We continue to believe that passing property in trust for both a surviving spouse and descendants offers the most benefit to your family, because of estate tax savings and creditor protection opportunities. However, a limitation of trusts is that trust property is ordinarily not eligible for a "step-up" in basis at a beneficiary's death. Property owned outright, on the other hand, does get a "step-up" in basis at death, which eliminates capital gains tax on any gains to that point. In the current tax environment of lower estate and gift tax rates coupled with higher income tax rates, this would seem to present an "either/or" choice - take advantage of the trust structure or give up the opportunity for capital gains tax relief afforded by the basis step-up rules.
By taking creative advantage of well-established tax principles, we have developed an innovative solution that avoids this "either/or" choice. Our solution is to include a new provision in trust agreements called the "contingent general power of appointment," or CGP. The CGP causes trust property to be included in a beneficiary's taxable estate at death in order to qualify for a step-up in basis, as long as that will not cause any increase in estate tax. The result - trust property with previously unrealized capital gains can be sold with no capital gains tax liability. The CGP is tailored to cause inclusion of the least amount of trust property that will afford the most basis step-up.
For example, assume a $1,000,000 trust for a child and his descendants. By the time of the child's death, say in 30 years, the trust assets have appreciated to $2,000,000. To keep the example simple, assume the child dies with $1,000,000 of his own assets as a resident of Florida (one of the many states without a state estate tax). If properly planned, the trust will escape estate taxation at the child's death. However, capital gains tax would ordinarily be due on any sale of trust assets. If all trust assets are sold after the child's death, the gain would be $1,000,000 and the capital gains tax about $200,000. With the CGP, however, the entire trust will be included in the child's estate without causing any estate tax, since the combined value of the child's $1,000,000 estate and the trust's $2,000,000 value is below the federal estate tax exemption. The included property will receive a "step-up" in basis to the value at the child's date of death and thus escape tax on the $1,000,000 of capital gains.
We are now incorporating the CGP in new estate planning documents. Please contact us if you would like to discuss the advantages of including the CGP in your existing documents.