The Trump family used this strategy to save on taxes

President Donald J. Trump and his family supposedly saved on taxes by using a particular kind of trust — a grantor-retained annuity trust, or GRAT.

Just what is a GRAT and why is it used?

At a high level, GRATs are complex vehicles used to transfer wealth in a tax-efficient way. Uber-wealthy families often use GRATs to remove wealth from their estate and transfer it to their children, who inherit that wealth tax-free.

In Mr. Trump’s case, his parents transferred properties such as apartment complexes in two GRATs, one in his father Fred’s name and the other his mother Mary’s name, according to an investigative report published Tuesday by the New York Times.

The Trump family is hardly alone. Other business titans — such as the Walton family of Wal-Mart fame, Facebook CEO Mark Zuckerberg, casino czar Sheldon Adelson and Goldman Sachs chairman Lloyd Blankfein — reportedly have also set up trusts of this type.

Here’s how the vehicle works.

GRATs are also known as split-interest trusts. The interest in an asset is split between the original owner (the grantor) and the beneficiary over a set number of years. The transfer can be short term (maybe two years) or longer term (10 or 20 years, for example).

The typical GRAT strategy is to put an asset into the trust that is likely to appreciate greatly in value, according to estate planners. The grantor receives annuity income — a combination of principal plus an interest rate set by the Treasury Department — over the GRAT’s term, and the beneficiary receives the remaining value tax-free.

Here’s a high-level illustration: The grantor puts $10 million worth of Apple stock into a GRAT with a five-year term and a 3% interest rate. The grantor would get $2 million in principal and $60,000 in interest payments every year for five years. Let’s say the Apple stock grew to $20 million over that time. The beneficiary would get a total of $9.7 million ($20 million – $10.3 million) tax-free.

Such a strategy would have saved Mr. Trump and his siblings more than $5 million in taxes back in 1999, when Fred Trump died.

However, there is ample room to game the system — by purposely low-balling the value of an asset, estate planners said.

Let’s say the grantor has real estate worth $50 million, but says the asset is only worth $10 million when it goes into the trust. The beneficiary will get a much bigger tax-free transfer in this scenario — roughly $30 million more than in the prior example.

“If you can fudge the value, you’re going to leave a big tax-free remainder that passes to your kids,” said Richard Behrendt, an estate planning attorney who worked at the Internal Revenue Service for more than a decade.

Indeed, the New York Times investigation found the Trump family was able to dodge hundreds of millions of dollars by “submitting tax returns that grossly undervalued” real estate assets. In one example, the Trumps valued 25 apartment complexes at $41.4 million in 1995; banks valued those same properties at $900 million in 2004, according to the Times.

Charlie Douglas, an estate planner, said there is a risk to using GRATs — if the grantor dies before the end of the trust’s term.

“If the grantor dies during the term of the GRAT, the whole thing is brought back into the estate, and I didn’t achieve anything for estate-tax purposes when I die,” Mr. Douglas said. “The grantor has to outlive the term of the GRAT.”

This is often why the wealthy opt for shorter-term GRATs rather than longer ones, estate planners said. Indeed, the Trumps opted for two-year GRATs, according to the Times.