Qualified Personal Residence Trusts
An increasingly popular estate planning tool, the Qualified Personal Residence Trust (“QPRT”), sometimes referred to as a Grantor Retained Income Trust (“GRIT”), is an effective planning technique to reduce the size of your taxable estate. Establishing a QPRT allows you to transfer one or more personal residences out of your estate at a drastically reduced gift tax cost. In addition, you freeze the value of the residence, resulting in dramatic estate tax savings as well.
WHAT IS A QPRT?
Essentially, a QPRT (pronounced “kupert”) is a trust designated to hold title to your residence for a specified term that you select, generally five years to twenty years. When the trust terminates, the residence is transferred to the remainder beneficiaries, usually family members or a charity. During the trust term, you enjoy the rent-free use of the residence without any unfavorable tax consequences to you.
HOW GIFT TAX IS SAVED
When you transfer a personal residence into a QPRT, the tax code treats you as having made a gift to the beneficiaries who will receive the home once your retained right to live in the home ends. The value of the gift is not the current fair market value of the transferred residence. Rather, the value of the gift is the current fair market value of the home less the present value of your right to live in the home for the term of years you selected. Consequently, for gift tax purposes, the value of the gift will be much less than the current value of the home, resulting in substantial gift tax savings to you.
For example, if a personal residence currently valued at $1 million were gifted into a QPRT, the value of that gift would only be $213,857, based on certain factors. This represents the current fair market value of the home minus the value of your right to live in the home for 15 years. Thus, you would exclude $786,143 ($1,000,000 – $213,857) from the value of the gift made, and thereby reap gift tax savings of up to $353,764 ($786,143 * 45% tax rate).
Not only do you save gift taxes by using a QPRT, if drafted properly, you may elect to pay all income and/or capital gains taxes on the trust property. If the home were sold following the initial term of the trust, you may choose to pay all capital gains taxes from your estate. By so doing, you would effectively be making another tax-free gift to your beneficiaries. Following such a sale, if the proceeds were invested and held in the QPRT, all interest, dividends and capital gains arising from such investments would be taxable to you. While it is true that you may have the trust drafted to cause income taxes to flow through to your beneficiaries, the maximum estate planning benefits come from shifting the tax burden to you.
DO I ALSO SAVE ESTATE TAXES?
Yes. You may realize a generous estate tax reduction in addition to the gift tax savings you enjoyed. This happens because all future appreciation in the home is removed from your estate. To illustrate, in the example above involving the transfer of the $1 million home into a QPRT, assume that, during the 15-year QPRT term, the home appreciated to $2,079,000 (using an annual growth rate of 5%). If you were to die at the end of the trust term, the value included in your estate, for death tax purposes, would only be $213,857, not the full appreciated amount. Consequently, you will have succeeded in not only removing the initially excluded value from your estate, but also in removing all subsequent appreciation. This translates into an estate tax savings of up to $1,143,450, if Congress fails to make the elimination of the estate tax permanent and the tax rate returns to 55%.
HOW DO I QUALIFY FOR A QPRT?
Particular attention must be paid when creating the QPRT, in order that the retained interest be a “qualified” interest. Otherwise, a substantial part of the tax savings will be lost. As presently enacted, the law allows a married couple to transfer up to three residences via the QPRT. Transfer of three residences can be accomplished in a series of steps. First, each spouse must own one residence as separate property. Next, each of those residences is transferred into separately established QPRTs. Then a jointly-owned third residence is transferred into a third QPRT. As discussed above, the dramatic estate tax savings may even warrant the purchase of a third residence to take maximum advantage of this unique planning tool.
To qualify for a QPRT, you must use the residence for personal purposes for a number of days which exceeds the greater of (1) 14 days, or (2) ten percent of the number of days during the year for which the unit is rented at fair rental value. Such a residence may include a house, apartment, condominium, mobile home, or boat, as well as all structures appurtenant to the dwelling. Thus, if you were to purchase a resort area condominium unit, and rent it out for 150 days of the year, you could still qualify it as a personal residence if you used it for 16 days during the year.
WHAT HAPPENS WHEN THE QPRT TERMINATES?
A QPRT terminates at the end of the specified term. Thereafter, you may continue to reside in the home. However, if you choose to do so, you must pay a fair rental value to the remainder beneficiaries for the use of the home. If the home has experienced significant appreciation, an excellent option for you to consider would be to repurchase the home either during the trust term or following its termination. When the trust agreement is properly drafted, repurchasing an appreciated home would yield even further tax benefits.
As discussed above, the QPRT is an outstanding estate planning tool when used under the right circumstance. It allows you to optimize the value of your home from both a gift tax and estate tax standpoint, while you retain the use and enjoyment of your home for many years.