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?”
What is a Qualified Personal Residence Trust?
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.
Advantages of QPRTs
- It removes the value of your primary or secondary residence, including all future appreciation, from your taxable estate at cents on the dollar. For example, if your home is worth $500,000, you could use as little as $100,000 of your lifetime gift tax exemption to remove a $500,000 asset from your taxable estate. This is great news, considering the value of your home could increase significantly, say $800,000, by the time you die.
- It allows continued use of the residence and tax benefits. During the retained income period of the QPRT, the homeowner can continue living in the residence rent-free and take all applicable income tax deductions.
- It protects against possible decreases in lifetime gift tax exemption and estate tax exemption. If your home is worth a lot of money, then the current lifetime gift tax exemption of $5,340,000 allows you to establish a QPRT without having to pay any gift taxes. If the future estate tax exemption significantly decreases, you will have locked in the value of your residence for gift and estate tax purposes, and you don’t have to worry about how much the house will be valued for or what the estate tax exemption will be the year of your death.
- It helps you create a legacy for your family. If you want your home to stay in your family for generations to come, a QPRT allows you to pass your residence to your heirs in a manner that encourages them to hold onto it for the long haul.
Disadvantages of QPRTs
- Selling a home owned by a QPRT can be challenging. If circumstances change and you need to sell the residence that was originally transferred to the QPRT, you have to invest the sale proceeds into a new home, or you have to accept payments of the sale proceeds in the form of an annuity.
- Beneficiaries inherit the residence with your income tax basis at the time of the estate transfer to the QPRT. QPRT is only ideal for a residence the heirs plan to keep in the family for several decades, because an heir who sells the home after the retained income period ends will have to pay capital gains taxes based on the difference between the donor’s income tax basis at the time of the transfer to the QPRT and the price of the sale.
- Once the retained income period is over, you’ll have to pay rent to use the residence. If you do not pass before the retained income period ends, your ownership still moves to your heirs, removing your right to occupy the residence rent-free. To continue living at the residence after the retained income term, you’ll have to pay your heirs fair market rent.
- Similarly, once the retained income period is over, you will lose property tax benefits. Once the retained income period ends, you can lose any property tax benefits associating with owning and occupying the property as your primary residence.
- If you die before the retained income period ends, the QPRT transaction will be completely reversed. The entire QPRT transaction will be undone, and the value of your residence will be included in your taxable estate at its full fair market value on the date of your death.
Frequently Asked Questions Regarding QPRTs
Do Generation-Skipping Transfer (GST) taxes apply to QPRTs?
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.
Can a homeowner put both his principal residence and vacation home in a QPRT?
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.
Can spouses transfer their residence they own as joint tenants to a QPRT?
Yes. It’s fairly complicated, but it is possible.
Can a residence and a large parcel of land be transferred to a QPRT together?
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.
What’s a standard term to retain the right to occupy the residence transferred 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.
What happens if the grantor dies while living in the home?
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.
What happens at the end of the QPRT 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.
If a grantor still wants to live in his or her home after the end of the trust term, what are the viable options?
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.
What are beneficiaries responsible for?
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.
Can the transferred residence to the QPRT be sold?
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.
Can the grantor buy the transferred residence back?
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.
Who can be a trustee?
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.
Can a grantor claim the real estate taxes and other deductible expenses as deductions on his or her income tax return?
Yes. Because the trust is a grantor trust, you are entitled to deduct the same expenses as when you owned the home.
Do I need professional legal help when creating a QPRT?
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.
Other Forms of Trusts
In addition to a QPRT, two other different types of trusts are Other types of irrevocable trusts and charitable remainder trusts. 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 and talk to Attorney Gregory R. Beyer to