BDIT: What is a beneficiary defective irrevocable trust?

The purpose of this post is to give you a useful, short example of an increasingly popular trust for estate, gift and income tax planning called a BDIT (pronounced “bee-dit”). BDIT also is often referred to as a beneficiary defective inheritor’s trust.

In this example a mother creates the written BDIT trust. Her son and grandchildren are the trust beneficiaries. The trust is designed purposely so that the trust is “defective” for income tax purposes as to the son. I explain this defective element further below.

The heart of this BDIT trust planning example is to enable the son to be a trust beneficiary of this BDIT trust to which the son sells his apartment building. The son sells the apartment to the BDIT trust for the primary purpose of:

    • freezing and avoiding having any future appreciation value of the apartment includible in his (the son’s) estate for estate tax purposes;
    • asset protection for the apartment within the BDIT trust; and
    • the son is a beneficiary of the BDIT trust and can receive distributions from the trust, if needed.

By contrast, without the BDIT design (i) the son cannot (or should not) be a beneficiary of a trust if he creates the trust (rather than his mother creating the trust); (ii) the son cannot get the above asset protection if he is a beneficiary of a trust he creates;  and (iii) the son cannot freeze the value of property in a trust that he creates if he (the son) is a beneficiary of his own self-created trust.

The term “defective” trust means all trust income, gains, losses, deductions for the BDIT trust are reportable on the son’s own personal income tax return Form 1040. These items are not reportable each year on a separate trust income tax return Form 1041.

So, why have this BDIT defective element for the son?

    • The defective trust feature enables the son to freeze the value of property that he (the son) might wish to sell to the BDIT trust. Assume in this example the son sells his apartment building to this BDIT trust and in return the son gets a promissory note from the trust. The trust then pays the note with rental income, etc.
    • The BDIT trust now owns the apartment building. Any future increase in value of the apartment will belong to the trust.
    • The BDIT trust “defective” status comes into play as the son’s sale to the trust is not recognized for income tax purposes. The BDIT defective status is deemed to be a sale of the apartment from the son to himself (to “himself” for defective trust income tax purposes). The sale to “himself” is not an income taxable event.

As I already stated above, the son benefits from the asset protection his mother’s BDIT trust can provide for him and his family, and the apartment building.

    • If the son later gets sued or has any other asset protection claim exposure, a third-party claimant cannot generally get hands on the apartment. The apartment is no longer an asset owned by the son. It is owned by the BDIT trust.

Finally, this BDIT trust is not a gifting trust for the son. The son can only sell property to this BDIT trust; he cannot, due to adverse estate tax rules, gift property to this trust.

3 thoughts on “BDIT: What is a beneficiary defective irrevocable trust?

    • Matt — The son can be the trustee. But, I would also include the option in the trust document later to bring in a fully discretionary independent trustee if needed in the future for iron-clad asset protection. But, this also requires avoiding a revolving door opting in and out of a HEMS (health, education, maintenance and support) vs. fully discretionary trustee, etc. James

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s