In this article, we’ll define and explain the pros and cons of a Qualified Personal Residence Trust (QPRT), answering questions like, “What is a Qualified Personal Residence Trust?” and “What are the advantages of a QPRT?” and “Is a QPRT right for my property?”
A Qualified Personal Residence Trust, or QPRT, is a unique kind of estate-planning tool that allows a homeowner to transfer his or her own home to an irrevocable trust for the purpose of reducing the amount of gift tax incurred when transferring assets to a beneficiary, all while retaining the right to remain living on the property for a specified term of years. Once that term is over, any interest remaining is transferred to the beneficiaries as “remainder interest.” Depending on the length of the trust, the value of the property during the retained interest period is calculated based on Applicable Federal Rates that the Internal Revenue Service (IRS) provides. Because the other remains a fraction of the value, the gift value of the property is lower than its fair market value, thus lowering its incurred gift tax. This tax can also be lowered with a unified credit.
QPRTs give homeowners the option to transfer a house to beneficiaries at a reduced gift-tax cost or remove an asset expected to appreciate in value from an estate. These trusts are less popular today, due to the updated high estate- and gift-tax exemptions. A QPRT is also useful when the trust expires prior to the death of the grantor. If the grantor dies before the term, the property is included in the estate and is subject to tax. Determining the length of the trust agreement can be risky, depending on the likelihood that the grantor will pass away before the expiration date. Creating a QPRT and transferring ownership of your residence into that trust is a very complex process that cannot easily be reversed. It’s important for everyone to seriously consider the pros and cons of incorporating a QPRT into your estate tax plan.
QPRTs are not typically used when preparing for GST taxes, because the GST tax exemption isn’t effective until the end of the initial QPRT term. During the period when the residence is included in the grantor’s estate if he or she died, the property has to be appraised at fair market value on the termination date of the QPRT and a U.S. Gift Tax Return (Form 709) has to be filed for the year the QPRT ends.
Yes. Each taxpayer can have up to two QPRTs, and each trust can only hold an interest in one home. Therefore, if you wanted to transfer both your principal residence and vacation home to a QPRT, you would have to create two separate trusts.
Yes. It’s fairly complicated, but it is possible.
As long as the land is reasonably appropriate for the residence, the IRS will consider your residence to include land adjacent
to the home. The location, use, and size of the home will be considered when determining how much of the surrounding land can be transferred with the home to the QPRT.
Every taxpayer’s situation is different, but the longer you retain the right to occupy the home, the smaller the value of the remainder interest transferred will be. As a general rule of thumb, you shouldn’t retain the right to the home for longer than your life expectancy, because if you die during the retained income period, the residence will be returned to your estate for tax purposes.
If the grantor dies during the retained income period, the residence will be returned to his or her estate for tax purposes. The home would’ve been included in his or her estate, had they not made the transfer, so there’s really progress to the transfer if the grantor dies during the trust term.
Once the QPRT term is over, the grantor is no longer the owner of the residence, meaning he or she loses control of the property. The value of the subsequent gift is determined by subtracting the value of the “retained interest” from the fair market value of the residence.
Although a grantor loses control of the property after the end of the trust term, he or she can still sign a lease with the remainder parties to occupy the residence and pay rent. The lease has to be for fair market rent, and if the grantor is paying rent to his or her own children, the rent will be another way of transferring funds out of the estate to them. The IRS won’t be crazy about this arrangement, and the rent is taxable income to the grantor’s children.
Beneficiaries of the QPRT may not understand how to manage property or want to take on such a large responsibility. Prior to the termination, beneficiaries should determine who is responsible for paying the bills for the residence, continuing homeowners insurance on the property, renovating or updating the property, collecting any rental incomes, and arranging the sale of the property if it is to be sold. A checking account should be opened for the new owner(s). Beneficiaries should also review the trust document for the QPRT to determine what happens to the property at the QPRT’s termination.
Yes. If you would like to sell the home transferred to the QPRT trust in order to purchase a different home, you have to reinvest the proceeds to another home that will be owned by the trust and subject to the same trust provisions. The trust specifically prohibits the sale or transfer of the home from the trustee to another individual both during the term of the trust and after. If there’s no desire to replace the property, the sale proceeds have to be converted into a qualified annuity interest within 30 days after the sale, with payments going back to the grantor or distributed outright.
No. The grantor may not repurchase the residence at the end of the QPRT’s initial term. Regulations also prohibit the grantor, the grantor’s spouse, and any other entity benefiting the grantor or grantor’s spouse from repurchasing the residence both during the trust term and after.
Anyone can be a trustee; if you are trying to select a trustee, make sure it’s a reliable person you’ve known for most of your life that understands your goals and financial plan. As with any trust, the document should provide for a successor trustee if you become incapacitated.
Yes. Because the trust is a grantor trust, you are entitled to deduct the same expenses as when you owned the home.
A QPRT is a serious document that should be carefully drafted by a qualified attorney to ensure all of the requirements under the Internal Revenue Code are being met. It’s helpful to contact a qualified local estate planning attorney who can answer your questions and walk you through the legal process of creating a QPRT.
In addition to a QPRT, two other different types of trusts are bare trusts and charitable remainder trusts. A bare trust gives the beneficiary the absolute right to the trust’s assets (both financial and non-financial, including real estate and collectibles), as well as income generated from these assets (rental income from properties or bond interest). A charitable remainder trust allows the donor to provide an income interest to a non-charitable beneficiary, while the remainder of the trust goes to a charitable organization. In both instances, the donor receives an income tax deduction from the present value of the remainder interest.
In conclusion, a QPRT is a popular estate planning technique that can freeze the value of the taxpayer’s residence at the time he or she creates the trust, resulting in significant estate tax savings for his or her heirs. The higher the federal rate, the lower the gift value, and the lower the potential gift tax. During the trust term, the grantor can claim an income tax deduction for any real estate taxes he or she pays. The grantor has a predetermined limit on the right to occupy the residence, and he or she has to relinquish ownership at the expiration of the QPRT term.
The decision to create a Qualified Personal Residence Trust includes balancing the potential estate tax savings, based in part on current interest rates, against the consequences of relinquishing ownership to the next generation. Before you commit to a trust, consider all of the potential tax and nontax consequences for your particular situation.