Using a Beneficiary Deemed Owner Trust (BDOT) in Generation Skipping

Ever heard of a trust where the beneficiary is technically the owner—but not really?

Welcome to the wild (but useful) world of BDOTs—Beneficiary Deemed Owner Trusts.

If you’re in the high-net-worth camp and looking for a creative way to skip estate taxes and generation-skipping taxes without losing control of your assets, then yes—BDOTs might just be your new secret weapon.

But don't worry, this isn't another dusty trust document lecture. We'll go through this as if we're chatting over coffee—and yes, there’s a story or two coming up.

📘 Table of Contents

• What is a BDOT? (Quick Overview)
• Understanding Generation-Skipping Transfer Tax (GSTT)
• How BDOTs Work for GST Planning
• The Hidden Benefit: Tax Basis Adjustment
• A Real Example (Diane's Story)
• When to Use a BDOT
• Common Mistakes to Avoid
• Final Thoughts

💼 What is a BDOT? (Quick Overview)

BDOTs are structured under IRC Section 678, where a beneficiary—not the original grantor—is treated as the "owner" for income tax purposes.

They can withdraw all income from the trust—or have the power to do so—which makes the trust taxable to them personally. It sounds like a headache, but it opens up a world of opportunity.

The trust remains irrevocable for legal purposes, so you still enjoy creditor protection and estate freeze potential. But tax-wise? You’ve turned the tables completely.

🏛️ Understanding Generation-Skipping Transfer Tax (GSTT)

The GST tax hits transfers to “skip persons” (e.g., grandchildren) with an extra 40% tax.

This tax applies *in addition* to estate or gift tax—unless you allocate your lifetime GST exemption properly, which in 2025 stands at $13.61 million per person.

Without thoughtful planning, skipping a generation could mean paying Uncle Sam *twice*.

🌐 How BDOTs Work for GST Planning

By designating a grandchild (a “skip person”) as the BDOT beneficiary, and giving them the power to withdraw trust income annually, the trust becomes taxable to them.

This status unlocks multiple benefits:

• Income is taxed at the beneficiary's lower rate.

• The trust escapes GST tax at distribution.

• Strategic use of Crummey powers allows for annual exclusion gifts.

Think of it as estate planning judo—you’re using the tax code’s own force to redirect the blow.

📊 The Hidden Benefit: Tax Basis Adjustment

One of the most overlooked superpowers of a BDOT is what happens to asset basis upon death.

Since the BDOT is considered a grantor trust owned by the beneficiary, assets inside the trust are included in that beneficiary’s estate.

Wait, isn’t that a bad thing?

Not really. Inclusion in the estate triggers a *step-up in basis*—so if that asset has appreciated significantly, the heirs will inherit it at its new, higher value.

This means capital gains are wiped out. The house bought at $400k and now worth $2M? Sold by the grandkids with **zero** taxable gain.

In contrast, traditional irrevocable trusts often lock in a low basis, leading to a hefty tax bill down the line.

So if you’ve got real estate or a low-basis stock portfolio sitting in trust, this one feature alone could save millions.

🧾 A Real Example: Diane's Story

Diane, a 73-year-old entrepreneur, wanted to gift part of her estate to her grandson, Max, without triggering GSTT.

She already used up most of her lifetime GST exemption, and setting up a traditional dynasty trust would have brought her dangerously close to a taxable transfer.

With her advisor, she pivoted to a BDOT structure: Max was granted a limited annual power to withdraw trust income, and voila—the BDOT trust kicked in.

Income was reported by Max (in a much lower bracket), and the distributions she made were *not* subject to GSTT.

Even better—when Max passed years later, the entire real estate asset in the BDOT got a basis step-up, allowing his own heirs to sell with zero capital gains.

“We saved well over $1.2 million in taxes just by changing three lines in a trust document,” Diane’s CPA later said. Sometimes, it’s not about working harder—it’s about structuring smarter.

🛠️ When to Use a BDOT

So when does this whole BDOT magic make sense?

• 💡 You want to skip a generation in your estate plan but don’t want GST tax implications.

• 💡 You have a beneficiary in a lower income tax bracket—perfect for income shifting.

• 💡 You’re dealing with low-basis assets that you eventually want stepped-up at death.

• 💡 You want asset protection but also some flexibility in how the trust operates.

In some advanced estate plans, BDOTs are paired with SLATs (Spousal Lifetime Access Trusts), GRATs (Grantor Retained Annuity Trusts), or ILITs (Irrevocable Life Insurance Trusts) for even more punch.

And while it may sound fancy, the implementation isn’t always expensive. The real key? Make sure your estate attorney or CPA understands IRC Section 678 cold. This is not a DIY project you tackle with a LegalZoom template.

⚠️ Common Mistakes to Avoid

Even the most powerful planning tool can blow up if used wrong. With BDOTs, these are the classic landmines:

• ❌ Giving withdrawal powers that are too broad—causing full estate inclusion when it’s not desired.

• ❌ Improper Crummey notices—if not documented properly, your annual exclusions could get voided.

• ❌ Assuming a BDOT is the same as a regular irrevocable trust—it’s not. The tax rules are night and day.

• ❌ Titling mistakes—if trust assets are misregistered, you lose basis adjustment benefits.

• ❌ Drafting errors—mixing BDOT elements into a SLAT or ILIT without careful integration can trigger unexpected inclusion and audit risks.

One seasoned CPA once told me, “A BDOT is like a Swiss Army knife for GST planning—versatile, powerful, but easy to slice your hand open if you don’t know what you’re doing.”

🧠 Final Thoughts

Using a BDOT in generation-skipping planning isn’t just clever—it’s strategic tax warfare.

When structured properly, it helps you:

• ✔ Avoid GST tax

• ✔ Shift income to lower brackets

• ✔ Achieve a basis step-up on death

• ✔ Preserve irrevocability and asset protection

But above all, it gives you control and flexibility—the two most valuable currencies in estate planning.

Still unsure? That’s normal. BDOTs are like learning to drive stick—awkward at first, but incredibly empowering once you get the hang of it.

Start with a conversation with a trust attorney or CPA who’s fluent in IRC 678 nuances. From there, you might discover this lesser-known trust structure is exactly what your multigenerational legacy plan was missing.

🔗 Further Reading from Trusted Sources:

Keywords: BDOT trust, generation-skipping tax planning, IRC Section 678, tax basis step-up, beneficiary deemed owner