MSTR Cat

Trust Law/Level V · Tax and legacy/5.1 Estate and gift tax/Lesson 6

Installment sales to grantor trusts

How a sale of assets to a grantor trust for a promissory note works, why it is not taxed as a sale, and the risks planners weigh.

Education, not legal advice. Trust law changes from country to country and state to state, and the right structure depends on your situation. Anything you sign should be drafted or reviewed by a qualified lawyer where you live.

The lean path

The cheapest, lowest-tax, simplest and most private route the law allows, best first. Each step names the rule it rests on and the condition that keeps it lawful.

  1. For an estate under the 2026 basic exclusion of $15,000,000, no sale is needed: growth assets held until death take a §1014 basis step-up, which assets sold into a grantor trust lose under Rev. Rul. 2023-2; state estate tax thresholds can be far lower.
  2. A simpler lawful freeze is gifting within the $19,000 annual exclusion for 2026, or using part of the $15,000,000 exclusion on Form 709; this avoids note, appraisal and audit costs, though gifted assets keep the donor’s basis.
  3. Where a sale is chosen, a sale to a wholly grantor trust is not a taxable sale (Rev. Rul. 85-13), so no gain and no taxable interest; the note must bear at least the AFR, for October 2026 4.25% short-term, 4.61% mid-term and 5.22% long-term.
  4. Appraise hard-to-value assets and seed the trust with real equity, often cited as about 10% (a convention, not a rule); an undervalued price is a gift, and a thin seed invites an IRS argument under §2036 or §2702.
  5. The technique pays only if the assets outgrow the AFR; it has no statutory approval, and whether the grantor’s death before the note is repaid triggers income tax on the sale remains unsettled.

MaterialsThe IRS monthly table of applicable federal rates (AFRs), free on irs.govThe text of IRC §§671–679, the grantor trust rules, free on law.cornell.eduLesson 5.1.5, on grantor trusts and ‘intentionally defective’ design

Wonder

  1. Why is a sale to the seller’s own grantor trust not taxed as a sale?
  2. What happens if the seller dies while the note is still unpaid?
  3. What makes the IRS treat the note as a real debt rather than a disguised gift?

Explore

  1. An intentionally defective grantor trust (IDGT) is an irrevocable trust drafted so that it is outside the grantor’s estate for US federal estate tax, while its income is taxed to the grantor under the grantor trust rules (IRC §§671–679; lesson 5.1.5). In an installment sale, the grantor sells assets expected to grow, such as shares in a family business, to the IDGT in exchange for a promissory note. The grantor’s estate then holds the note, whose value is fixed, while growth above the note’s interest rate builds up inside the trust.
  2. For income tax, the grantor and the trust are treated as the same taxpayer. Revenue Ruling 85-13 held that where a grantor is treated as owner of the entire trust, a transfer between the grantor and the trust is not recognized as a sale. So the sale produces no capital gain, and the note’s interest is not taxable income to the grantor or deductible by the trust. The trust keeps the grantor’s basis in the assets. The grantor still pays income tax on the trust’s own income; Revenue Ruling 2004-64 held that paying it is not a gift.
  3. To avoid a gift, the price should equal the fair market value of the assets, and the note should bear interest at least at the applicable federal rate (AFR) for its term, which the IRS publishes monthly. Notes are often written with interest-only payments and a final ‘balloon’ payment of principal. Hard-to-value assets, such as private company shares, are commonly appraised, because if the IRS later shows the assets were worth more than the price, the difference can be treated as a gift by the grantor.
  4. Practitioners often fund the trust first with a separate ‘seed’ gift, frequently cited as about 10% of the value of the assets to be sold, so that the trust has its own equity to support the debt. This figure is a practitioner convention, not a rule found in the Code, the regulations or any IRS ruling. Without enough equity or other security, the IRS may argue that the note is not a real debt and that the grantor in substance kept an interest in the assets sold, which could bring IRC §2036 or §2702 into play.
  5. Death during the note term raises several questions. The unpaid note, including accrued interest, is part of the grantor’s gross estate. The assets in the trust stay outside the estate, but Revenue Ruling 2023-2 held that assets in a grantor trust that are not included in the grantor’s gross estate do not receive a stepped-up basis at death under IRC §1014. Whether death while the note is unpaid triggers income tax on the earlier sale is unsettled; commentators disagree, and no statute or ruling answers it directly.
  6. No statute or regulation expressly approves the installment sale to a grantor trust. It rests on Revenue Ruling 85-13 and long practice, and the IRS has challenged some sales in court, with several cases settling before a decision. Planners generally regard it as an aggressive technique, especially when the seed is thin or the assets are hard to value. Its benefit depends on the assets outgrowing the AFR; if they do not, the trust may struggle to repay the note. This lesson describes how the technique works; it does not suggest using it.

Key facts

  • Rev. Rul. 85-13: when a grantor is treated as owner of the entire trust, a transfer between the grantor and the trust is not recognized as a sale for income tax.
  • The note in an installment sale to a grantor trust commonly bears interest at no less than the IRS’s applicable federal rate (AFR), published monthly.
  • A ‘seed’ gift of about 10% of the value sold is a practitioner convention, not a requirement of the Code, the regulations or any IRS ruling.
  • If the grantor dies during the note term, the unpaid note is in the gross estate, while the trust’s assets stay out.
  • Rev. Rul. 2023-2: assets in a grantor trust that are not in the grantor’s gross estate get no basis step-up at death under IRC §1014.
  • Rev. Rul. 2004-64: a grantor’s payment of income tax on grantor trust income is not a gift to the trust’s beneficiaries.

Exercise nine, six, three, one

9CollectList up to 9 facts about an installment sale to a grantor trust you are reading about (some lists are shorter), such as the assets sold, their appraised value, the seed gift, the note amount, the interest rate, the note term or the trust’s beneficiaries.
6ClusterSort them into 6 categories: assets sold, valuation, seed gift and trust equity, note terms, grantor trust status, and facts you are unsure about.
3DistillReduce the 6 categories to 3 groups: facts that bear on whether the note is a real debt, facts that bear on gift tax, and facts that bear on what happens if the grantor dies during the note term.
1CrystallizeWrite 1 sentence explaining, in your own words, why a sale to a grantor trust can be ignored for income tax but still count for estate tax.

Fact check

Dates, figures and claims checked against the published sources listed below.

Open in the interactive academy →

PT ES ZH JA KO RU DE FR MS