Financial planning strategies for depressed asset values

By Robert A. Westley, CPA/PFS

The confluence of historically low interest rates and volatile financial markets produces unique opportunities in wealth planning. Given the volatility in the capital markets, inquire whether clients have depressed assets on their balance sheets with the expectation of an eventual rebound. 

Gifting temporarily depressed assets or leveraging one of the following techniques may help to shift all the rebound appreciation out of the client's taxable estate and to his or her beneficiaries free of transfer taxes.

Here are some strategies that merit further consideration for high-net-worth individual tax clients.

GRANTOR RETAINED ANNUITY TRUST

A grantor retained annuity trust (GRAT) is an advantageous wealth-transfer technique when a client has an asset that is anticipated to increase significantly in value in a short time. The donor transfers assets to an irrevocable trust and retains the right to receive an annuity for a term of years. When the term of years expires, any assets remaining in the trust pass to the chosen remainder beneficiaries either outright or held in further trust for their benefit.

Generally, a transfer with a retained interest to a family member counts as a gift of the full amount transferred without being reduced for the value of the retained interest. However, Sec. 2702(b) describes a qualified interest as an annuity or unitrust interest, and this interest qualifies for the subtraction method in valuing the gift. For example, if a client transfers $1,000,000 to a GRAT and retains an annuity with a value of $999,999, then the taxable gift is $1.

The interest rate assumption built into the IRS table to value the annuity stream uses the Sec. 7520 rate, which was 1.2% in April 2020 and changes monthly. If the assets in the GRAT outperform the 1.2% IRS hurdle rate, then the excess return will pass to the remainder beneficiaries free of any gift or estate tax. 

The convergence of low interest rates and volatile asset values makes GRATs an attractive option for clients looking to enhance the transfer of assets to their heirs.

INTRA-FAMILY LOANS

Another worthwhile planning strategy in a low-interest-rate environment is the use of intra-family loans. The technique involves lending money or selling assets in exchange for a promissory note to a trust for the benefit of family members in lower generational levels. The strategy, like a GRAT, is a freeze technique that locks in the value of the note in the grantor's estate at the original loan amount or purchase price. All the appreciation occurring in the trust above the applicable federal interest rate being charged on the note is removed from the grantor's estate and transferred to the trust free of any transfer taxes.

The receptacle trust should be drafted as a grantor trust so that all items of income are taxed to the grantor. Grantor trust status amplifies the effectiveness of the technique, as income taxes will not diminish the trust. In addition, the grantor will not recognize any taxable income as a result of the sale or loan, and the payment of interest on the note will also be disregarded for income tax purposes. 

MONITOR SWAP POWERS AND REVIEW ASSETS

Volatility in the financial markets creates an opportunity to help clients review the cost basis and value of assets already located in irrevocable trusts. If the trust provides the grantor the power of substitution, it may be beneficial to swap low-cost-basis assets from an irrevocable trust back to the individual grantor. The low-tax-cost assets remaining in the grantor's taxable estate at death will receive a step-up in income tax basis under Sec. 1014. It is also advantageous to swap assets with temporarily depressed values from the individual grantor to an irrevocable trust. The benefit is to shift the ensuing rally in asset value out of the client's taxable estate and into the trust.

For a detailed discussion of the issues in this area, see "Personal Financial Planning: Four Financial Planning Opportunities to Take Advantage of in 2020," in the June 2020 issue of The Tax Adviser.

Robert A. Westley, CPA/PFS


The Tax Adviser is the AICPA's monthly journal of tax planning, trends, and techniques.

Also in the June issue:

  • A guide to changing previously filed partnership returns.
  • A discussion of modifications to the cost recovery rules.
  • A look at how young tax professionals can build a foundation for success.

AICPA members can subscribe to The Tax Adviser for a discounted price of $85 per year. Tax Section membership includes a one-year subscription to The Tax Adviser.

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