GRATs: Transferring Appreciation with Zero Gift Tax
A Grantor Retained Annuity Trust (GRAT) is an irrevocable trust into which the grantor transfers assets and retains the right to receive fixed annuity payments back for a specified term (typically 2–10 years). At the end of the term, the remaining trust assets pass to beneficiaries (usually children or a dynasty trust) free of gift tax. The gift tax value of the transferred interest is calculated using IRS Section 7520 rates — when the trust is designed so the present value of the annuity payments equals the contributed assets' value (a "zeroed-out GRAT"), the taxable gift is essentially zero.
The strategy succeeds when the assets inside the GRAT appreciate faster than the Section 7520 rate (the "hurdle rate" — approximately 120% of the monthly AFR). All appreciation above the hurdle rate transfers to beneficiaries without gift or estate tax. If assets in the GRAT underperform the hurdle rate, the GRAT fails and the assets return to the grantor with no worse outcome than if the GRAT had never been established (the grantor still has the assets). This asymmetric payoff — large upside if assets appreciate, no downside beyond transaction costs — makes GRATs particularly attractive for high-growth assets.
Rolling GRATs is a strategy of establishing multiple short-term (2-year) GRATs in succession rather than one long-term GRAT. Rolling 2-year GRATs capture the asymmetry repeatedly: any GRAT that captures appreciation succeeds; those that don't are cost-free failures. The practical risk is the grantor's mortality — if the grantor dies before the GRAT term expires, the assets are pulled back into the estate. Using short-term GRATs reduces mortality risk relative to longer terms.