How falling AFRs affect estate planning strategies.

• Author: Drudy, Philip
• Position: Applicable federal interest rates

The applicable Federal rates (AFR) for December 1998 reflect a significant interest rate drop. Although this is good news for homebuyers and those looking to refinance, the lower rates also affect income, estate and gift tax values on many types of transfers. The current rate, under Sec. 7520 (which is used to value annuities, life estates, term interests and remainders and reversions for estate, gift and income tax purposes), is 5.4%. This rate has never been lower. In many cases, the lower rates may produce more favorable results for individuals engaging in certain types of transactions; in other cases, they may not.

What follows is an analysis of how the low AFRs may affect qualified personal residence trusts (QPRTs) and grantor retained annuity trusts (GRATs), and the steps to be pursued for those clients looking to formulate or reevaluate their estate planning needs.

QPRTs

A QPRT allows a grantor to transfer his primary residence into a trust while retaining the right to live in it for a specified number of years. At the expiration of the term, the residence is transferred to a specified beneficiary or beneficiaries. The value of the transfer for gift tax purposes is the present value of the beneficiaries' remainder interest as determined at the transfer date. The value of the transfer is based on rates published monthly and determined in accordance with Sec. 7520.

There are many advantages to using a QPRT to transfer a primary residence, including:

* All future appreciation in the value of the house, from the date the transfer occurs, will not be included as part of the grantor's estate.

* The grantor retains the ability to use the residence during the trust term.

* The grantor can include a provision in the trust document to ensure that, on termination of the trust period, he will have the right to rent the property from the beneficiaries at a fair market rent. This not only provides a continuous residence for the grantor, but also a means of transferring cash to beneficiaries that will not be considered a gift (further reducing the grantor's estate by the cost of rent payments).

* If, during the trust term, the grantor decides to dispose of the property, a replacement property can be placed in the trust.

GRATs

To establish a GRAT, a grantor transfers an appreciable asset to a trust while retaining the right to receive a fixed annuity for a period of years. The annuity is usually paid from the contributed asset's income. At the end...