the way the grantor held title to the property; since the property was no longer in his name, but rather in his grantor trust; his estate will avoid probate for anything in the trust; avoiding probate is not avoiding estate tax.

 

3. If the assets are in the trust, the trust "owns" the assets (ie. holds legal title to them); but remember, the trust is holding the assets for the benefit of the grantor.

 

4. It doesn't matter where you put the money after a sale; for the reasons stated; It would seem that if the real objective was to avoid probate, the assets (now net sales proceeds) should remain in the trust.

 

Just a word of caution...with all due respect....it appears that you're dealing with a potential substantial transaction here; trust accounting & taxation can get complicated real fast & often a change of a word or two in the trust can have a substantial impact on what happens tax wise; from your questions, it appears that you don't have a lot of experience in this area & the knowledge isn't something you are going to acquire quickly; you can't advise without income, estate & legal knowledge; they are all meshed into a maze of interrelated issues; I have no idea what your background is or what your role may be in this particular circumstance; but you should get some help to analyze the trust & determine what has been done income tax wise to date; it wouldn't be unusual to find that it is all wrong or it could be perfect; talk to the accountant who has been/was/is preparing the grantor's income tax returns; he/she should know what's going on. There's nothing wrong with talking to the lawyer about these matters; in fact not to do so would, in my opinion, constitute a disservice to whomever owns these assets. AWTTWIS or at least it should be. Good Luck.

Stephen G.
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Customer reply replied 8 years ago
Thanks - what you have confirmed is that I am not that stupid about these things. I've read the Trusts .... we've done our analysis .... and I could not see anywhere that the tax burden was shifted so why all the work to shift back.
Tax Professional: Stephen G., Sr Income Tax Expert replied 8 years ago

 

I have no idea; that's why I question whether or not you actually have grantor trusts.

As we've discussed, if the grantor is also the current beneficiary (while he/she is alive & well, the trust is disregarded for income tax reporting purposes.

 

Thanks very much for your payment. I am putting this response under "need Info" so you can get at it without using "answer". However, I don't expect a response unless you have a follow-up question.

 

Steve Grizey

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