A GRAT trust, short for Grantor Retained Annuity Trust, is an irrevocable trust you fund with assets and then receive fixed annuity payments from for a set number of years. If the assets inside the trust grow faster than an IRS benchmark interest rate, everything above that rate passes to your chosen beneficiaries free of gift tax when the term ends. It is one of the most reliable tools in estate planning for moving appreciating assets out of a taxable estate, and when structured correctly, the gift tax cost can be reduced to zero.1
The Three Roles Inside a GRAT
Every GRAT has three players. The grantor creates the trust and transfers assets into it. The trustee holds legal title to those assets and manages them during the trust term. The remainder beneficiary, usually a child or other heir, receives whatever is left in the trust after the annuity term expires.
The structure is governed by a specialized set of valuation rules under 26 U.S.C. § 2702, which determines whether the IRS treats the transfer as a taxable gift and how much that gift is worth. Your retained annuity interest is valued using IRS actuarial tables, and only the portion of the transfer that exceeds that value counts as a taxable gift.
How the Annuity Works
When you create a GRAT, you pick a fixed term. Two to ten years is typical. The trust then pays you an annuity every year of that term, set either as a fixed dollar amount or a fixed percentage of the initial value of the assets you transferred in.
Federal regulations require that payments happen at least once a year and that the trust document lock in the annuity formula from the start. The annuity amount can increase from year to year, but no single year’s payment can exceed 120% of the prior year’s payment. Once the term ends, whatever assets remain pass to the remainder beneficiaries.
The trust document must also prohibit any additional contributions after the initial funding. You get one shot to put assets in. If you want to fund a GRAT with different assets later, you need a new trust.
The Section 7520 Rate and Why It Matters
Every GRAT lives or dies by the Section 7520 rate, published monthly by the IRS. The rate equals 120% of the federal midterm rate, rounded to the nearest two-tenths of a percent. For early 2026, the rate sits at 4.6% for January and February and 4.8% for March. The IRS uses it to calculate the present value of the annuity payments you will receive during the trust term.
Think of the 7520 rate as a hurdle. The IRS assumes your trust assets will grow at exactly that rate. Any actual growth above the hurdle passes to your beneficiaries without triggering gift tax. If you fund a GRAT with $5 million in assets and those assets grow at 10% while the 7520 rate is 4.6%, the difference between those two rates, compounded over the trust term, is what your beneficiaries receive tax-free. A lower 7520 rate makes the hurdle easier to clear, which is why estate planners pay close attention to rate movements.
Why Most GRATs Are Zeroed Out
Most GRATs today are structured as “zeroed-out” trusts. The annuity payments are calibrated so that the present value of your retained interest equals the full value of the property you transferred in. Under the IRS’s math, this leaves a taxable gift of zero. You still file a gift tax return to report the transfer, but you owe no gift tax and you do not eat into your lifetime exemption.
Here is how the mechanics work. The annuity is set high enough that if the trust assets earn exactly the 7520 rate, the final payment would exhaust every dollar in the trust, leaving nothing for the beneficiaries. If the assets outperform the 7520 rate, the trust has more than it needs to make the annuity payments, and that surplus passes to beneficiaries gift-tax-free. You are essentially betting that your assets will beat a government-set interest rate, and the tax code rewards you for being right.
What You Can Put Inside a GRAT
GRATs work best with assets likely to appreciate significantly during the trust term. Publicly traded stocks with strong growth potential, commercial real estate, and closely held business interests are common choices. The higher the expected return relative to the 7520 rate, the more wealth passes to your beneficiaries.
Every asset transferred into a GRAT needs a defensible fair market value at the time of funding. Publicly traded securities are simple because the market price on the transfer date establishes value. Closely held business interests and real estate require formal appraisals from qualified professionals, and valuation discounts can play a significant role here. When you transfer a minority stake in a private company, the appraiser will often apply a discount for lack of control, because the holder cannot dictate company decisions, and a discount for lack of marketability, because there is no public market to sell the interest on. These discounts can range from 10% to 45%, which means you are transferring an asset into the trust at a lower value for gift tax purposes than its proportionate share of the company’s total worth. That lower starting value makes the zeroed-out annuity calculation more favorable and increases the potential tax-free transfer.
Income Tax While the Trust Runs
A GRAT is classified as a grantor trust for income tax purposes, which means all income, capital gains, and losses flow through to your personal tax return. You pay income tax on everything the trust earns, even income that stays inside the trust. This sounds like a disadvantage, but it is actually a feature. Your tax payments effectively shrink your taxable estate further, because the money you spend on taxes does not count as an additional gift to the trust beneficiaries. The IRS confirmed this treatment in Revenue Ruling 2004-64.
Many GRATs include a provision giving the grantor the power to swap personal assets for trust assets of equivalent value. Under 26 U.S.C. § 675(4)(C), this substitution power must be exercisable without the trustee’s approval and outside any fiduciary capacity. If the trust holds an asset that has appreciated dramatically and you want to lock in the gain for your beneficiaries, you can swap in cash or another asset of equal current value. The appreciated asset comes back to you, where it gets a stepped-up basis at death, and the trust keeps going with equivalent value. This flexibility also helps maintain grantor trust status throughout the term.
Where GRATs Fail
Dying During the Term
This is the biggest risk with any GRAT. If you die before the annuity term expires, the full date-of-death value of the trust assets gets pulled back into your taxable estate under 26 U.S.C. § 2036(a). Not just the remaining annuity payments. The entire trust. The IRS treats the retained annuity as a continued right to enjoy the property, and because that right did not end before your death, the whole transfer is undone for estate tax purposes. The GRAT has not cost you anything in this scenario, since the assets were going to be in your estate anyway, but you have lost the planning benefit entirely.
Underperformance
If the trust’s assets do not outperform the 7520 rate, there is nothing left for your beneficiaries after the annuity payments are made. With a zeroed-out GRAT, the worst case is a wash. You get all your assets back through the annuity payments, and your beneficiaries receive nothing. You have not lost money, but you have not transferred any wealth either. The time and legal fees are the real cost of a failed GRAT.
Compliance Failures
The IRS holds GRATs to strict technical requirements. The trust document must prohibit additional contributions, fix the annuity terms from inception, and specify a term measured by a set number of years or the grantor’s life (or the shorter of the two). Annuity payments cannot be satisfied with promissory notes. The trustee must pay the annuity on schedule every year; missing a payment or paying late can jeopardize the trust’s qualification. Failing to meet these requirements could cause the IRS to treat the retained interest as having zero value, which would make the entire transfer a taxable gift at full value.
Rolling GRATs
Rather than creating one long-term GRAT, many planners use a series of short-term GRATs, typically with two-year terms, in a technique called rolling or cascading GRATs. When the first GRAT pays its annuity back to you, you immediately use that payment to fund a new GRAT. Each successive GRAT captures a fresh window of potential appreciation.
Short-term rolling GRATs have a real advantage over a single long-term trust. A ten-year GRAT needs its assets to outperform the 7520 rate over the entire decade, and one bad year can drag down the whole result. A two-year GRAT only needs to beat the hurdle over two years. If it does not, you simply get your assets back and try again at the current 7520 rate. Successful GRATs pass wealth to beneficiaries, and the unsuccessful ones wash out with no tax consequence. The approach also reduces the risk of dying during the trust term, since each individual GRAT has a shorter window of exposure.
Reporting and the Final Distribution
You must file IRS Form 709 to report the creation of the GRAT, even if the taxable gift is zeroed out. The return is due by April 15 of the year after you funded the trust. A zeroed-out GRAT will not generate any gift tax, but the filing itself is required so the IRS has a record of the transfer and can start the statute of limitations on the gift tax valuation.
For context, the federal lifetime gift and estate tax exemption for 2026 is $15,000,000, following the enactment of the One Big Beautiful Bill in July 2025. GRATs remain valuable even with this high exemption, because a properly structured zeroed-out GRAT transfers wealth without using any of it. For individuals whose estates approach or exceed $15 million, GRATs move appreciation out of the estate without reducing the exemption available for other planning.
When the annuity term ends, the trustee transfers all remaining assets to the remainder beneficiaries. Those assets belong to the beneficiaries free of gift tax, outside the grantor’s estate, and without consuming any lifetime exemption. The trustee completes a final accounting confirming every annuity payment was made and all remaining property has been distributed, and the trust terminates.