In our last post, we considered how swap powers were a strategic way to minimize tax liabilities on assets in trusts. Recall that swap powers grant the right to substitute—or swap—property of equal value in a trust. This adjusts the cost basis of the property to the FMV at the time of death. If heirs sell the appreciated asset at a later date, capital gains tax liability should be reduced, since it will be calculated on the new basis.
This post takes a look at how one might put swap powers into action.
Putting swap powers to work:
Rev Ruling 2008-22 lists the following requirements for how swaps should be handled and documented:
- The trustee must confirm that the swapped assets have the same or equivalent value.
- The trustee signs acknowledgment confirming compliance with the swap and documenting the transaction.
Consider the following case:
A husband and wife have a revocable living trust (RLT) and the husband passed away in 2009. Their RLT uses a marital funding clause that results in $500,000 of stock funded to a bypass trust, and $2M in cash funded to a trust for the wife. By its nature, the bypass trust is not included in wife’s estate.
Imagine that by 2016, the bypass trust assets have grown to $2M, and the wife still has $2M in cash in her trust. If the wife dies today with $2M in the bypass trust there would be no step up in basis for these assets. The beneficiaries thus inherit stock with a basis of $500k but a FMV of $2M. If the beneficiaries wanted to sell this stock, they would need to pay capital gains on the $1.5M difference.
To avoid this, one solution would be to swap $2M in cash from the wife’s trust for the $2M of stock in bypass trust. Upon the wife’s death, the stock is included in her estate and receives a step-up based on the FMV of the stock at the date of death. The stock is now valued at a $2M basis. The beneficiaries can then liquidate this stock with no capital gains tax.
Swap power planning opportunities:
Attorneys should partner with CPAs as they discuss planning options with clients. Existing plans may need to be revised to incorporate swap powers. Wealth Docx® includes options for customized swap powers to be held with the grantor or trust protector.
One may also need to revisit irrevocable trusts that have swap powers, in order to analyze assets and consider moving highly appreciated assets out of trusts to allow for a step up in basis. For irrevocable trusts that do not contain bypass trusts, consider utilizing decanting to pour assets into new irrevocable trusts that include swap powers. Again, Wealth Docx allows one to draft these plans accordingly.
Swap powers are an important element to include in estate planning. They afford significant tax benefits and can help preserve client assets. WealthCounsel resources contain helpful guidelines for attorneys to help clients explore such possibilities and to draft swap provisions accordingly.
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