Like a grantor retained annuity trust (GRAT), an installment sale to a grantor trust may be an effective means for a wealthy client to transfer part of the future income or appreciation from a high-income or rapidly-appreciating asset with little or no gift or estate tax cost.

A "grantor trust" is a trust of which the grantor is considered the owner for federal income tax purposes. This means that the grantor must report, on the grantor's individual income tax return, all of the income, deductions, and credits of the trust, just as if the grantor was the owner of the grantor trust assets. The IRS has also ruled that a sale or other transactions between a grantor trust and the grantor does not result in any capital gain or loss, or any other tax consequences. The trust is ignored for federal income tax purposes and the grantor is still the owner.

For example, suppose you have an asset worth $1 million which is growing in value at annual rate of 12% while the Applicable Federal Rate is 4.58%.  If you set up a grantor trust you could sell the asset to the trust taking back a 15-year note with annual payments of $93,627.  At the end of 15 years, you would have received total payments of $1,404,405, including interest.  Because the rate of growth in value of the asset was much higher than the interest rate, at the end of the 15 year note term, the grantor trust would have remaining assets of $1,983,199.  Thus, nearly $2 million in growth has been removed from your taxable estate for Federal Estate Tax purposes without the use of any of your Federal Gift or Estate Tax exemption, and you would not have to realize any capital gain on the sale of the asset or taxable income on the note interest payments.