It is possible to use irrevocable trusts to eliminate U.S. estate taxation on real estate holdings. Here is a simple example of how it works.
Own nothing taxable
The key to preventing U.S. estate taxation is to not own something that is taxable. The U.S. estate tax is imposed only on human beings, and only on what they own when they die. For nonresidents the only thing the U.S. taxes is “something” that is located in the United States.
The key to using a trust is that a human being doesn’t own the real estate, so the estate tax doesn’t get applied to it–remember that the estate tax is imposed on the assets of deceased people.
With a trust, the people involved own something–the right to use the trust’s assets. The key to this strategy is that everyone involved owns something that has a zero value when they die, so there is nothing to tax.
The people who can use the trust’s real estate (they are called “beneficiaries”) are really like tenants who don’t have to pay for using the real estate.
Example
Father sets up a trust and contributes cash to it. The trust buys a house, and Son lives in the house.
If Father is a nonresident, when he dies there will be no U.S. estate tax. Father made a cash gift to the trust and had no further control over the trust, the cash, or the real estate.
Whether Son is a resident or nonresident of the United States, when he dies there will be no estate tax imposed. Son’s right to use the trust’s real estate terminates when Son dies.
All of this assumes the trust is set up and operated correctly. And there is a universe of tax technicalities in that sentence.
Doing it right
It has to be an irrevocable trust. The person contributing the money to the trust can’t control the trust, directly or indirectly. Nor can the person contributing the money enjoy the benefits of the trust. (These are called “retained interests” in tax jargon).
The trust can be set up as a foreign trust or a U.S. domestic trust.
The typical situation for this strategy is where nonresident parents wants to provide a house in the U.S. for their child. It works best when the parents have no desire to eventually reclaim the money–they see the structure as an outright gift.
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