BDIT & SLAT – How to Minimize Tax Obligations on Appreciating Assets through Trust Planning
Appreciating assets are ideal – the taxes associated with them are not. Estate planning involves looking at your liabilities and assets to understand what structure will minimize your taxes now, see you comfortably through retirement and benefit your family through the future. We’ve written about putting appreciated assets into Charitable Remainder Trusts to reduce capital gains taxes and support causes you care about. Beneficiary Defective Inheritor’s Trusts (BDITs) and Spousal Lifetime Access Trusts (SLATs) are two additional types of irrevocable trusts that allow donors to transfer appreciating assets, while also maintaining limited control and minimizing the tax burden on both beneficiaries and themselves. Here’s how we advise clients on keeping appreciation out of their taxable estate through BDITs and SLATs.
Why use a BDIT or SLAT?
Trusts serve many purposes for those who have assets they plan to retain for a long period of time while minimizing the taxes they pay on those assets. Estate taxes, capital gains taxes and others can take a huge chunk out of those assets if they’re not managed properly.
For the ultra wealthy, BDITs and SLATs allow you to set up an irrevocable trust that locks in the value of assets – like real estate, stock, interests in a closely-held business, etc. – for gift and estate tax purposes. As the name implies, SLATs can only be set up with a spouse as the beneficiary. In both types of trusts, when the contributed assets appreciate, your estate taxes won’t. The appreciation takes place outside of your estate and inside the trust. You’re “freezing” the value of the assets at the time of creating the trust.
In addition to reducing your estate tax, BDITs and SLATs allow the donor to manage assets even once they’ve been transferred into the trust. For example, if the donor chooses to donate the stock of an operating business, the donor would still be able to operate and manage the business. While assets are irrevocable and final, they are still accessible, unlike many other trusts. Unfortunately, upon the death of the donor, there is no step up in basis of the assets.
When should you transfer assets into a BDIT or SLAT?
For either type of trust, it’s most beneficial to transfer assets into the trust before you exceed your lifetime gift tax exemption limit, which is currently $12.92M for individuals and $25.84 for married couples. However, tax policies in consideration could reduce these amounts significantly, so we are advising our clients to consider and set up trusts sooner rather than later.
How do you set up a BDIT or SLAT?
Like many estate planning processes for high net worth individuals and families, an attorney is needed to set up these types of trusts. For BDITs, once the trust is set up, you would sell your assets to the trust on a tax-neutral basis. This removes the assets from your taxable estate in exchange for a note receivable from the trust. For SLATs, once the trust is set up, you contribute (instead of sell) the assets to the trust on a tax-neutral basis. This also removes the assets from your taxable estate and uses up some of your lifetime exclusion for the fair market value of the assets.
How much can a BDIT or SLAT save you in estate taxes?
The simplest example to consider is a piece of real estate. If you buy a house at $500,000 and that house appreciates to $1.5M, you would normally owe the estate tax rate of 40% on the appreciated value of $1M. If instead the house was put into a BDIT or SLAT prior to appreciating, that $1M in appreciation would no longer be part of your taxable estate.
How are BDITs and SLATs different?
The main difference is that SLATs can only be used if a legal spouse is the beneficiary. Even if the spouse doesn’t remain a spouse, like in the case of divorce, the gifts are irrevocable. Additionally, a SLAT uses up some of your lifetime exclusion immediately when assets are transferred, while a BDIT trades the assets for a note receivable.
While BDITs and SLATs are not the most common types of trusts, they are hugely beneficial, especially for the ultra-wealthy. BDITs require extra compliance and loan repayment tracking that are best performed by estate planners and family offices. These trusts are not quick and easy to set up nor maintain, but they can significantly reduce the tax burden for those with many valuable assets they’re hoping to hand down to future generations.
If your estate planning has you considering BDIT or SLAT trust planning strategies, we’d love to talk you through it. Schedule an appointment with our CPA team here.