The Structural Math of Installment Sales to an IDGT / IDIT
Leveraging Revenue Ruling 85-13, 10% Seed Capital Rules, and Revenue Ruling 2004-64 Tax Burn.
An Installment Sale to an Intentionally Defective Grantor Trust (IDGT or IDIT) is one of the most powerful estate tax freeze and wealth transfer strategies available to high-net-worth families, tech founders, and real estate developers. It enables a grantor to transfer massive future growth out of their 40% taxable estate while retaining an income stream via an installment promissory note.
Revenue Ruling 85-13: Tax-Free Sale Nonrecognition
Under IRS Revenue Ruling 85-13 (1985-1 C.B. 184), transactions between a grantor and their grantor trust are not recognized for federal income tax purposes. When a grantor sells appreciated assets to an IDGT in exchange for an installment note:
- No Capital Gains Tax: The sale triggers zero immediate capital gains tax.
- Nonrecognition of Note Interest: Promissory note interest paid by the trust back to the grantor is not taxable income to the grantor, nor is it deductible by the trust.
The 10% Seed Capital Rule & Estate Planning Best Practices
To respect the promissory note as bona fide debt rather than a retained equity or income interest under IRC §§ 2036, 2038, or 2702 (based on existing precedents, IRS PLR 9535026, and practitioner best practices), the trust must possess independent equity:
- 10% Benchmark (PLR 9535026 PDF): The trust should be seeded with independent cash or liquid assets equal to at least 10% of the sale value prior to executing the note. (10% Seed Equity Notes →)
- Debt vs. Retained Interest Principles (Fidelity-Philadelphia Trust Co. PDF): Note payments must not be tied solely to the income generated by the transferred assets to avoid IRC § 2036 estate inclusion (the judicial reasoning of which is applied by analogy in the IDGT context). (Case Summary PDF →)
- Settled IRS Audit Cases (Estate of Woelbing PDF & Estate of Davidson PDF): In Woelbing v. Commissioner and Davidson v. Commissioner, the IRS challenged IDGT sales lacking independent seed equity (asserting § 2036 inclusion and § 2702 zero-valuation). Although settled without establishing binding judicial precedent, these cases highlight the importance of seeding independent capital to support commercial substance. (Audit Challenge Notes →)
Revenue Ruling 2004-64 & Independent Trustee Tax Reimbursement
Because the grantor pays income tax on all trust earnings under IRC § 671, the grantor's tax payments "burn" their outside taxable estate without incurring gift tax (IRS Revenue Ruling 2004-64, 2004-2 C.B. 7).
State Law & Independent Trustee Guardrails:
To protect grantors from tax illiquidity, state enabling statutes in Delaware (12 Del. C. § 3344), New York (EPTL § 7-1.11), Florida (Fla. Stat. § 736.08145), and Texas (Tex. Prop. Code § 112.035) permit discretionary tax reimbursement.
*Critical Drafting Rule: Reimbursement authority MUST be granted strictly to an Independent Trustee. Mandatory reimbursement clauses cause 100% estate inclusion under IRC § 2036(a)(1).
Educational Tool & Legal Disclaimer
This calculator and accompanying text are provided solely for educational and modeling purposes. IDGT transactions involve complex tax rules under federal estate tax and income tax codes. Accreting.com does not provide personalized legal, accounting, or tax advice. Always consult a qualified estate planning attorney and CPA prior to executing an IDGT installment sale or promissory note.