Balancing Act: Estate Planning Options for Appreciated Assets That Consider Future Income Tax Consequences

Estate Tax laws are constantly changing and the current exemption amount of $13.99 million per person is the highest it has ever been. Proposals to reduce the exemption were floated in 2021 when the amount was $11.7 million but they were not passed. Regardless, the threat of the lower exemption caused some taxpayers to make large taxable gifts in advance of possible legislation - especially older taxpayers with significant taxable estates who were able to afford to gift the full $11.7 million. But, by gifting, those taxpayers gave up their ability to realize a step-up in income tax basis to fair market value upon their death on the appreciated assets they chose to transfer. Depending on the appreciation of the gifted assets, state and federal income tax rates, and timing of future sales, the additional income tax paid by beneficiaries who receive appreciated assets may exceed the estate tax saved through lifetime gifting. As will be explained in this article, if the taxpayer is unable to utilize their full exemption due to insufficient assets or future spending needs, the additional income taxes imposed may far exceed any estate tax savings.

Although many practitioners believe that Congress will likely act to extend or make permanent the increased estate tax exemption (and some Republicans have proposed eliminating the estate tax altogether while retaining the step-up in income tax basis on assets included in the estate at death), current law provides that the estate tax exemption will automatically drop by 50% after 2025. Taxpayers who want to use their increased exemption before the change and who need to do so by gifting appreciated assets again will be faced with the decision of whether to make gifts to reduce estate tax or retain such assets until their passing to get a step-up in income tax basis. This article will review the factors that determine whether gifting in advance of such change will have a positive tax benefit and will discuss five unique estate planning options available to these taxpayers regardless of any change in the estate tax exemption:

1. Exercise of Replacement Right in a Successful Sale to a Defective Grantor Trust,
2. Rolling Grantor Retained Annuity Trust and Swap,
3. Post First Death Planning for Spouses,
4. Lifetime Charitable Planning, and
5. Family Charitable Remainder Trust.

Total Tax Consequences of Gifting Appreciated Assets

Before discussing the various solutions, it is important to understand the tax issues. The assumption among many taxpayers (and advisors) may be that gifting assets will yield the largest tax savings since any appreciation on those gifted assets will be shielded from estate tax and the estate tax rate is higher than the tax rate on capital gain. If the estate tax exemption is expected to be reduced, then it could be further assumed that gifting makes even greater sense. However, the opposite is likely true in many cases when total tax is considered. For example, assume a taxpayer with a $9 million estate gifted $5 million of assets with an income tax basis of $4 million in year 2025 presuming her available exemption was going to drop from $13.99 million to $7 million. While the estate tax savings if she passed away would be zero, even if the law changed, the later sale of the gifted assets would subject the beneficiary to as much as $300,000 in income tax. The counter argument would be that by gifting, the future appreciation on the assets would also be excluded from estate tax and provide more benefit. But, in many cases the estate tax saved on the appreciation is offset by the additional income tax incurred on the growth. If the gifted assets are likely to be sold prior to death of the taxpayer, the loss of the step-up in basis is less applicable, but the estate tax benefit of passing the growth outside the estate is still lessened by the additional income tax incurred by the recipient. Even in the unique situations where there is some net overall tax benefit considering the interplay between estate and income tax, that benefit can be much less than the taxpayer expected and may not be worth the spending constraint on the taxpayer giving up access to a larger portion of their net worth.

While increased overall taxes by gifting can be the result when a taxpayer has a smaller estate subject to tax, some taxpayers (and advisors) assume that if the taxpayer has sufficient assets to gift their full $13.99 million, the loss of the step-up will be far outweighed by the estate tax savings. However, if the only assets available for gifting have a very low basis - such as depreciated real property or closely-held founder stock - the opposite will often be true. Specifically, if the taxpayer gifted $13.99 million of assets with a $4 million basis, due to the negligible difference between the income tax rates and estate tax rates and loss of the step-up in basis, the gift does not produce any net overall tax savings even if the estate tax exemption drops in half after year 2025. Furthermore, in situations where the income tax basis of the property gifted is more than 30% of the total value such that gifting could produce some overall tax savings, if the taxpayer passes away before year 2026 or if the increased exemption is renewed, the gift will result in more overall tax to the beneficiaries. To prevent this worst case scenario where gifting to reduce estate tax only increases income taxes, a taxpayer may be better off waiting until 2025 to decide whether to make a gift. This is especially true for married taxpayers who receive a step-up in income tax basis at the first death and can avoid any estate tax at that time using the unlimited marital deduction on transfers to a spouse. The loss of the step-up in income tax basis has less negative effects if the recipient has no plans to sell the asset but may still create more income tax if the property is depreciable. If the taxpayer instead believes the asset will be sold prior to death at a higher price and can use a grantor trust to shield the recipient from having to pay the income tax, then the loss of the step-up in income tax basis will also have a less negative effect. However, a premature death before the asset is sold could negate any benefit of engaging in estate planning to shift the appreciation out of the estate.

While waiting until closer to December 31, 2025 to do outright gifting is beneficial for most taxpayers with predominately appreciated property, outright gifting for the reasons stated above may never be desirable. However, that does not mean those taxpayers who are likely to have a taxable estate should be resolved to do nothing and pay higher estate taxes. This is especially true if the assets of the taxpayer are likely to appreciate over time. Instead, taxpayers will need to look to more creative solutions that are designed to reduce future estate tax and preserve the step-up in basis. One option is to use a relatively common strategy, a Sale to a Defective Grantor Trust, but plan to take additional steps to preserve the step-up in basis.

Exercise of Replacement Right in a Successful Sale to a Defective Grantor Trust

A sale to a defective grantor trust or "DGT" is relatively common strategy used by taxpayers for decades to shift the appreciation on growth assets out of the taxpayer's estate. The technique involves a taxpayer creating an irrevocable trust for the benefit of the taxpayer's heirs or other beneficiaries and retaining a power that causes the trust to be treated as a "grantor trust." If the trust is a grantor trust, all transactions between the taxpayer and the trust are ignored for income tax purposes. One of the powers that causes a trust to be a grantor trust, that is often included in a DGT, is the right to replace trust assets with other assets of equivalent fair market value. Once the trust is created and some initial gift is made to settle the trust, the taxpayer sells appreciating assets to the trust in exchange for a promissory note. If the value of the asset sold appreciates at a higher rate than the interest rate on the note, the excess appreciation will grow outside the taxpayer's estate. Once the note has been repaid, the value of the property is retained by the irrevocable trust and passes to the trust beneficiaries free from estate tax.

While transferring appreciating assets into a DGT can significantly reduce a taxpayer's estate tax, any appreciation on the assets held in the irrevocable trust will miss out on the step-up in income tax basis at taxpayer's death and subject the trust beneficiaries to additional income tax. However, if the taxpayer exercises her right to replace assets by swapping out the appreciated assets with high-basis assets, such as cash, fixed income, or newly purchased assets prior to their death, then the appreciated assets included in the taxpayer's estate will receive a step-up in basis, leaving less or possibly no income tax due on sale of the non-appreciated assets in the irrevocable trust. As long as the exchange occurs while the trust is a grantor trust and prior to the death of the grantor, the grantor would receive a step-up in basis on the assets she receives from the trust in the exchange and the then fair market value of the non-appreciated assets transferred into the trust would escape estate taxation. While such an exchange is explicitly prohibited with some estate planning techniques such as a Qualified Personal Residence Trust, there is no such prohibition for a standard DGT. To the extent the grantor does not have non-appreciated assets to exchange into the trust, an option would be for the grantor to purchase the appreciated property from the trust in exchange for a promissory note - a reverse DGT sale.

The inherent problem with doing the exchange for non-appreciated assets or a note is that the grantor does not know when she will pass away, and an unexpected death would result in loss of the desired step-up. To hedge against a premature death, the grantor could purchase life insurance to offset the additional income tax created due to the loss of the step-up in basis. Assuming the taxpayer has some forewarning of her eventual death, she could allow the assets to grow inside the grantor trust until death seems more likely and conduct the exchange close to the time of death to get the maximum benefit. However, to the extent that the taxpayer passes away before the appreciated assets can be exchanged with the non-appreciated assets, the gain inherent in the DGT assets is locked into the irrevocable trust. The worst case scenario arises if the taxpayers sells appreciated assets into the DGT for a note and passes away unexpectedly before the assets can appreciate. Not only is the taxpayer now deceased, the promissory notes received from the sale are included in the taxpayer's estate at the same fair market value of the assets transferred. Furthermore, the appreciated assets do not receive any step-up in income tax basis at the taxpayer's death and the beneficiaries will pay unnecessary income tax on the sale. In situations where this strategy is not appropriate because death is more likely in the near future, another option is to use another relatively common strategy, a Grantor Retained Annuity Trust, with some enhancements.

Rolling Grantor Retained Annuity Trust and Swap

A Grantor Retained Annuity Trust ("GRAT") is a codified strategy that has been around for decades as a technique to freeze the value of one's estate by exchanging assets for a fixed annuity payable to the grantor over a number of years. The payments are fixed upon contribution and are typically high enough so that the exchange does not create gift tax. To the extent the assets appreciate at a rate above the prescribed interest rate, the growth can pass to the grantor's beneficiaries tax-free. If the grantor passes away during the initial term when she is entitled to annuity distributions, the trust assets are included in her estate and subject to estate tax. For this reason, it is often suggested that older taxpayers use alternative estate tax planning strategies, such as a sale to a DGT, without the risk of estate tax inclusion on a premature death.

However, to the extent the GRAT is funded with highly appreciated assets, it is often more beneficial from an overall tax perspective to use a GRAT if death is more likely. If a taxpayer transfers highly appreciated assets to a DGT in exchange for a note and passes away, the note is still included in the estate at death so only the post transfer appreciation above the interest rate on the note escapes estate taxation. While a premature death with a GRAT can cause all the assets, including appreciation, to be included in the taxpayer's estate, the beneficiaries will receive a step-up in income tax basis on all of the assets transferred to the GRAT. With a state and federal income tax rate on capital gain as high as 30%, compared to the 40% estate tax rate, the loss of 100% of a step-up in basis on appreciated assets often outweighs the estate tax benefit of allowing the growth to escape estate tax. For example, assume a taxpayer has $10 million of stock with a $1 million basis and contributes the stock to existing DGT in exchange for a note bearing interest at 4%. Even if the stock appreciates to $12 million and that the stock dividends cover the annual interest on the note, a premature death will only reduce the taxpayer's estate by $2 million and save $800,000 in estate tax. However, the heirs will have to pay tax on capital gain of $11 million resulting in more than $3 million in income tax. With the GRAT, a premature death would have resulted in $800,000 in estate tax but the net tax savings from the avoidance of income tax would be over $2.2 million. Even if the assets transferred had only $2 million of gain upon contribution (i.e., an $8 million income tax basis and $12 million value at death) the additional $1.2 million in income tax would still outweigh the estate tax savings. While there may be some particular tax situations or growth scenarios where the estate tax savings with the DGT will exceed the GRAT on a premature death, it should not be automatically assumed that the GRAT is not the preferred option of someone with a shorter life expectancy.

To the extent that a taxpayer decides to transfer highly appreciated assets to a GRAT to minimize future growth from being included in the estate, there are still steps that can be taken to minimize the risk of a premature death. First, instead of doing a longer term GRAT, the taxpayer could create the GRAT with the minimum two year term. If, at the end of the second year, the appreciated assets have not been sold, the GRAT must return most of the appreciated assets to the taxpayer as annuity payments (therefore including those assets in the taxable estate but benefiting from a step-up in basis at death). However, to the extent the growth on the assets exceeds the stated applicable federal rate on the date of contribution and therefore the total GRAT assets exceed the required annuity payments, the excess can remain in a trust and be excluded from the estate. That remainder trust can be set up as a grantor trust so that taxpayer can then swap non-appreciated property for the remaining appreciated assets held by the remainder trust without income tax consequences. If the taxpayer retains those appreciated assets until death, she would then receive a step-up in basis on those appreciated assets and the unappreciated assets would escape estate taxation. This is similar to the DGT strategy mentioned above although the exchange would typically occur immediately at the end of the two year GRAT so there is little risk of the assets missing out on the step-up in income tax basis.

The main problem with this strategy is that about half of the property is returned to the taxpayer at the end of year one, much of the remaining property is returned at the end of year two, and even the growth on the excess swapped back to the taxpayer on a successful GRAT is included in the grantors estate. Therefore, if the assets continue to appreciate, that growth will be included in the taxpayer's estate. However, if the taxpayer sets up a series of GRATs by immediately rolling the GRAT annuity distributions at the end of years one and two, as well as any additional property swapped back into the estate from a successful GRAT, into a new GRAT then the taxpayer can get the future appreciation on the property out of the estate. When the taxpayer passes away, only the GRATs created during the last two years will be included in her estate and either way the property in those GRATs will receive a step-up in income tax basis at death. To minimize the administrative inconvenience of managing multiple trusts long-term, the annual distributions of assets from any outstanding GRATs can be added to a single new GRAT each year and the excess from any successful GRAT can be passed into a single remainder trust.

While this strategy does involve several transfers and requires the creation of at least one new GRAT each year, it can be very successful for taxpayers with highly appreciated assets that are likely to continue to appreciate. However, this strategy does not allow generation-skipping tax ("GST") planning since the GST exemption cannot be allocated to the property until the end of the initial GRAT term after the property has appreciated. Additionally, this strategy does not work well when the property being contributed is difficult to value since it will require a new determination of value upon the contribution to the GRAT and upon each annuity payment in-kind. Lastly, to the extent the taxpayer has no non-appreciated assets to exchange with the remainder trust at the end of the term, then some of the appreciated property will remain in the remainder trust and not receive a step-up in basis. However, unlike the DGT sale where the entire property misses out on a step-up in income tax basis at death, in this situation only the appreciation held in the remainder trust will be later subject to income tax. For older married taxpayers, especially those residing in a community property jurisdiction, doing a modified GRAT or sale to a DGT with appreciated property may not be advisable, at least not until the death of the first spouse.

Post First Death Planning for Spouses

For married taxpayers, there is an advantage in trying to preserve a step-up in basis with estate planning since estate tax can be avoided at the first death under the unlimited marital deduction. The surviving spouse will have the ability to do estate tax planning, such as an outright gift or sale to a DGT following the first death with the assets that received a resulting step-up in basis. The married couple will also be able to use the first spouse to die's estate tax exemption to shield future growth on assets without sacrificing the step-up at the first death. If the married couple has high basis assets with which to do planning and/or is unlikely to hold assets until death to get the step-up in basis due to age or the nature of the asset, waiting to do planning will be less effective since the loss of the step-up in basis is less meaningful. However, for a married couple with mostly appreciated assets with which to do planning, this strategy provides some estate tax benefit without the large corresponding income tax detriment. For taxpayers who live in a community property jurisdiction, this benefit is even greater since the surviving spouse will receive a step-up on 100% of their community property assets at the first death.

One concern in proposing the surviving spouse gift away assets after the death of his spouse is that the surviving spouse still needs assets to support his lifestyle spending throughout the remainder of his lifetime. To the extent the estate plan is set up to fully fund a Bypass Trust for the benefit of the surviving spouse at the first death, then the surviving spouse can rely on those assets if he exhausts his share of the non-gifted estate. For example, if the estate consists of $18 million of appreciated community property at the first death in 2026 and the exemption has returned to $7 million per person, the deceased spouse's estate could set up an irrevocable trust for the benefit of the surviving spouse (the "Bypass Trust") with $7 million of non-appreciated assets, due to the step-up in basis, and the remaining $11 million of non-appreciated assets could pass to the surviving spouse. The surviving spouse could then gift $7 million of non-appreciated assets to the couple's heirs and use the remaining $4 million for living expenses. If the surviving spouse exhausts those funds during his lifetime, then he could receive support and maintenance distributions from the Bypass Trust. In that case, upon the surviving spouse's death, no estate tax would be dueand the beneficiaries would have a basis in the remaining assets of no less than $14 million.

Another complicating factor in this planning arises from the fact that many couples do not want to give the surviving spouse unlimited discretion to dispose of the deceased spouse's share of the estate for fear that the surviving spouse will later decide to disinherit the deceased spouse's heirs. This concern can be mitigated to the extent the estate of the deceased spouse creates a Bypass Trust with the deceased spouse's remaining estate tax exemption. For amounts over the estate tax exemption or to the extent a Bypass Trust is not created at the first death, another common technique is the use of an irrevocable Qualified Terminable Interest Property Trust ("QTIP") at the first death to hold the deceased spouse's share of the estate. While this helps protect against the surviving spouse from disinheriting the deceased spouse's heirs, it may prevent the surviving spouse from maximizing their estate tax reduction opportunities at death. While an alternative would be for the surviving spouse to purchase assets from the Trustee of the QTIP for an interest-bearing note and then to gift some or all of those assets to get the future appreciation on those purchased assets out of the estate, there are fiduciary responsibilities that must be considered and payments of interest on the note may create income tax consequences. Therefore, if the plan is for the surviving spouse to gift assets after the first death or sell assets to a Defective Grantor Trust, the better option is to transfer such amounts outright to the surviving spouse.

A problem with this strategy of waiting for a step-up at first death arises when the spouses have a longer life expectancy and the assets are increasing in value, since waiting to do planning causes the taxable estate to grow and therefore more estate tax to be due. In that case, it is best to pair another strategy, like the Sale to Defective Grantor Trust and exchange, or Rolling Grantor Retained Annuity Trusts and exchange, while the spouses are younger and then use this Post Death Planning as the spouses get older. But, if a taxpayer with appreciated property is also charitably inclined, additional opportunities are available - either as a substitute for the above-mentioned strategies or as a part of an overall strategy.

Lifetime Charitable Planning

For gift and estate tax, the law provides a 100% charitable deduction for amounts passing to a qualified public charitable organization. Most of a qualified public charitable organization's income is tax-exempt so gifting or bequeathing appreciated property to them allows them to sell that property without recognition of income tax. If a taxpayer sells an appreciated capital asset during life and bequeaths the after-tax cash proceeds to their heirs at death, the effective overall tax rate could be as high as 58%. As a result, the after-tax cost to the heirs of gifting the appreciated capital asset to charity could be as little as 42% of the original amount.

A charitable contribution will result in zero gift or estate tax regardless of whether one contributes during life or at death, but by satisfying the bequest with appreciated capital assets during life, the donor receives additional income tax benefits. If the appreciated capital assets are gifted to a public charity, and not a private foundation, then the donor can also take an income tax deduction equal to the fair market value of the assets - regardless of whether the assets have appreciated. While the amount of the income tax deduction that can be used to offset the income tax of the donor in any year is limited to a percentage of the donor's adjusted gross income for the year, the full fair market value of the contributed asset is deductible. Assuming the taxpayer can utilize the full deduction against ordinary income, the after-tax cost of gifting appreciated capital assets to charity during life drops to as little as 12% of the original amount of those assets. Even if one does not account for the estate tax due on passing the sale proceeds to a beneficiary, since it occurs much later, the avoidance of capital gains tax on the sale plus the income tax deduction can result in an after-tax cost of giving appreciated assets to charity for as little as 20% of the original amount.

If the taxpayer has charitable intent but has not yet identified a charitable organization that she would like to gift the appreciated asset during life, a good option is to transfer the appreciated asset to a private foundation or a donor advised fund created at a sponsoring organization qualified as a public charity. If the contribution of the appreciated property to the charity is made well in advance of the later disposition by the public charity, then the charity will be able to dispose of the property without income tax and the donor can distribute the full fair market value of the proceeds from the sale of the property to charities over time. However, if the appreciated property is not publicly traded securities, then giving to a private foundation will limit the donor's income tax deduction to the donor's income tax basis so giving outright to a donor advised fund at a public charity provides a better income tax result. Additionally, a gift to a private foundation versus a donor advised fund also reduces the percentage of the donor's adjusted gross income that can be offset in any given year from 30% to 20%. However, a taxpayer can divide the gift of appreciated property between a private foundation and a donor advised fund in order to be able to deduct up to 30% of the donor's adjusted gross income in any year. In either case, any charitable deduction not used in any taxable year can be rolled over for up to five years and can offset future taxable income of the donor.

If the taxpayer with an appreciated assets has charitable intent but needs some of the proceeds from the later sale, a good option is the use of a charitable remainder trust. Charitable remainder trusts are statutorily approved vehicles that taxpayers can use to defer recognition of income tax on the sale of appreciated property. Like other charitable vehicles, to the extent appreciated assets are contributed to the charitable remainder trust in advance of disposition, a taxpayer can effectively diversify his holdings and defer recognition of any gain until the taxpayer receives distributions from the charitable trust. The taxpayer will receive annuity distributions each year from the charitable remainder trust based on a percentage of the value of assets held in the trust. The annuity distributions to the donor can continue for the lifetime of the taxpayer or a term of years no greater than 20 years. Since the taxpayer is retaining an annuity interest in the trust assets, the deduction will only be the present value of the charitable interest passing to charity at the end of the term and that amount must be at least 10% of the assets contributed to the trust. However, at the end of the term, the trust assets are distributed to charity, which can include the taxpayer's private foundation, and so there is no estate tax due. As a result, like outright gifts to charity, the taxpayer using a charitable remainder trust can avoid immediate recognition of the gain upon the sale, avoid estate taxation, and get an income tax deduction to offset other taxable income.

For taxpayers with strong charitable intent, transferring appreciated assets to a charitable vehicle allows the taxpayer to satisfy her charitable goals in a tax efficient manner. Some taxpayers are less charitably motivated but may instead provide large amounts to charity at their passing for fear that giving their entire estate to their children will have negative effects on their children's productivity. Other taxpayers provide large bequests to charity at their passing primarily to avoid the 40% estate tax due. In all of these cases, satisfying these testamentary charitable goals by gifting appreciated property during life provides the best overall tax result and can minimize the need to other tax planning. Again, these charitable strategies can be paired with some of the above-mentioned estate planning techniques to provide estate tax and charitable benefits. However, there is another option that uses a single strategy for appreciated assets to achieve both estate and charitable benefits in a tax efficient manner - the Family Charitable Remainder Trust.

Family Charitable Remainder Trust

While making outright gifts of appreciated property to charity or transferring appreciated property to a charitable remainder trust during life is a great way to satisfy charitable intent in a tax advantaged way, these are not great options for taxpayers who want to transfer their appreciated property to family or other individuals. One option that provides the tax advantages of a charitable transfer while providing a substantial wealth transfer to individual beneficiaries is a Family Charitable Remainder Trust ("FCRT").

The FCRT is a technique that effectively allows a taxpayer to diversify an appreciated position without immediate income tax and pass wealth to individuals like successive generations without substantial transfer tax. Additionally, like the charitable options mentioned above, it provides the taxpayer with an immediate income tax deduction and a significant benefit to the taxpayer's favorite charity. The FCRT in its most simple form combines three established structures, a family limited partnership, a charitable remainder trust, and a sale to a grantor trust, in a unique way.

The FCRT starts with a family limited partnership funded with highly appreciated publicly traded securities. The taxpayer would hold all the limited partnership interests in the entity and such interest would represent 99% of all interests in the entity. The taxpayer would then create a DGT for the benefit of her heirs and gift cash or property to the trust. The amount of the "seed" gift is typically equal to 10% of the amount to be later sold to the trust but can be less if the taxpayer does not have sufficient lifetime exemption remaining. The taxpayer will also want to allocate generation-skipping transfer tax exemption to the gift so that the trust can be held estate tax-free for multiple generations.

Where the strategy differs from a normal sale to a DGT is that the partnership then creates a 20-year fixed term charitable remainder trust with the largest permissible annuity that provides a charitable remainder equal to 10% of the fair market value of the property contributed-typically about 11% per year. The contribution would create a charitable deduction and at least 99% of the charitable deduction passes to the taxpayer as the owner of all the limited partnership interests in the entity. The taxpayer then sells the limited partnership interests to the previously created DGT in exchange for a secured promissory note equal to the appraised fair market value of the interest. The appraised fair market value will be reduced by the 10% remainder interest set-aside for charity and likely will garner a minority interest discount equal to, if not greater, than the marketability discount applicable to a standard family limited partnership holding marketable securities.

The appreciated property contributed to the charitable remainder trust can then be liquidated without immediate income tax and the sale proceeds reinvested in a diversified portfolio. The charitable remainder trust would make the 11% distribution annually to the entity in cash and the entity can either reinvest the cash in the entity or distribute some of it to the partners - 99% of which would pass to the DGT. The DGT could then use the distribution to make interest and principal note payments to the taxpayer. While any distribution passes 99% to the DGT, the gain passing to the partners from the charitable remainder trust distribution passes to the taxpayer due to the grantor trust nature of the irrevocable trust. As a result, the trusts effectively receives the 11% distribution tax-free. The taxpayer can then use the note payments to pay any income tax associated with the distribution. Depending on the growth assumptions, it is expected that the notes could be fully repaid to the taxpayer from the DGT in 10-12 years. The remaining 8-10 years of distributions from the charitable remainder trust accumulate in the DGT income tax-free and the taxpayer will further deplete her estate by continuing to cover the income tax associated with such distributions for the full 20 years. At the end of the 20 years, the balance of the charitable remainder trust then passes to the taxpayer's chosen charity, which can include the taxpayer's private foundation. In the end, the FCRT allows the taxpayer to liquidate out of an appreciated position without immediate recognition of income tax and converts the proceeds into an income stream passing in part to a taxpayer's beneficiaries, like children and grandchildren, in a highly tax advantaged way. The main caveat with the FCRT is that the taxpayer does have to want a portion of their estate to pass to charity. If they do not then the first three strategies suggested above are likely better options.

Conclusion

For taxpayers holding highly appreciated assets, gifting those assets in advance of any potential estate tax law change in 2025 can result in more overall tax when considering the additional income tax created by the loss of step-up in basis at death. However, there are planning options available to taxpayers with appreciated assets who are likely to have a taxable estate. Taxpayers with time can transfer appreciated assets to a defective grantor trust and later exchange of those appreciated assets back for higher basis assets. Taxpayers with a shorter life expectancy could instead do a series of rolling grantor retained annuity trusts to prevent against the risk of a premature death before the exchange. However, for older married taxpayers, waiting to do such planning until after the first death may be more advisable. For charitably minded taxpayers, using the appreciated assets to fund charitable transfers during life or at death can provide substantial tax benefits. For those charitably minded taxpayers who also want to benefit their heirs or other individuals, the family charitable remainder trust can achieve both income tax and estate tax benefits. Therefore, given the uncertainty around potential tax law changes in 2025, taxpayers should consider all these tax planning options with a qualified professional before simply gifting away highly appreciated assets.