Qualified Personal Residence Trust Planning

Content and Structure:

Qualified Personal Residence Trusts (QPRTs) are an estate planning strategy used to remove the value of your personal residence out of your taxable estate while better leveraging the use of your estate and gift tax exclusion amount. QPRTs are a preferred estate planning strategy because they are relatively straight forward to establish and administer, require little sacrifice on the donor’s behalf, and the IRS has published detailed regulations as to guide the formation and administration of the trust. QPRTs are irrevocable trusts created to hold your primary or secondary residence(s). Once created, the trust is funded by transferring the ownership interest of your residence, or an undivided interest therein, to the trust. Although you no longer hold legal title to the residence, the trust agreement provides you the right to live in the residence rent-free for a specified term of years.

Primary Benefits:

• Estate and Gift Tax Leverage – Noteworthy estate and gift tax benefits are achievable by transferring your primary or secondary residence(s) into a QPRT. The transfer into the trust is a taxable gift that will use up a part of your remaining estate and gift tax exclusion amount. However, because the gift is of a future interest, the value of the gift to the trust is reduced for estate and gift tax purposes to reflect two variables: (1) your right to remain in the residence during the specified term of years, and (2) the possibility that you will pass away during the trust term and the property reverting to your estate. The valuation of your retained interest (the discount for gift and estate tax purposes) is calculated by using length of the retained interest term provided for in the trust and the applicable 7520 interest rate. Therefore, the longer the retained interest term and the higher the 7520 interest rate, the greater the estate and gift tax benefit.
• Undivided Interest Discounts – The value of the gift to the QPRT can be further reduced by transferring undivided interests in the residence(s) to separate QPRTs. For example, one spouse can transfer 50% to his/her QPRT and the other spouse can transfer 50% to his/her QPRT. Such transfers result in fractional interest discounts for lack of marketability and lack of control because neither interest has control over the property and the marketability of the interest is less because a potential buyer would have to own the property with another owner.
• Continued Use of Residence – Unlike a traditional gift that requires delivery and relinquishment of the asset, QPRTs provide you and your spouse with the right to continue to live in the residence rent-free during the retained interest term. Since you, as the grantor of the QPRT, continue to pay operating expenses, you remain eligible to claim all appropriate income tax deductions on your tax return (i.e., real estate tax deduction). If the residence is sold, then a replacement residence can be purchased in the QPRT and the same trust terms will continue to apply to the new residence.

Important Considerations:

• Tax Basis – Since your beneficiaries will receive the residence via gift, they will receive a carryover basis in the property equal to the basis you hold in the property (i.e., the amount you paid for the residence and the cost of any improvements). For highly appreciated assets, this means your beneficiaries could pay a large amount of capital gains tax upon the sale of the property. However, depending on your current assets, this could be a more favorable option since the estate and gift tax rate (40%) is currently higher than the long-term capital gains tax rate (15% or 20%).
• Expiration of QPRT Period – Once the retained interest term expires, so does your right to the rent-free occupancy of the residence. Nonetheless, you will still be able to occupy the residence, but to do so, you must pay a fair market rent for such occupancy. Generally, QPRTs are established to maintain the property in trust after the retained interest term expires. As such, rent would be paid to the trust and the trust would be responsible to pay expenses relating to the property (e.g., taxes, insurance and improvements). Any amount of the rent in excess of the expenses would remain in the trust for later distributions to the beneficiaries.
• Premature Death – To receive the tax benefits of a QPRT, you must survive the retained interest term designated in the trust agreement. If you pass away before the end of the retained interest term, the value of the property held in the QPRT will revert to your estate and will be included in your taxable estate for estate and gift tax purposes. As such, although longer retained interest terms reduce the amount of the gift, such benefit must be balanced with the potential of not surviving the retained interest term.
• Low Interest Rate Environments – Since the value of the remainder interest gift takes into account the applicable 7520 interest rate, the interest rate environment can have a significant impact on the effectiveness of the QPRT strategy. The lower the 7520 interest rate, the less effective QPRTs will be in leveraging the estate and gift tax exclusion amount. However, depending on other market and family considerations, QPRTs may still be a beneficial estate and wealth transfer tool, even during a low interest rate environment.

If prudently structured and implemented, QPRTs are valuable tools in estate and wealth transfer planning. If you are interested in learning whether a QPRT is right for your family’s current needs, please contact a member of our wealth transfer firm for further discussion.