Are there assets that do not possess growth potential but still work in a GRAT

Lawrence came to me last month, devastated. He’d funded a Grantor Retained Annuity Trust (GRAT) with a portfolio of high-yield, but stable, dividend-paying bonds. His intention was to gift a substantial portion of his wealth to his children, reducing his estate tax liability. Unfortunately, the bonds performed exactly as expected: steadily, but without significant appreciation. The annuity payments came due, and because the assets hadn’t exceeded the IRS’s hurdle rate, the entire principal, less the annuity payments, returned to his estate. Lawrence effectively paid gift taxes on assets that hadn’t grown and received no additional tax benefit – a $30,000 mistake he was eager to avoid repeating.

The short answer is, yes, assets lacking high growth can work in a GRAT, but it requires a very specific strategy and an understanding of the nuances of the IRS code. The primary function of a GRAT isn’t necessarily explosive asset appreciation, but rather the transfer of wealth free of gift and estate tax when the asset’s performance exceeds a predetermined rate. This rate is the IRS § 7520 ‘Hurdle Rate’, currently around 0.8% for a short-term GRAT. If the assets’ value increases by more than this rate over the GRAT term, the excess growth passes to your beneficiaries tax-free. Conversely, if the assets fail to outperform the hurdle rate, they simply revert to your estate – a ‘heads I win, tails I tie’ situation.

However, bonds, CDs, and other low-growth instruments can be useful, particularly in a ‘zeroed-out’ GRAT. This is where the annuity payment is set to equal the initial asset value over the GRAT term. The risk is the complete return of principal if the asset doesn’t appreciate, but it allows a significant transfer of wealth if the asset even marginally exceeds the hurdle rate. It’s a bet on exceeding a very low bar. Furthermore, the strategy works best when combined with other assets in the estate that are expected to grow substantially, allowing the GRAT to absorb any underperformance from the stable assets.

What about Real Estate inside a GRAT?

Real estate is a common consideration, but introduces complexities. While transferring a home into a GRAT doesn’t trigger immediate reassessment, the distribution to children at the end of the term will trigger a full property tax reassessment under Prop 19 unless the child moves in as their primary residence within one year. This potential tax hit needs to be carefully weighed against the estate tax benefits. Moreover, accurately valuing real estate for GRAT purposes can be challenging, requiring professional appraisal.

What if assets intended for the GRAT are not funded before death?

This is a critical issue we address frequently. If an asset intended for the GRAT was left in your name and reverts to the estate after your death (valued up to $750,000), it qualifies for a ‘Petition’ under AB 2016 (Probate Code § 13151) for ‘Petition for Succession’. This allows a judge to transfer the asset to the intended beneficiaries as though it were originally funded in the GRAT. It’s important to differentiate this from a Small Estate Affidavit – we are pursuing a ‘Petition’ which requires court approval, providing a more secure transfer than a simple affidavit.

As an Estate Planning Attorney and CPA with over 35 years of experience, I always emphasize the value of a comprehensive approach. As a CPA, I can accurately value assets for step-up in basis calculations, minimize capital gains implications, and guide you through the complex tax considerations associated with GRATs. While a GRAT may not be suitable for all assets, strategic planning and professional guidance can unlock significant wealth transfer benefits.

What determines whether a California trust settlement remains private or erupts into public litigation?

Success in trust administration depends on more than just the document; it requires active management of assets, precise accounting to beneficiaries, and careful navigation of tax rules. Whether dealing with a blended family or complex real estate, understanding the mechanics of trust law is the only way to ensure the grantor’s wishes survive scrutiny.

Ultimately, the success of a trust depends on the details—proper funding, clear terms, and a trustee willing to follow the rules. By anticipating friction points and documenting every step of the administration, fiduciaries can protect the estate and themselves from liability.

Verified Authority on GRAT Administration & Compliance

• Zeroed-Out Structure (IRC § 2702): Internal Revenue Code § 2702
  The governing statute for Grantor Retained Annuity Trusts. It allows the grantor to retain an annuity value equal to the contribution, effectively “zeroing out” the gift tax value of the remainder interest.
• IRS Hurdle Rate (§ 7520): Section 7520 Interest Rates
  The critical benchmark for GRAT success. The trust’s assets must appreciate faster than this monthly published rate for any wealth to pass tax-free to the beneficiaries.
• Real Estate Reassessment (Prop 19): California State Board of Equalization (Prop 19)
  Vital for GRATs holding real property. While funding the GRAT is safe, the eventual transfer to children at the end of the term is subject to strict Prop 19 reassessment rules if the property is not used as a primary residence.
• Estate Tax Exemption (OBBBA): IRS Estate Tax Guidelines
  Reflects the OBBBA permanent increase to a $15 million per person exemption (effective Jan 1, 2026). This is the “safety net” if a GRAT fails and assets are pulled back into the grantor’s taxable estate.
• Missed Asset Recovery (AB 2016): California Probate Code § 13151 (Petition for Succession)
  If an asset intended for the GRAT was legally left out, this statute (effective April 1, 2025) allows for a “Petition for Succession” for assets up to $750,000, bypassing full probate to clean up funding errors.
• Digital Asset Valuation (RUFADAA): California Probate Code § 870 (RUFADAA)
  Mandatory for GRATs funded with volatile digital assets (crypto). Without RUFADAA powers, a trustee cannot access or properly appraise these assets for the required annual annuity payments.