Using the IDGT (Intentionally Defective Grantor Trusts) to Protect Your Personal Residence.
As you know if you’ve been reading my newsletters for any amount of time, I believe that NO estate or financial plan can be complete if they do not incorporate asset protection.One of the most difficult assets to help our clients protect is their personal residence. It is also usually one of the most valuable assets of many clients and therefore should be protected.
Let’s review the traditional personal residence protection tools before getting into the IDGT discussion.
1) Be fortunate enough to live in a state like Texas or Florida. A few states like Texas and Florida asset protect the entire value of the home from creditors through state statutes (with limitations of the new bankruptcy laws).
2) Use a Qualified Personal Residence Trust (QPRT). A QPRT is an irrevocable trust with not very favorable terms and the use of a QPRT as an asset protection tool is usually a tip off that the advisor does not know the better options for protecting the home.
3) Equity stripping (also known as Equity Harvesting). This concept can work out very well from a financial and asset protection standpoint when done right (which is rare) and especially when coupled with the 1% cash flow arm mortgage.
4) Limited Liability Companies (LLCs) (multi-member). Many undereducated advisors will read about the power of LLCs for asset protection and recommend that a client use one to protect the home. The problem with such advice is: 1) the client loses the mortgage deduction; 2) the client could lose the $250,000 per spouse capital gains tax exemption (the client must own the house in his/her own name for 2 years out of 5 in order to use the exemption); 3) in some states the property taxes will double because the client can’t claim the residence as a homestead.
Estate Street Partners recommends equity stripping/harvesting when it is a good fit for a client financially. Equity stripping/harvesting is not for every client with equity (notwithstanding what the Missed Fortune 101 followers believe). That leads us into the discussion about using an Intentionally Defective Grantor Trust (IDGT) to protect the home.
IDGTs (Intentionally Defective Grantor Trusts)
Most advisors are not aware of the power of IDGT when it comes to “advanced” estate and business transition planning. Having said that, this discussion will focus not on a capital gains, income, estate, or gift tax play with an IDGT, but instead will focus on how to use an IDGT for “asset protection.”
I think the best way to explain how to use an IDGT to protect the home is simply to give readers a flow chart for how to set up and use one. For purposes of this discussion, you need to know that, as a general statement, an IDGT is a disregarded entity for tax purposes when the grantor is making the transfer to the trust.
The steps for using an IDGT (Intentionally Defective Grantor Trust) to protect the personal residence
1) The client’s attorney setups up an IDGT (which is just an irrevocable grantor trust).
2) The client “sells” the residence to the IDGT for fair market value (FMV) in exchange for an “installment note.”
3) The client enters into a lease with the IDGT to live in the residence
4) The client pays rent to the IDGT (FMV rent)
5) The IDGT pays the client annual installment payments via the installment note
What really happened? The client sold the residence to the trust and entered into a lease with the trust to live in it. The client pays X dollars to the trust as rent and the trust pays back to the client Y dollars via the installment note.
Frequently Asked Questions: Protecting your personal residence with the Intentionally Defective Grantor Trust (IDGT)
- Is the rent deductible to the client? No.
- Is the rent income to the IDGT? No.
- Is the installment note payment to the client from the IDGT income to the client? No.
- Can the note be accelerated? Yes. If the client ultimately would like the house sold, that can be accomplished in the IDGT and the proceeds can be paid to the client through an accelerated installment note payment.
- What happens if the property has a mortgage? The IDGT would make the mortgage payments which would still be deductible to the client/grantor as if the house is owned individually.
Summary of the IDGT
This newsletter is not meant to give you chapter and verse for how to use an IDGT (Intentionally Defective Grantor Trusts) to protect the value of a personal residence. Instead, the newsletter is simply meant to make you aware of the fact that an IDGT can be used to protect the residence. If you have wealth and significant equity in your homes, Estate Street Partners can discuss with you on how to protect your home’s equity.
Call Estate Street Partners 888-93-ULTRA (888-938-5872) and one of our advisors can help you.
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Helpful resources: Common follow-up reading includes Grantor vs Trustee vs Beneficiary, What Is a Trust Protector, and official IRS estate and gift tax guidance when comparing planning options.
What often changes the answer
After reviewing Intentionally Defective Grantor Trusts to Protect Residence, many people want a clearer sense of how the answer changes once real life timing, funding, and control are added to the discussion.
What usually shapes the next step
- Definitions matter because grantor, trustee, beneficiary, and protector do not carry the same legal power.
- Control matters because the wrong role design can weaken the protection people expected to gain.
- Funding matters because even the best role design still needs correctly transferred assets.
Where readers often continue
A practical next reading path is Grantor vs Trustee vs Beneficiary, What Is a Grantor, and What Is a Trust Protector. When the question turns from reading to implementation, many readers move from these guides to a direct planning conversation.
