Grantor Trusts and Substitution Powers, Part 5

Exercise by a legal representative?

If we are making a deathbed “swap” of low-basis assets in a grantor trust for high(er)-basis assets of the grantor, does the grantor actually have capacity to execute that swap? Likewise, can a grantor effectively release a substitution power if incapacitated?

Table of Contents

1. Where We Left Off

2. The Ideal Drafting Solution?

3. Nonfiduciary Power?

4. Uniform Power of Attorney Act

5. Conflicting Terms of Trust(s)

6. Key Takeaways

Where We Left Off

In coverage of substitution powers so far, we have covered both the high-level – how a substitution power intentionally creates a wholly-grantor trust in a manner allowing grantor trust status to be “turned off” – and some esoteric issues around the structure, parties, and asset-specific limitations of a substitution power. Most recently, we discussed the dual definition of “grantor” between trust creators versus trust contributors, and how a substitution power granted to a trust creator may not extend to another person who makes a contribution to a trust. The outcome can be a partial-grantor trust, which can create accounting and tax headaches.

We also discussed how the substitution power does not have to be held by the grantor themselves. It can be held by another person in a non-fiduciary capacity. But, this raises an interesting conflict in execution. If we are making a deathbed “swap” of low-basis assets in the trust for high(er)-basis assets of the grantor, does the grantor actually have capacity to execute that swap? Likewise, can a grantor effectively release a substitution power if incapacitated? If not, would a legal representative such as an agent, attorney-in-fact, or conservator have this power? This article addresses this mismatch.

The Ideal Drafting Solution?

Perhaps as a simple solution, a durable power of attorney would expressly grant an agent the power to exercise or release any rights of substitution on behalf of the grantor. Likewise, the trust instrument itself (under which the substitution power is created) would extend this power to a grantor’s legal representative. But, this is not usually how these documents and provisions are drafted. Taking it a step further, with prudent incapacity planning, significantly all of a grantor’s assets might also be held in a revocable trust subject to management by a successor trustee. Unfortunately, the rights of such successor trustee may not extend to the substitution of the grantor’s property in the revocable trust for assets in the (irrevocable) grantor trust.

It is rare to find these issues addressed in any of the three documents mentioned above, much less a combination thereof. If you remember nothing else from this discussion, it is that perhaps we should start to address these issues from a drafting perspective between instruments. For those who do not have express authorizing language in these instruments, however, can anything be done? And can this issue be drafted around as simply as portrayed? To understand this outcome, we need to first examine fiduciary duties themselves.

Nonfiduciary Power?