The Qualified Personal Residence Trust (often referred to by its acronym, “QPRT”) can be an effective estate planning technique for a high net worth individual. The concept is simple: the owner of a personal residence transfers it to a trust, but retains the right to live in the residence for a specified period of years. At the end of that period of years, the children (or other designated beneficiaries) become the owners of the residence. Thereafter, the residence will no longer be a part of the former owner’s taxable estate.
How This Technique Works
The tax advantage of the technique comes primarily from the way in which the value of the gift to the trust is calculated. The value of the gift is not the value of the residence on the date of the gift. Instead, the gift is only the value of the children’s right to take possession of the residence at the end of the specified period of years, which can be far less than the current value of the property. For example, a $1,000,000 home can be gifted to a QPRT, removing $1,000,000 from the grantor’s taxable estate, but the taxable gift may be as little as 10 or 20 percent of the value of the residence. By keeping the gift tax value of the QPRT transfer below the $675,000 in 2000 and 2001 exemption from federal gift tax, the grantor can avoid paying federal gift tax on the gift. If the value of the residence is so large that even the reduced value of the transfer to the children would trigger a gift tax, the use of the QPRT will still be valuable and the payment of the gift tax may actually prove to be advantageous. Any gift tax paid now will reduce the estate tax due at death, provided the grantor lives at least three years after the tax is paid. Although the concept of a QPRT is simple, the decision to created one should not be made without a fairly complex tax calculation to determine the value of the taxable gift which will be made. This value is a function of (i) the age of the grantor; (ii) the number of years during which the grantor will retain the right to occupy the property; (iii) the current appraised value of the property; and (iv) the current IRS actuarial tables and interest rates used to calculate future values.
The QPRT trust document may contain provision such as these:
A. The Grantor could be the sole Trustee of the QPRT, and make all management decision.
B. The QPRT would continue for a specified number of years, after which the property could be transferred either outright to the children or in a further trust for their benefit. The number of years that the QPRT is designed to continue requires careful thought since the tax benefits are lost if the grantor dies before the QPRT ends. A longer trust term increases the tax advantages, but also increases the risk that premature death will erase those advantages.
C. During the term of the QPRT, the grantor would be entitled to all rights of occupancy, and would be responsible for all costs of maintenance.
D. If the residence is sold during the term of the QPRT, another home can be purchased. If a replacement home of equal value is not purchased, the unused cash proceeds must either be distributed back to the grantor (thus forfeiting the tax benefit), or the cash must be invested and the grantor will be paid an annuity for the balance of the QPRT term (thus reducing, though not necessarily entirely eliminating, the tax benefit), after which the remaining trust assets will be distributed to the children.
Tax Implications of the QPRT
A. The objective of the QPRT is to reduce estate taxes by removing the property from the grantor’s estate. If the grantor’s death occurs after the QPRT has ended, the grantor’s taxable estate for federal estate tax purposes will include only the value of the children’s future interest in the residence when the trust was created, and all appreciation in value after the date of the gift will have been removed from the grantor’s estate.
B. On the down side, if the grantor has survived the QPRT term, the residence will not receive a “step up” in its income tax cost basis to estate tax value because the residence will not have been taxed in the grantor’s estate. For this reason, the QPRT is best suited for a home likely to stay in the family until the children’s deaths, when the residence will get the desired step-up in basis. However, even if the property is later sold by the children, the capital gains tax (at least under current tax law) will be far less than the inheritance tax that otherwise would have been due had the QPRT not been created.
C. During the QPRT term, the grantor will be treated for income tax purposes as if he or she were still the owner of the property; ie., the grantor can deduct real estate taxes, take advantage of tax elections on the sale of the property, etc. If the property is sold by the QPRT, a capital gains tax will be due in the same amount as if the grantor still owned the property. Additionally, the grantor must pay the capital gains tax out of his or her own funds, which often produces a good estate tax result because payment of the tax reduces the grantor’s taxable estate.
D. If the grantor dies before the completion of the term of years specified in the QPRT, the trust will end and the property will be distributed to the grantor’s estate and be disposed of by the grantor’s Will. The tax advantages will be lost, but there will be no tax detriments – taxes will be calculated as though the QPRT had never been created.
COMMONLY ASKED QUESTIONS
Q: How Long Should The QPRT Last?
A: Generally, the QPRT should be planned to last as long as possible so as to make the value of the taxable gift to the children as small as possible – but not so long that the grantor dies before the QPRT ends, which would lose the tax benefit because the property would be included in the grantor’s taxable estate.
Q: Can I Still Use My Residence After the QPRT Ends And The Children Become the Legal Owners?
A: That is entirely up to the family. If the property continues to be the grantor’s residence, presumable an agreeable rental arrangement will be worked out.
Q: Can I Use a Vacation Home Or Condominum For My QPRT?
A: Yes. A QPRT can hold either your primary residence or one other residence that you occupy.
Q: May I Use My Spouse’s Unified Credit (Lifetime Exemption Of $675,000 in 2000 and 2001) To Shelter My QPRT Gift If The Value Of My Gift Exceeds My Own $675,000 in 2000 and 2001?
A: Yes. However, it is risky (and probably unwise) to do so, because if you die before the QPRT ends, your spouse’s exemption will have been wasted. This unfavorable result can be avoided by giving your spouse a one-half interest in the residence first, and then creating two QPRTs, one for each of you.
Q: What Happens If I Wish To Stop Using The Property In The QPRT As A Personal Residence?
A: There are two choices. The trust agreement can provide that the trust will end and the property is to be given back to you. This may be unattractive, for if the cash proceeds are distributed to you, the tax shelter ends. Alternatively, the trust agreement can provide that the property is to be sold and either (a) a new residence purchased for you, or (b) the cash can be invested and you will receive a cash annuity – for example, if the net proceeds are $1,000,000, you might receive $100,000 per year until the termination of the trust. This will continue the tax shelter.
Q: What Are The Costs Of Managing a QPRT?
A: Little or none. If the grantor or a family member or friend is the sole trustee, which commonly is the case, there are no Trustee’s fees. Usually no court costs or court supervision is involved. If the grantor is also the Trustee, the trust does not file tax returns. There are costs involved in establishing the trust, however, such as attorneys’ fees for preparing the trust agreement and deeds of transfer and accountants’ fees for preparing the gift tax return.
Q: Can My (Wife) (Husband) Have The Right To Live In Our Home After My Term Expires?
A: Yes. Taxes are not affected.
This memorandum is intended to convey to you the principal considerations of qualified personal residence trusts as they apply to common situations. For that reason I have deliberately simplified the technical aspects of the tax law in the interest of clear communication. Under no circumstances should you rely on the contents of this Memorandum for technical advice nor should you reach any decisions with respect to qualified personal residence trusts without further discussion and consultation with your legal counsel and tax advisors.
Courtesy of: Steven W. Tarta, Attorney at Law. 45 N. Broad Street Ridgewood, NJ 07450 PHONE 201-444-8448 E-MAIL: TARTALAW@ATT.NET Fax 201-612-0827Please be sure to check out www.tartalaw.com for estate planning learning center information.