Intentionally Defective Grantor Trust (IDGT) — §675

What is an IDGT?

An Intentionally Defective Grantor Trust (IDGT) is an irrevocable trust that is designed to be a grantor trust for income tax purposes (under §675 or other grantor trust provisions) but a completed gift for estate tax purposes. The trust is 'defective' in the sense that the grantor retains certain powers that cause the trust to be treated as a grantor trust for income tax purposes, but those powers do not cause the trust to be included in the grantor's taxable estate.

The key advantage of the IDGT is that the grantor can sell assets to the trust in an installment sale without recognizing capital gains (because a sale between a grantor and a grantor trust is disregarded for income tax purposes). The installment note received by the grantor in exchange for the assets freezes the value of the transferred assets in the grantor's estate, while any future appreciation on the assets passes to the trust beneficiaries estate-tax free.

Installment Sale to an IDGT

The most common use of the IDGT is an installment sale of a closely held business interest or other appreciating asset to the trust. The grantor sells the asset to the IDGT in exchange for an installment note bearing interest at the applicable federal rate (AFR). The sale is not subject to capital gains tax (because the sale is between the grantor and a grantor trust). The installment note freezes the value of the transferred asset in the grantor's estate, while any future appreciation on the asset passes to the trust beneficiaries estate-tax free.

The installment note must bear interest at the applicable federal rate (AFR) to avoid gift tax. The AFR for long-term obligations (over 9 years) is published monthly by the IRS. For April 2026, the long-term AFR is approximately 4.5%. The grantor reports the interest income on the installment note on their personal income tax return (as a grantor trust, the interest income is disregarded for income tax purposes).

Seeding the IDGT

Before making an installment sale to the IDGT, the grantor must 'seed' the trust with an initial gift of at least 10% of the value of the assets to be sold to the trust. The seed gift ensures that the trust has sufficient assets to make the installment note payments and demonstrates that the trust is not a sham. The seed gift uses the grantor's lifetime gift and estate tax exemption.

For example, if the grantor plans to sell a $10 million business interest to the IDGT, the grantor should first make a seed gift of at least $1 million to the trust. The $1 million seed gift uses $1 million of the grantor's lifetime exemption. The grantor then sells the $10 million business interest to the trust in exchange for a $10 million installment note bearing interest at the AFR.

§675 Grantor Trust Powers

The IDGT is made a grantor trust for income tax purposes by including one or more grantor trust powers in the trust document. The most common grantor trust power used in IDGTs is the power to substitute assets of equivalent value (§675(4)(C)). This power allows the grantor to swap assets in and out of the trust without triggering capital gains, which provides significant flexibility for tax planning.

Other common grantor trust powers include: the power to borrow from the trust without adequate security (§675(2)), the power to add beneficiaries (§674), and the power to reacquire trust assets by substituting other property of equivalent value (§675(4)(C)). Practitioners should carefully select the grantor trust powers to include in the IDGT to avoid inadvertently causing estate inclusion under §2036 or §2038.

IDGT vs. GRAT vs. SLAT

The IDGT, GRAT, and SLAT are all estate freeze techniques, but they have different characteristics and are appropriate for different situations. The IDGT is best for clients who want to freeze the value of a closely held business interest and transfer future appreciation to the next generation through an installment sale without recognizing capital gains. The GRAT is best for clients who want to transfer appreciation without using their lifetime exemption. The SLAT is best for married couples who want to transfer assets to an irrevocable trust while retaining indirect access through the beneficiary spouse.

Frequently Asked Questions