When a dying grantor (whether a Nonresident Alien (NRA) or a U.S. grantor) repurchases a highly appreciated asset from a foreign irrevocable grantor trust, the transaction can have significant tax implications. This strategy is often used to bring the asset back into the grantor’s estate to take advantage of the step-up in basis at death under IRC § 1014, which can eliminate capital gains tax on the appreciation. This paper explores the tax consequences of such a transaction for both NRA grantors and U.S. grantors, including income tax, estate tax, and gift tax considerations.
1. General Framework
The grantor repurchases the highly appreciated asset from the foreign irrevocable grantor trust using cash or other assets held in the trust.
The goal is to bring the asset back into the grantor’s estate to take advantage of the step-up in basis at death.
The tax consequences depend on the grantor’s residency status, the nature of the trust, and the specific transaction.
2. Tax Consequences for a U.S. Grantor
a. Income Tax Implications
No Capital Gains Tax on Repurchase: If the trust is a grantor trust at the time of the repurchase, the transaction is not a taxable event for income tax purposes. This is because the grantor and the trust are treated as the same taxpayer under IRC § 671.
Deemed Sale at Death: If the grantor dies shortly after repurchasing the asset, the asset is included in the grantor’s estate and receives a step-up in basis to its fair market value (FMV) at the date of death (IRC § 1014). This eliminates capital gains tax on the appreciation that occurred before the grantor’s death.
b. Estate Tax Implications
Inclusion in the Grantor’s Estate: The repurchased asset is included in the grantor’s estate for estate tax purposes. The value of the asset is subject to federal estate tax, which is calculated using the progressive rates under IRC § 2001(c) (up to 40% for 2023).
Unified Credit: The grantor’s estate may use the unified credit (currently $12.92 million for 2023) to offset the estate tax liability.
c. Gift Tax Implications
No Gift Tax: The repurchase of the asset is a sale, not a gift, so it does not use any of the grantor’s lifetime gift tax exemption under IRC § 2505.
Example 1: U.S. Grantor
A U.S. grantor repurchases highly appreciated U.S. real estate (basis: 100,000,FMV:100,000,FMV:1,000,000) from a foreign irrevocable grantor trust using cash in the trust.
The grantor dies shortly after, and the real estate is included in their estate with a stepped-up basis of $1,000,000.
The estate pays no capital gains tax on the $900,000 of appreciation.
3. Tax Consequences for an NRA Grantor
a. Income Tax Implications
No Capital Gains Tax on Repurchase: If the trust is a grantor trust at the time of the repurchase, the transaction is not a taxable event for U.S. income tax purposes. This is because the grantor and the trust are treated as the same taxpayer under IRC § 671.
Deemed Sale at Death: If the grantor dies shortly after repurchasing the asset, the asset is included in the grantor’s estate and receives a step-up in basis to its FMV at the date of death (IRC § 1014). This eliminates capital gains tax on the appreciation that occurred before the grantor’s death.
b. Estate Tax Implications
Inclusion in the Grantor’s Estate: The repurchased asset is included in the grantor’s estate for U.S. estate tax purposes, but only if the asset is U.S.-situated property (e.g., U.S. real estate or stock in a U.S. corporation). Foreign assets are not subject to U.S. estate tax.
Unified Credit for NRAs: NRA grantors are entitled to a unified credit of $60,000 (as of 2023) to offset estate tax liability on U.S.-situated assets.
c. Gift Tax Implications
No Gift Tax: The repurchase of the asset is a sale, not a gift, so it does not use any of the grantor’s lifetime gift tax exemption under IRC § 2505.
4. Key Considerations
a. Timing of the Repurchase
The grantor must repurchase the asset before death to ensure the asset is included in their estate and receives a step-up in basis. If the grantor dies before completing the repurchase, the asset remains in the trust and does not receive a step-up.
b. Nature of the Asset
For NRA grantors, only U.S.-situated assets are subject to U.S. estate tax. Foreign assets are not included in the grantor’s estate.
For U.S. grantors, all assets (both U.S. and foreign) are subject to U.S. estate tax.
c. Trust Status
The trust must be a grantor trust at the time of the repurchase to avoid capital gains tax on the transaction. If the trust is no longer a grantor trust, the repurchase could trigger capital gains tax.
Example 2: NRA Grantor
An NRA grantor repurchases highly appreciated U.S. real estate (basis: 100,000,FMV:100,000,FMV:1,000,000) from a foreign irrevocable grantor trust using cash in the trust.
The grantor dies shortly after, and the real estate is included in their estate with a stepped-up basis of $1,000,000.
The estate pays no capital gains tax on the $900,000 of appreciation.
Conclusion
The strategy of a dying grantor repurchasing highly appreciated assets from a foreign irrevocable grantor trust can provide significant tax benefits, including the elimination of capital gains tax through a step-up in basis at death. However, the tax consequences depend on the grantor’s residency status, the nature of the asset, and the timing of the transaction. Proper planning and compliance with tax and reporting requirements are essential to maximize the benefits of this strategy.
Disclaimers
This paper is intended for informational purposes only and does not constitute legal, tax, or financial advice. The application of trust and estate tax laws depends on the specific facts and circumstances of each case. Tax laws and regulations are complex and subject to change. You should consult a qualified tax professional or attorney for advice tailored to your situation. The author and the law firm disclaim any liability for actions taken or not taken based on the content of this paper.
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Cynthia Wu is the Founder and Managing Partner of a law firm, with a strong legal background encompassing complex business litigation, probate, and guardianship cases. She holds a Juris Doctor degree from the University of Arizona and an LLM in Taxation from the University of Florida. Cynthia's experience spans estate planning, probate, and business litigation, and she is admitted to practice law in California, the District of Columbia, Texas, and Florida, as well as before the U.S. Tax Court and the Chinese National Bar.
Tax Consequences of a Dying Grantor Repurchasing Highly Appreciated Assets from a Foreign Irrevocable Grantor Trust
Introduction
When a dying grantor (whether a Nonresident Alien (NRA) or a U.S. grantor) repurchases a highly appreciated asset from a foreign irrevocable grantor trust, the transaction can have significant tax implications. This strategy is often used to bring the asset back into the grantor’s estate to take advantage of the step-up in basis at death under IRC § 1014, which can eliminate capital gains tax on the appreciation. This paper explores the tax consequences of such a transaction for both NRA grantors and U.S. grantors, including income tax, estate tax, and gift tax considerations.
1. General Framework
The grantor repurchases the highly appreciated asset from the foreign irrevocable grantor trust using cash or other assets held in the trust.
The goal is to bring the asset back into the grantor’s estate to take advantage of the step-up in basis at death.
The tax consequences depend on the grantor’s residency status, the nature of the trust, and the specific transaction.
2. Tax Consequences for a U.S. Grantor
a. Income Tax Implications
No Capital Gains Tax on Repurchase: If the trust is a grantor trust at the time of the repurchase, the transaction is not a taxable event for income tax purposes. This is because the grantor and the trust are treated as the same taxpayer under IRC § 671.
Deemed Sale at Death: If the grantor dies shortly after repurchasing the asset, the asset is included in the grantor’s estate and receives a step-up in basis to its fair market value (FMV) at the date of death (IRC § 1014). This eliminates capital gains tax on the appreciation that occurred before the grantor’s death.
b. Estate Tax Implications
Inclusion in the Grantor’s Estate: The repurchased asset is included in the grantor’s estate for estate tax purposes. The value of the asset is subject to federal estate tax, which is calculated using the progressive rates under IRC § 2001(c) (up to 40% for 2023).
Unified Credit: The grantor’s estate may use the unified credit (currently $12.92 million for 2023) to offset the estate tax liability.
c. Gift Tax Implications
No Gift Tax: The repurchase of the asset is a sale, not a gift, so it does not use any of the grantor’s lifetime gift tax exemption under IRC § 2505.
Example 1: U.S. Grantor
A U.S. grantor repurchases highly appreciated U.S. real estate (basis: 100,000,FMV:100,000,FMV:1,000,000) from a foreign irrevocable grantor trust using cash in the trust.
The grantor dies shortly after, and the real estate is included in their estate with a stepped-up basis of $1,000,000.
The estate pays no capital gains tax on the $900,000 of appreciation.
3. Tax Consequences for an NRA Grantor
a. Income Tax Implications
No Capital Gains Tax on Repurchase: If the trust is a grantor trust at the time of the repurchase, the transaction is not a taxable event for U.S. income tax purposes. This is because the grantor and the trust are treated as the same taxpayer under IRC § 671.
Deemed Sale at Death: If the grantor dies shortly after repurchasing the asset, the asset is included in the grantor’s estate and receives a step-up in basis to its FMV at the date of death (IRC § 1014). This eliminates capital gains tax on the appreciation that occurred before the grantor’s death.
b. Estate Tax Implications
Inclusion in the Grantor’s Estate: The repurchased asset is included in the grantor’s estate for U.S. estate tax purposes, but only if the asset is U.S.-situated property (e.g., U.S. real estate or stock in a U.S. corporation). Foreign assets are not subject to U.S. estate tax.
Unified Credit for NRAs: NRA grantors are entitled to a unified credit of $60,000 (as of 2023) to offset estate tax liability on U.S.-situated assets.
c. Gift Tax Implications
No Gift Tax: The repurchase of the asset is a sale, not a gift, so it does not use any of the grantor’s lifetime gift tax exemption under IRC § 2505.
4. Key Considerations
a. Timing of the Repurchase
The grantor must repurchase the asset before death to ensure the asset is included in their estate and receives a step-up in basis. If the grantor dies before completing the repurchase, the asset remains in the trust and does not receive a step-up.
b. Nature of the Asset
For NRA grantors, only U.S.-situated assets are subject to U.S. estate tax. Foreign assets are not included in the grantor’s estate.
For U.S. grantors, all assets (both U.S. and foreign) are subject to U.S. estate tax.
c. Trust Status
The trust must be a grantor trust at the time of the repurchase to avoid capital gains tax on the transaction. If the trust is no longer a grantor trust, the repurchase could trigger capital gains tax.
Example 2: NRA Grantor
An NRA grantor repurchases highly appreciated U.S. real estate (basis: 100,000,FMV:100,000,FMV:1,000,000) from a foreign irrevocable grantor trust using cash in the trust.
The grantor dies shortly after, and the real estate is included in their estate with a stepped-up basis of $1,000,000.
The estate pays no capital gains tax on the $900,000 of appreciation.
Conclusion
The strategy of a dying grantor repurchasing highly appreciated assets from a foreign irrevocable grantor trust can provide significant tax benefits, including the elimination of capital gains tax through a step-up in basis at death. However, the tax consequences depend on the grantor’s residency status, the nature of the asset, and the timing of the transaction. Proper planning and compliance with tax and reporting requirements are essential to maximize the benefits of this strategy.
Disclaimers
This paper is intended for informational purposes only and does not constitute legal, tax, or financial advice. The application of trust and estate tax laws depends on the specific facts and circumstances of each case. Tax laws and regulations are complex and subject to change. You should consult a qualified tax professional or attorney for advice tailored to your situation. The author and the law firm disclaim any liability for actions taken or not taken based on the content of this paper.