I set up an intentionally defective grantor trust (IDGT) and funded it with $5 million cash. I now want to exercise my substitution power to swap my New York apartment into the trust in exchange for cash equal to the apartment's appraised value. Since I already gave the trust the cash and I'm just swapping assets I control, is this exempt from New York's Real Estate Transfer Tax as a gift?

Plain-English summary

In December 2012, facing an imminent reduction in the federal gift-tax credit, a taxpayer's advisor set up an intentionally defective grantor trust (IDGT) rather than completing an outright gift of her New York apartment to her son before year-end. Under an IDGT, contributed assets are excluded from the grantor's taxable estate, but the grantor still pays income tax on the trust's earnings — a structure made possible by a "substitution power" that lets the grantor swap trust property for other property of equivalent value, which is what classifies the arrangement as a grantor trust for income tax purposes. The grantor contributed $5 million cash to the IDGT and later intended to exercise her substitution power to swap her New York condominium apartment into the trust, receiving cash equal to the apartment's appraised value in return.

The Department held that this substitution swap is subject to New York's Real Estate Transfer Tax (RETT). Tax Law § 1402(a) taxes conveyances of real property where consideration exceeds $500, and Tax Law § 1401(e) defines "conveyance" to expressly include an exchange. Once the apartment is substituted into the trust in place of cash, the grantor no longer holds any beneficial interest in the real estate — a transfer squarely within the statutory definition. Although the grantor's original goal was a tax-free gift to her son, the actual transaction as structured doesn't qualify as one: to get the Tax Law § 1405(4) gift exemption, a conveyance must be made without consideration, and exemptions from RETT are strictly construed (citing Matter of Grace v. New York State Tax Commissioner and Matter of Viacom). Here, the grantor receives cash equal to the apartment's appraised value in the exchange — real consideration — so the gift exemption doesn't apply. Because the property is residential real estate worth $1 million or more, the additional 1% tax under Tax Law § 1402-a applies on top of the ordinary RETT.

What this means for you

An IDGT substitution swap is a taxable exchange, not a tax-free gift, when cash of equal value comes back to the grantor

Even though an IDGT is disregarded for income-tax purposes and its assets are outside the grantor's estate, receiving cash equal to the property's value in a substitution swap is real consideration for RETT purposes — the income-tax and estate-tax treatment of an IDGT does not carry over to a RETT exemption.

RETT exemptions are strictly construed — "it's just moving assets within my own estate plan" isn't enough

The Department expressly invoked the rule that RETT exemptions (like the gift exemption) are strictly construed against the taxpayer. A transaction motivated by estate planning, involving assets the grantor effectively still controls, doesn't get favorable treatment unless it independently satisfies the exemption's terms — here, "no consideration."

If your original plan (an outright gift) falls through, expect the substitute structure to be judged on its own facts

The grantor's original intent to gift the apartment outright didn't carry over to protect the substitution-swap structure that was actually implemented instead — the Department analyzed the transaction the taxpayer actually did, not the one originally intended.

Common questions

Q: If I fund my IDGT with cash and later substitute in real property for that cash, is that RETT-free because I'm just moving my own assets around?
A: No. Because you receive cash consideration equal to the property's value in the exchange, it's a taxable conveyance under Tax Law § 1402(a) — the IDGT's favorable income/estate tax treatment doesn't exempt it from RETT.

Q: Does the RETT gift exemption cover a substitution-power exchange if the values are equal?
A: No. The gift exemption under Tax Law § 1405(4) requires the property to be conveyed without consideration. Receiving cash equal to the property's appraised value is consideration, regardless of whether the values match.

Q: Does the additional 1% "mansion tax" apply on top of ordinary RETT here?
A: Yes, if the residential property's value is $1 million or more — Tax Law § 1402-a's additional tax applies to residential conveyances (including condominium units) meeting that threshold.

Citations and references

Statutes and case law:

• Tax Law § 1402(a)
• Tax Law § 1401(e)
• Tax Law § 1401(d)
• Tax Law § 1402-a
• Tax Law § 1405(4)
• Matter of Grace v. New York State Tax Commissioner, 37 N.Y.2d 193
• Matter of Viacom (N.Y. Tax Appeals Tribunal, May 3, 2007)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/real_estate_tran_ao_2014.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/real_estate/a14_2r.pdf

Original ruling text

New York State Department of Taxation and Finance
TSB-A-14(2)R
Real Estate Transfer Tax
December 4, 2014

Office of Counsel

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. M130816A

The Department of Taxation and Finance received a Petition for Advisory Opinion from
REDACTION REDACTION REDACTION REDACTION (“Petitioner”). Petitioner, the grantor of
an intentionally defective grantor trust, asks whether the conveyance of her New York apartment to
the trust, in exchange for cash she previously conveyed to the trust when it was created, equal to the
value of the apartment, is exempt from the New York State real estate transfer tax (RETT).
We conclude that the conveyance of a New York condominium apartment by Petitioner to
the trust in exchange for cash equal to the value of the apartment is a conveyance, subject to the
RETT. The consideration for the conveyance is equal to the cash received from the trust.
Facts
In December, 2012, the federal estate and gift tax laws allowed a unified $5 million credit,
that, without Congressional action, was set to be reduced to $1 million after December 31, 2012.
During that month, Petitioner met with her tax advisor and concluded that she wanted to gift her
New York apartment to her son. Because Petitioner was unable to complete the transfer of the
apartment to her son before the end of December 2012, when the higher federal tax benefits for gifts
expired, the structure that her advisor recommended and subsequently implemented was an estate
planning technique known as an intentionally defective grantor trust (“IDGT”).
Under an IDGT, the assets that are contributed to the trust are not part of the grantor’s estate,
but, nevertheless, the income generated by those assets remains taxable to the grantor. In order to
accomplish this purpose, the terms of the IDGT may permit the grantor to retain the power to
acquire or reacquire all or any portion of the assets in the trust by substituting other property of
equivalent value. This substitution power causes the IDGT to be classified as a grantor trust for
income tax purposes.
In December 2012, Petitioner contributed $5 million cash to the IDGT. Petitioner now
intends to exercise her power of substitution to exchange her New York condominium apartment
for cash equal to the value of the apartment.
Analysis
Under Tax Law § 1402(a), a tax is imposed on each conveyance of real property or interest
therein when the consideration exceeds $500. The rate of tax is equal to $2 for each $500 of
consideration. A “conveyance” means the transfer or transfers of any interest in real property by
any method, including but not limited to an exchange. See Tax Law § 1401(e). “Consideration”

-2-

TSB-A-14(2)R
Real Estate Transfer Tax
December 4, 2014

means the price actually paid or required to be paid for the real property or interest therein, whether
or not expressed in the deed and whether paid or required to be paid by money, property, or any
other thing of value. See Tax Law § 1401(d). An additional tax on each conveyance of residential
real property or interest therein is imposed when the consideration for the entire conveyance is $1
million or more. For purposes of this additional tax, residential real property includes any premises
that is or may be used in whole or in part as a personal residence, and shall include a one, two, or
three-family house, an individual condominium unit, or a cooperative apartment unit. The rate of
this additional tax is one percent of the consideration. See Tax Law § 1402-a.
Although Petitioner originally had intended to transfer the condominium to her son in a nontaxable transaction, the form of the actual transaction would not qualify as such. Once the
apartment is substituted for the cash as an asset of the IDGT, under the terms of the IDGT,
Petitioner would no longer hold any beneficial interest in the real estate. This transfer of the
Petitioner’s condominium apartment to the IDGT fits within the statutory definition for RETT
purposes of a conveyance of real property or interest therein. Further, in order for a conveyance to
qualify for the exemption under Tax Law § 1405(4) as a gift, a property must be conveyed without
consideration. Exemptions from the real estate transfer tax must be strictly construed. See Matter
of Grace v. New York State Tax Commissioner, 37 NY 2d 193; Matter of Viacom, Tax Appeals
Tribunal, May 3, 2007. Here, in exchange for the conveyance of the condominium apartment to the
IDGT, Petitioner would receive cash equal to the amount of the appraised value of the apartment.
Thus, Petitioner is receiving cash consideration, and the conveyance of the apartment to the IDGT
would be subject to RETT and the additional tax.

DATED:

December 4, 2014

/S/
DEBORAH R. LIEBMAN
Deputy Counsel

NOTE:

An Advisory Opinion is issued at the request of a person or entity. It is limited to the
facts set forth therein and is binding on the Department only with respect to the person
or entity to whom it is issued and only if the person or entity fully and accurately
describes all relevant facts. An Advisory Opinion is based on the law, regulations, and
Department policies in effect as of the date the Opinion is issued or for the specific time
period at issue in the Opinion. The information provided in this document does not
cover every situation and is not intended to replace the law or change its meaning.