There are several advantages to including a trust as part of your estate plan. Trusts are very useful because they can provide a means for avoiding probate. Depending on the type of trust you choose, they can provide asset protection, as well. There is a special type of irrevocable trust, the beneficiary defective irrevocable trust, which could provide special advantages to your beneficiary. Here is what you need to know.
The basics of a trust
A trust is essentially a fiduciary agreement between the trustee and the person who creates the trust (the grantor). That means the agreement is based on confidence and trust. Trustees are given the authority to gather and manage all of the assets in the trust and administer them on behalf of the named beneficiaries.
The two categories of trusts
With all of the various types of trusts available, they can all be categorized as either revocable or irrevocable, which is an important distinction. A revocable trust allows the grantor to retain the ability to modify its terms as the grantor sees fit. That also means that you can revoke or cancel a revocable trust at any time before your death. When the grantor passes away, then, the trust will generally become irrevocable. What does that mean?
What makes an irrevocable trust different?
An irrevocable trust, by definition, is different because it cannot be modified once it has been properly executed. There are still quite a few benefits that come with being irrevocable, however. Some of those benefits include favorable tax consequences and asset protection. If, for example, you transfer your assets to an irrevocable trust, those assets are now considered out of reach from creditors, probate and estate taxes. Therefore, while you may have to relinquish some control over the assets in an irrevocable trust, you also gain many other benefits.
What is Beneficiary Defective Irrevocable Trust?
A Beneficiary Defective Irrevocable Trust (also referred to as a BDIT), has become a very popular trust for estate planning. The term “defective,” in the context of this trust, means that the trust income, deductions, gains and losses relating to the BDIT trust are included on the personal income tax return of the beneficiary, as opposed to the separate trust income tax return, each year.
Assume for example that you create this special type of irrevocable trust and name your son and his children as beneficiaries of the trust. Your son has rental property and he sells that property to the BDIT. This benefits him because it provides asset protection for the rental property. Also, because the son is the beneficiary of the BDIT and is, therefore, allowed to receive distributions from the irrevocable trust when necessary. By selling the rental property to the trust, the son also has the benefit of freezing the value of that property at the time it is sold to the trust.
Other benefits in selling property to the BDIT
In addition to being able to freeze the value of any property that is sold to the BDIT, the promissory note issued by the trust for that sale can be paid with the rental income from the same property. Also, since the BDIT now own the rental property, all increases in its value will belong to the trust. The tax benefit comes in the fact that the sale of the property to the trust is not recognized for income tax purposes. Why? Because the sale of the rental property is actually from the son to himself, as the beneficiary of the trust.
Why an irrevocable trust is great for protecting assets
When you transfer your property to any type of trust, that property is then considered to belong to the trust. Since the trust cannot be revoked, the assets are no longer considered yours in any manner. It is for this reason, your property is no longer subject your creditors or legal liabilities.
Required terms for proper asset protection
In order to be sure that your assets will actually be protected from third-party claims, there are specific terms that must be included in your trust agreement. For instance, any interests that you leave to your beneficiaries are required to be contingent on a future event or be subject to the trustee’s sole discretion. Another helpful provision is known as a “spendthrift” provision, which provide extra protection of assets from creditors, as well as the beneficiaries themselves, who may not capable of managing the trust property on their own.
If you have questions regarding an irrevocable trust, or any other estate planning issues, contact the Northern California Center for Estate Planning and Elder Law for a consultation, either online or by calling us at (916) 437-3500.