Ownership through irrevocable trusts

 

By settling an irrevocable domestic (U.S.) trust, a foreign investor may be able to both exclude the US. real property interest from his or her U.S.
estate, as well as be taxed at capital gains rates on the gain from the ultimate sale of the interest (as long as the property was held for at least one year).44
Therefore, from a pure income tax perspective, this holding structure provides the desired tax results.

This technique is most appropriate when the foreigner is willing to part with control of some portion or all of the interests held by the trust.
As long as the foreigner did not retain any interests therein, assets contributed by a foreigner to an irrevocable trust should not be included in the foreigner’s U.S. gross estate.45
Furthermore, by contributing cash (preferably from a non-U.S. bank account) to the irrevocable trust for the purchase of U.S. real property, the foreigner will not be subject to U.S. gift taxation on the cash contribution (as opposed to a transfer to the trust of U.S. real property already owned by the foreigner).46

It is this author’s experience that foreign investors prefer to maintain anonymity.
For this reason, and only when appropriate, foreign investors may choose to hold their interest in their business entity (i.e., the LLC or U.S. partnership) through a nongrantor trust.47
Although the implications of using this approach are beyond the scope of this article, it is nonetheless important to note that close consideration should be given to the matter.

When creating an irrevocable trust for the benefit of a third party (including the investor’s family members), no gift tax liability arises upon the initial transfer of cash to the trust.
Furthermore, since the U.S. real property is owned by the trust upon the death of the investor, no estate tax inclusion arises.
As an aside, this structure offers the added bonus of eliminating the need for probate.

As noted earlier, the downside to this structure is the investor’s inability to retain an interest in the trust or the underlying property.
However, some practitioners draft provisions in these irrevocable trusts that empower the trustee to make discretionary distributions to the investor (referred to as the “settlor” of the trust).
Where laws of the trust situs permit the settlor’s creditors to reach the trust assets during the settlor’s life, the estate of the settlor will include the trust principal.48
This is because such jurisdictions deem the settlor to have reserved the power to alter, amend, revoke, or terminate the trust under I.R.C. §203849 therefore, the settlor is deemed to have “retained an interest.”50
Furthermore, the IRS has taken the position that such "arrangements" will, in fact, cause inclusion "if there was an implied understanding that the settlor would have continued enjoyment of the assets transferred in trust or their income," even if the trustee is unrelated to the settlor.51
Several states (most notably Alaska, Delaware, and Nevada), as well as numerous foreign jurisdictions, have laws protecting this type of "self-settled discretionary" trust from the settlor’s creditors.
Accordingly, the initial gift to the discretionary trust in those jurisdictions should be deemed "completed" for gift tax purposes and thereby remove the assets from the settlor’s gross estate.52