You can have your cake and eat it too

Perhaps your first husband passed away and a marital (QTIP) trust was created for your benefit. That marital (QTIP) trust will be included in your taxable estate at your death at its then-current fair market value. However, you now believe that one of the assets of such trust is about to appreciate substantially and would like to be able to capitalize on such appreciation for the benefit of your children, the remainder beneficiaries of the marital trust. What can you do?

If you have sufficient gift tax exemption remaining (currently $5,430,000, less exemption you used on other lifetime transfers) to cover the current value of the asset you would like to gift, it may be possible to trigger a provision of the Internal Revenue Code (the “Code”) such that you will be deemed to have made the gift of the interest during your lifetime. This will result in the assets being treated as if they were gifted to your children currently using some of your remaining gift tax exemption rather than the asset being taxed at your death at the substantially increased value. The appreciation on the property will pass to your descendants free from additional transfer tax. Although this is an effective technique for transferring the appreciating asset to the next generation, you may be concerned about making a present gift because your standard of living requires you to maintain the income flow from the remaining marital trust assets.

In order to obtain the benefits of making the gift while maintaining access to the income generated by the assets, you need to first isolate the appreciated property to be gifted from the other marital trust assets. The marital trust will need to be severed into two separate trusts — one with the target property (“Trust A”) and one which will hold the balance of the marital trust assets (“Trust B”). If the marital trust also contained a spendthrift provision preventing any transfer of your interest in the trust, Trust A can be modified by court action such that the spendthrift provision is inapplicable to such trust.

Once the marital trust has been severed, you will then make a gift of your income interest in Trust A only which, under section 2519 of the Code, is a deemed gift of all of the property owned by Trust A, other than your income interest. Depending upon your current financial position and the provisions of the marital trust, there are a number of ways in which this transaction can be structured, and it is quite possible that you will be able to maintain an interest in the “gifted” property such that you are not giving up assets with which you need to live. If the terms of the marital trust upon your death provide for lifetime trusts for your children, your remaining generation-skipping transfer tax (“GST”) exemption (also $5,430,000 less GST exemption used on other lifetime transfers) can also be allocated to Trust A at this time to protect the gifted property from future generation-skipping transfer taxes. The result is a win-win for your family.