Sale to an Intentionally Defective Grantor Trust (IDGT)
A sale to an intentionally defective grantor trust freezes the value of an appreciating asset in your estate and moves all of its future growth to your children or grandchildren. You sell the asset to a trust you created, in exchange for a promissory note. Because the trust is treated as you for income tax purposes, the sale triggers no capital gain, and the interest you receive is not taxable income. The asset grows inside the trust for your family; what stays in your estate is a note whose value does not grow at all.
The name is unfortunate but precise. The trust is “defective” only in the sense that it is deliberately drafted to be ignored for income tax purposes while being fully effective for estate and gift tax purposes. That mismatch is the engine of the technique.
Milvidskiy Law Group P.C. designs IDGTs, structures the seed gift and the sale, coordinates the valuation, and administers the note so that the transaction holds up as a genuine sale.
Key Takeaways:
- You sell an appreciating asset to a grantor trust for a note bearing interest at the minimum rate the IRS allows. No gain is recognized on the sale, and the asset’s growth above the note rate passes to your beneficiaries free of gift and estate tax.
- Unlike a GRAT, a sale to an IDGT can be made to a trust that lasts for generations, with generation-skipping exemption allocated to the small seed gift rather than to the full value of the asset.
- The trust must be able to repay the note from the asset’s cash flow or its sale. A seed gift of roughly one-tenth of the purchase price is customary to give the trust economic substance.
How the Sale Works
Step one: the trust and the seed gift
You create an irrevocable trust for your children, grandchildren, or both, drafted as a grantor trust for income tax purposes. You make an initial gift to the trust, commonly around ten percent of the value of the asset you plan to sell. The seed gift uses part of your lifetime exemption, which is $15,000,000 per person for 2026 according to the Internal Revenue Service, and is reported on a gift tax return. Its purpose is to give the trust enough equity that the later sale is a real transaction rather than a disguised gift.
Step two: the sale
You sell the asset to the trust at its appraised fair market value in exchange for a promissory note. The note carries interest at least equal to the applicable federal rate the IRS publishes for the month of the sale, which is typically far below the return you expect from the asset. The note can be structured with interest-only payments and a balloon at the end of a term of years, or as an amortizing loan. Because you and the trust are the same taxpayer for income tax purposes, the sale produces no capital gain and the interest payments are not income to you.
Step three: growth inside the trust
Suppose you sell a $10 million interest in a business or a real estate portfolio to the trust for a nine-year note at a low single-digit interest rate, and the asset returns substantially more than that each year. The trust pays the interest, and eventually the principal, from the asset’s cash flow or a partial sale. Everything the asset earns above the note rate accumulates in the trust for your family. What remains in your estate is the note, worth its face amount, while the asset that would have doubled is no longer yours. The figures are illustrative.
Why a Sale to an IDGT Rather Than a GRAT
The two techniques share a goal, shifting appreciation above a hurdle rate, and differ in important ways.
- Generation-skipping. Exemption from the generation-skipping transfer tax can be allocated to the seed gift at the outset, so the entire trust, including the purchased asset and all of its growth, can pass to grandchildren and beyond. A GRAT cannot allocate that exemption efficiently until the term ends.
- Mortality. If you die during a GRAT term, the trust is largely included in your estate. If you die while an IDGT note is outstanding, only the note’s remaining balance is included; the asset’s growth is not. The income tax consequences of death with a note outstanding are less settled, and we plan for them.
- Hurdle rate and flexibility. The IDGT uses the applicable federal rate, often lower than the rate used for GRATs, and the note terms can be tailored. Payments can be made in kind and refinanced if rates fall.
- Cash flow. A GRAT must pay a fixed annuity regardless of performance. An IDGT note needs only interest until maturity, which suits assets with modest current cash flow and large expected appreciation.
The GRAT’s advantage is certainty: its treatment is spelled out in the regulations, and a zeroed-out GRAT requires no seed gift. The IDGT sale rests on well-established principles rather than a statutory safe harbor, which is why its execution matters.
Grantor Trust Status: The Tax Engine
The trust is drafted with a provision that makes you its owner for income tax purposes without causing the assets to be included in your estate. The most common is a power to substitute assets of equivalent value, held by you in a non-fiduciary capacity. That same swap power has a second use: before death, you can exchange high-basis assets or cash for the trust’s low-basis assets so that the low-basis assets return to your estate and receive a step-up in basis, while the trust keeps the value.
Because you pay the income tax on the trust’s earnings, the trust grows undiminished and the tax payments are not gifts. If that burden becomes too large, the trust can be drafted so that the grantor trust status can be released or a trustee can reimburse you for the tax, with care taken so that the reimbursement power does not cause inclusion.
Assets and Valuation
The technique fits assets with high expected appreciation and enough cash flow to service the note: interests in a closely held business ahead of growth or a sale, real estate and real estate partnership interests, and marketable securities in a concentrated position. Non-voting or minority interests in a family entity often support valuation discounts, which lower the purchase price and increase the wealth shifted. A qualified appraisal is essential, and the sale documents typically include a defined-value or adjustment mechanism so that a valuation change on audit adjusts the price rather than creating an unintended gift. Our business succession planning page describes how these sales fit into the transfer of a family company.
State Considerations
New York has no gift tax, so the seed gift is not taxed by the state, though taxable gifts within three years of death are added back to the New York estate, whose exclusion is $7,350,000 for 2026 with a cliff that can tax the entire estate once the exclusion is exceeded by a small margin. Removing a large appreciating asset from a New York estate through a sale can be the difference between falling under and over that cliff. Connecticut taxes lifetime gifts with an exemption equal to the federal amount, so the seed gift is reported on a Connecticut return. New Jersey has no estate or gift tax, and its inheritance tax does not reach transfers to children or grandchildren. Since the sale itself is a sale, not a gift, it generates no gift tax reporting in any of the three states if properly priced.
When a Sale to an IDGT Is Not the Right Tool
The sale is not worth its complexity when your estate will remain below the federal and state thresholds, when the asset is unlikely to outperform the note rate, or when the asset cannot generate the cash to service the note and no sale is expected. It is not suitable for retirement accounts. It requires disciplined administration: the trust must actually pay the interest, the note must be real, and the appraisal must be defensible. Clients who want a simpler, regulation-backed structure with no seed gift may prefer a GRAT; clients whose problem is this year’s capital gains tax rather than the next generation’s estate tax should compare an installment sale to a trust; clients whose priority is protection rather than tax should look at our asset protection and irrevocable trusts pages, and our tax planning page sets out the alternatives.
What Our IDGT Service Includes
- Modeling the transaction with your CPA and financial adviser: the asset, the seed gift, the note terms, the hurdle rate, and projected results under several return scenarios.
- Drafting the trust as a dynasty trust where appropriate, with the grantor trust provisions, swap power, trustee and trust protector roles, and generation-skipping allocation.
- Structuring the seed gift and, where useful, guarantees from beneficiaries to strengthen the trust’s ability to pay.
- Coordinating the qualified appraisal, the purchase agreement, the promissory note, security documents, and any entity-level consents.
- The gift tax return for the seed gift, generation-skipping allocation, and Connecticut reporting where applicable.
- Administration of the note, including interest payments, refinancing when rates fall, and planning for the note’s treatment at death, with periodic review through our Client Care Program.
Schedule a Consultation About an IDGT Sale
If you own a business interest, real estate, or a concentrated investment that you expect to grow substantially, and your estate is at or near a taxable level, a sale to a grantor trust can move that growth to your family while you keep a fixed return. Our attorneys practice in New York, New Jersey, and Connecticut. Contact Milvidskiy Law Group P.C. to schedule a consultation.
This page is provided for general informational purposes only and does not constitute legal advice. Laws differ by state and change over time. Tax figures are as of the date stated and change annually. For advice about your situation, consult a qualified attorney.
Frequently Asked Questions
What is an intentionally defective grantor trust?
It is an irrevocable trust drafted so that you are treated as its owner for income tax purposes but not for estate tax purposes. The trust’s income is taxed to you, transactions between you and the trust are ignored for income tax, and yet the trust assets are outside your taxable estate. The word defective refers only to that deliberate income tax treatment.
How does a sale to an IDGT work?
You make a seed gift to the trust, then sell an appreciating asset to it at appraised fair market value in exchange for a promissory note bearing interest at the applicable federal rate. Because you and the trust are one taxpayer for income tax, no gain is recognized and the interest is not income to you. The asset’s growth above the note rate stays in the trust for your beneficiaries.
Why is a seed gift needed?
The trust must have enough of its own assets to make the sale a genuine purchase rather than a disguised gift. Practitioners customarily fund the trust with a gift of roughly ten percent of the purchase price before the sale. The seed gift uses lifetime exemption and is reported on a gift tax return; guarantees from beneficiaries are sometimes used to supplement it.
Is there capital gains tax when I sell the asset to the trust?
No. Because the trust is a grantor trust, the sale is disregarded for income tax purposes, so no gain is recognized and the interest payments you receive on the note are not taxable income. The trade-off is that the trust takes your basis in the asset and there is no step-up at your death for assets held in the trust.
What is the difference between a sale to an IDGT and a GRAT?
Both shift appreciation above a hurdle rate. A GRAT is defined by regulations, requires no seed gift, and pays you a fixed annuity, but it fails if you die during the term and is inefficient for grandchildren. An IDGT sale uses a lower hurdle rate, needs only interest payments until maturity, allows generation-skipping exemption to be allocated to the small seed gift, and includes only the note balance in your estate if you die.
What happens if I die while the note is still outstanding?
The unpaid balance of the note is included in your taxable estate at its value; the trust’s assets and their growth are not. The income tax consequences of death with an outstanding note are less settled than the estate tax result, and we structure the note term and payment schedule with that in mind.
Who pays the income tax on the trust's earnings?
You do, as the grantor. That is a feature: the trust grows without being reduced by tax, and your payment of the tax is not a gift. The trust can be drafted to allow the grantor trust status to be turned off later, or to permit a trustee to reimburse you for the tax, with care so that the reimbursement power does not cause estate inclusion.
Can the trust benefit my grandchildren?
Yes, and this is one of the technique’s main advantages. Generation-skipping transfer tax exemption is allocated to the seed gift when the trust is funded. The purchased asset and all of its growth are then covered, and the trust can continue for grandchildren and later generations as a dynasty trust for as long as state law allows.
What assets are suitable for a sale to an IDGT?
Assets expected to appreciate faster than the applicable federal rate and able to service the note: closely held business interests, real estate and partnership interests, and concentrated securities. Non-voting or minority interests often support valuation discounts. Retirement accounts and assets with low expected returns are not suitable.
How does New York treat a sale to a grantor trust?
New York has no gift tax, so the seed gift is not taxed, though taxable gifts within three years of death are added back to the New York estate. The sale itself is a purchase at fair value, not a gift. Moving a large appreciating asset out of a New York estate matters because the state’s exclusion is $7,350,000 for 2026 and an estate that exceeds it by a small margin can lose the exclusion entirely.
