Qualified Personal Residence Trust

by Scott Golightly

Many people have quite a bit of money tied up in their personal home and/or a vacation home.  Despite current market conditions, real estate has a long history of appreciating in value over time.  A Qualified Personal Residence Trust (QPRT) may allow you to transfer your home and one vacation home to the next generation at a nice discount while at the same time saving big money in estate taxes.  With today’s low real estate values, now may be a great time to set up a QPRT.  Interested?  Read more to unveil the mystery behind the QPRT – a really good planning tool that is underused and often misunderstood.

First off, a QPRT involves both trust and tax planning, so the underlying mechanisms can be complex.  Discuss this planning with a CPA and an experienced estate planner.  You will need their help to set up a QPRT, but the tax savings will most likely far outweigh having to put up with (and pay) these professionals.

So, how does a QPRT work?  In very basic terms, a QPRT involves transferring your primary residence and/or one vacation home into an irrevocable trust.  In the trust, you choose the beneficiaries (usually children) who will become the owners of the home after a predetermined term of years (let’s say 10 years).  You continue to live in the home as you always have rent-free until the end of the 10-year term.  After the 10-year term, your children become the legal owners of the home.  If you want to stay in the home after the term, you simply rent the home from your children at market rent.

Now, why go through all of this, and why in the world would I want to pay my children rent?  What’s the benefit?  Well, there are two main benefits to this transaction– one involves a discount and the other involves saving on estate taxes.  Let’s discuss them one at a time.

Discount.  When you created the trust, you “retained” the right to live in the home rent-free for a period of years (10 years in our example).  So, your children have to wait out the term before they become the legal owners.  In other words, your retained interest means that the children are getting less than they would have if you just gave them the home outright.  Because of this, the IRS allows you to discount the gift.  The lawyer and CPA will calculate the amount of the discount, but this discount can be significant.  Basically, the longer the QPRT term, the bigger the discount.  For some hard numbers, we set up a QPRT for a client in 2010.  The home was valued at $750,000.  We used a 10-year QPRT term, and we were able to claim a discount on our gift tax return (Form 709) of about $300,000.  Now, instead of making a $750,000 gift, we made a $450,000 gift, which used less of the client’s lifetime gift exclusion.  Because of the current generous gift exclusion (currently $5,000,000), we did not pay any gift tax at time of transfer, nor will we ever pay a gift tax based on this transaction.  (See my “Estate Tax Alert” blog for a discussion of the gift exclusion.)  Discounts are good.

Saving on Estate Taxes.  At the end of the 10-year term, your children are the new owners of the home.  So, the value of the home – including any and all appreciation in the home’s value since you created the QPRT – are excluded from your estate for tax purposes.  In 2013, estate taxes of 55% are scheduled to hit all Americans with a gross estate of more than $1,000,000.  (See (again) my “Estate Tax Alert” blog.)   So, the more we can exclude from your gross estate, the better.  Also, with real estate prices depressed, the amount of the gift will likely be less than it would have been back in 2008, which means you get both a gift tax discount based on your retained rights and a market discount.  Nice.

If you would like to discuss whether a QPRT might make sense, please contact me or your personal estate lawyer and work through the numbers.  Good planning often requires that you take the initiative.  Is there any other time than now to do good tax planning?  Thanks for reading!