The short answer
GRATs and intentionally defective grantor trusts (IDGTs) do the same basic job. Each freezes the value of a fast-growing asset in your estate and shifts the future growth to your heirs, free of estate and gift tax. The Walton family used GRATs to move Walmart stock, and sales to IDGTs are a staple of family-office planning.
The key differences come down to three things:
- The hurdle. A GRAT must beat the IRS Section 7520 rate, 6.2% for November 2026. An IDGT sale must beat a lower rate, the applicable federal rate (AFR), as low as 4.67% for a short-term note that month (IRS Rev. Rul. 2026-21).
- Death risk. If you die during a GRAT's term, the assets come back into your estate. An IDGT has no such cliff.
- Grandchildren. An IDGT can be made exempt from generation-skipping tax from day one. A GRAT cannot.
The rule of thumb: a GRAT for a quick, gift-free bet on a volatile asset; an IDGT for a larger, longer-term, multigenerational transfer. Many families use both.
How a sale to an IDGT works
You already know how a GRAT works: you get back your assets plus the IRS rate, and heirs keep the excess. An IDGT reaches a similar result through a sale instead of an annuity.
You sell the asset for a note; growth above the note rate stays with heirs
Own a business, LLC units or stock likely to grow
Irrevocable, outside estate
Buys the asset with a note
You pay its income tax
Children and grandchildren
Can be GST-exempt
- Seed the trust. You gift cash or assets to a new irrevocable trust, commonly about 10% of the value you plan to sell, so the trust looks creditworthy (McCarthy Fingar).
- Sell the asset to the trust. The trust buys your shares or LLC units with a promissory note at the applicable federal rate. Because the trust is a grantor trust, the IRS ignores the sale for income tax: no capital gain (Northern Trust).
- Collect the note. The trust pays you interest, often interest-only with a balloon at the end, from the asset's cash flow.
- Heirs keep the growth. Once the note is repaid, everything left in the trust, all the growth above the note rate, belongs to your heirs outside your estate.
The “defective” part is deliberate: the trust is outside your estate for estate tax, but its income is still taxed to you.
The rate gap: why IDGTs often pass more
The IDGT's edge comes from its lower hurdle. A GRAT's payments are priced at the Section 7520 rate, while an IDGT note only has to pay the AFR, which is almost always lower (McCarthy Fingar). An interest-only note also leaves more assets compounding inside the trust.
Over nine years, an IDGT sale passes about twice as much as a GRAT
$10M asset, 9-year term, November 2026 rates: GRAT hurdle 6.2%, IDGT note at 5.08% mid-term AFR. Seed gift excluded.
Annual growth of the asset; amount passed to heirs after the trust repays you
Reading the chart. At 10% annual growth, the IDGT passes about $6.7 million versus about $3.4 million for a nine-year GRAT. At 6% growth, below the GRAT's hurdle, the GRAT passes nothing while the IDGT still passes about $1.1 million.
What the chart leaves out. The IDGT needs a seed gift, typically about $1 million here, which uses part of your exemption. The GRAT needs no gift at all. And a nine-year GRAT carries real mortality risk; in practice most families would roll shorter two-year GRATs instead.
GRAT vs. IDGT, head to head
| GRAT | Sale to an IDGT | |
|---|---|---|
| How value moves | You take back an annuity; heirs keep the excess | You sell for a note; heirs keep growth above the note rate |
| Hurdle rate (November 2026) | Section 7520 rate: 6.2% | AFR: 4.67% short-term, 5.08% mid-term, 5.52% long-term |
| Gift or exemption used | Near zero when zeroed out | A seed gift, commonly about 10% of the sale |
| If you die during the term | Assets pulled back into your estate | No cliff; only the unpaid note is in your estate |
| Generation-skipping (GST) | Exemption cannot be allocated until the term ends | Exemption can be allocated from day one |
| Payment flexibility | Annuity can rise at most 20% a year | Interest-only with a balloon is common |
| Income tax | Grantor trust: you pay the trust's tax | Grantor trust: you pay the trust's tax |
| IRS certainty | Rules set by statute and regulations | Built on IRS rulings and case law, with more audit risk |
| Best for | Volatile assets, quick bets, no exemption left | Larger, long-term, multigenerational transfers |
Sources: IRS Rev. Rul. 2026-21; McCarthy Fingar.
IDGT rules and risks to understand first
The seed gift. Planners commonly fund the trust with about 10% of the note's value before the sale so the trust can credibly repay its debt (McCarthy Fingar). That gift uses part of your lifetime exemption, now $15 million per person.
The note must be real. Interest at least at the AFR, a written note, and actual payments on schedule. A note that is never paid invites the IRS to recast the sale as a gift.
Paying the trust's income tax is a feature. The IRS has ruled that your payment of the trust's income tax is not a gift (Northern Trust). Every tax dollar you pay lets the trust keep more for your heirs, and shrinks your taxable estate.
No step-up in basis. Assets in an IDGT are outside your estate, so they do not get a new basis at your death. The IRS confirmed this in Rev. Rul. 2023-2 (Journal of Accountancy). Many trusts include a power to swap high-basis assets back in for low-basis ones, a planning step to discuss with your advisor.
Death before the note is paid. The unpaid note balance is part of your estate, and the income tax treatment of the remaining note is unsettled. Shorter notes and life insurance can limit this risk.
Valuation discounts add leverage, and scrutiny. Selling non-voting LLC or partnership units at a discount lets more value move per dollar of note, but the discount must be supported by a qualified appraisal.
Using both, and the California angle
Many families do both. A common pattern: rolling two-year GRATs for a volatile asset such as pre-IPO stock, plus a sale to a GST-exempt IDGT for a stable business or real estate LLC meant to benefit grandchildren. A GRAT's remainder can also be poured into an existing IDGT when the term ends.
Timing matters this year. November 2026 rates are higher than October's for both strategies. A GRAT or note set up by October 31 locks in a 5.6% Section 7520 rate and a 4.61% mid-term AFR (IRS Rev. Rul. 2026-19), rather than November's 6.2% and 5.08% (IRS Rev. Rul. 2026-21).
California. California has no gift or estate tax, so neither transfer is taxed by the state. Both trusts are grantor trusts, so their income is taxed to you at California rates of up to 13.3% while you are alive. Transfers of California real estate into either trust can trigger a property tax reassessment, and Proposition 19 sharply limits the parent-child exclusion (Greenberg Glusker). Holding real estate in an LLC and transferring minority interests is a common workaround to review with counsel.
FAQ
What is the difference between a GRAT and an IDGT?
Both shift an asset's future growth to heirs free of estate tax. A GRAT pays you back through an annuity priced at the Section 7520 rate; an IDGT buys the asset from you with a note at the lower applicable federal rate.
Which passes more to heirs?
Usually the IDGT, because its hurdle rate is lower and an interest-only note keeps more assets compounding. In our nine-year example at 10% growth, the IDGT passed about $6.7 million versus about $3.4 million for the GRAT.
Why is it called “intentionally defective”?
The trust is deliberately drafted to be outside your estate for estate tax but still yours for income tax. That “defect” lets you sell to it without capital gains tax and pay its income tax for your heirs.
Do I need to use my exemption for an IDGT?
Typically yes, for the seed gift, often about 10% of the sale. A zeroed-out GRAT uses essentially none.
What happens if I die before the note is repaid?
The unpaid note is part of your estate, but the trust's growth is not. With a GRAT, dying during the term pulls the assets back into your estate.
Can either trust benefit grandchildren?
An IDGT can be GST-exempt from day one, which makes it the better dynasty tool. A GRAT cannot receive a GST allocation until its term ends.
Do assets in these trusts get a step-up in basis at my death?
No. Assets that have passed to the trust keep your original basis, as the IRS confirmed in Rev. Rul. 2023-2.
Important Disclosures
Source: Gideon Strategic Partners, Important Disclosures (effective April 1, 2026).
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Sources
Listed in the order they first appear in this article.
- IRS Rev. Rul. 2026-21: Section 7520 rate and AFRs for November 2026
- McCarthy Fingar: Utilizing FLPs, GRATs and sales to defective grantor trusts
- Northern Trust: Tax planning with irrevocable grantor trusts
- Journal of Accountancy: No basis step-up for grantor trust assets (Rev. Rul. 2023-2)
- IRS Rev. Rul. 2026-19: Section 7520 rate and AFRs for October 2026
- Greenberg Glusker: Proposition 19 limits on parent-child transfers
- Gideon Strategic Partners: Important Disclosures