Transferring your legacy
Swap powers in your irrevocable trust: How do you properly exercise them?
A “swap power” is also called a “power to substitute.” It is a special right reserved to you (or someone else) in a trust you create while you are alive. This right gives you the power to swap an asset of yours, say cash, for an asset held in the trust you created. Why would you want to include a swap power in a trust you create?
Bottom line is that grantor trust status can provide valuable flexibility and a swap power may just be the ticket to that benefit.
Generally, the person setting up the trust (the “settlor” or “grantor”) would hold the swap power under the terms of the trust. More technically, any person who is designated in the trust document and who acts in a nonfiduciary capacity (i.e., not a trustee) can hold this power. Whoever is appointed should have no fiduciary ties to the trust.
If you are planning a new trust with a swap power, you might also address what happens if you are incapacitated. For example, the trust might provide that if you are incapacitated the agent under your durable power of attorney can instead act. If that is done be sure that you have a durable power of attorney (names an agent to handle legal and financial matters if you cannot) and that the document gives the agent the right to exercise your swap power if you are disabled. Other mechanisms might be integrated into the trust document to name successor power holders.
A swap power gives you (or the other person holding the power) the right to substitute your assets for trust assets. More technically, it is the right to reacquire the trust property (corpus) by swapping (substituting) other property of an equivalent value.
Your holding a swap power should not cause inclusion of the trust assets in your gross estate for estate tax purposes. This is because the right to swap assets does not enable you to consummate additional wealth transfers to reduce your estate. If you swap highly appreciated Apple stock worth $100,000 you have to transfer into the trust $100,000 of another asset, say cash, so there cannot be any wealth transfer if you properly exercise the power.
The IRS issued Revenue Ruling 2008-22 that provides important guidance on using a substitution power. If you set up the trust (you were the grantor) and you retained the power, exercisable in a nonfiduciary capacity, to acquire property held in the trust by substituting other property of equivalent value, the trust assets should not be included in your taxable estate. The IRS Ruling explains that the substitution power will not, alone, cause the value of the trust corpus to be includible in the grantor’s gross estate.
But it sets forth a number of requirements on the Trustee:
The Ruling also sets forth a number of requirements on you as the holder of the swap power:
If you are going to exercise a swap power, be certain to comply with the terms of the power held in the trust and the requirements of Revenue Ruling 2008-22. Both you and the trustee should document that you have complied with each of the above requirements. As to confirming that the properties swapped are of equivalent value, if either or both properties are not marketable (e.g., an interest in a real estate rental property) have qualified appraisals completed. Be certain to save all of the corroborating documentation as part of the permanent trust records. Also, consider whether the swap should be disclosed on your gift tax return as a non-gift transaction. If the swap is adequately disclosed on the gift tax return it may serve to toll the statute of limitations for a later IRS audit.
The contents in this article are being provided for educational and informational purposes only. The information and comments are not the views or opinions of Union Bank, its subsidiaries or affiliates.
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