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Using An IDGT To Protect A Personal Residence.

By Roccy M. DeFrancesco, JD, CWPP™, CAPP™ - Email Editor

Date : Dec 05, 2006

Dear Subscriber:

One of the most difficult assets to protect is the 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 Intentionally Defective Grantor Trust (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 statues (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 percent cash flow arm mortgage. For more information on this concept and the 1 percent CFA mortgage, please e-mail us for a free PowerPoint presentation.

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.

I recommend equity stripping/harvesting when it is a good fit for a client financially. That is not every client with equity (notwithstanding what the Missed Fortune 101 followers believe). That leads us into the discussion about using an IDGT to protect the home.

IDGTs

Most people 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 setup 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 to protect the personal residence:

1.) The client’s attorney sets 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 enters 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

-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
This material is not meant to give you chapter and verse for how to use an IDGT to protect the value of a personal residence. Instead, this is simply meant to make you aware of the fact that an IDGT can be used to protect the residence. If you have significant equity in your home, you should consider all of the above listed options and an IDGT when figuring out which is the best way to protect the equity in your home.

Roccy M. DeFrancesco, JD, CWPP™, CAPP™

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