Qualified Personal Residence Trust
- How does it work?
- What are the key benefits of a QPRT?
- If I have a second home, can I use the QPRT for both homes?
- Is a gift tax return required when a gift is made to a QPRT?
- Are there any other tax benefits offered by a QPRT?
- What If I Die During the QPRT's Term?
- Does my age and the QPRT term affect the tax consequences of the QPRT?
- What if I outlive the QPRT's term and want to continue living in the residence?
- Can the residence be sold while it is in the QPRT?
- Will my children receive the residence with step up in basis at the End of the QPRT Term?
- Do any income tax returns have to be filed in connection with a QPRT?
Qualified Personal Residence Trusts: Overview
In 1990, the U.S. Congress passed legislation that opened an unusually generous opportunity for people who want strong asset protection for their homes and also wish to minimize the impact of estate taxes on children or other heirs by making a pre-death gift of their residences. Called the Qualified Personal Residence Trust (QPRT), this estate-planning tool is an excellent means for individuals with large estates to transfer assets at the lowest possible values.
With this strategy you essentially can have your cake and eat it too. You are able to ‘give’ away your home in order to reap significant tax benefits. At the same time you get to continue to live in the property and you or you and your spouse can be the trustees of the trust. As such, you have full power to buy, sell, or refinance the property. The interest deduction is reported directly on your tax return, and all of the other advantages of home ownership are preserved.
How does it work?
The mechanics of establishing a QPRT are comparatively simple. The residence is transferred to a trust that names the persons who are to receive the residence at the end of the stated term, usually a child or children of the donor. The donor is the trustee and maintains control of the trust and the residence during the selected term. The donor is still considered the owner for income tax purposes. The donor continues to make mortgage payments, if any, and pays for property taxes, insurance and routine maintenance. As a result the donor gets to take the income tax deductions related to the property. He or she also receives the tax benefits associated with the sale of a principal residence.
What are the key benefits of a QPRT?
There are several tax, economic and asset protection benefits associated with a QPRT.
Leveraging a person's estate and gift tax credit.
A transfer of property to a QPRT is currently treated as a taxable gift. The value of the gift is based on the present value of the remainder beneficiary's right to receive the property at the end of the QPRT term.
For example, without this exception, a gift of a residence worth $1,000,000 and subject to the right of the donor to live in the residence for 15 years (or any other term) would be valued at $1,000,000 for gift tax purposes. However, with the passage of this law, the same $1,000,000 gift of the residence made in January 2008 would be valued at only $310,380 for gift tax purposes. Because the estate tax rate can approach or even surpass 50%, this would obviously result in significant estate tax savings. You would have effectively transferred an asset worth $1,000,000 to your children by using only $310,380 of your estate and gift tax credit (your gift credit is currently valued at $5,000,000 as of January 2011, and your estate tax credit is $5,000,000 as of that date).
Protects the home from potential creditors
Because a QPRT is an irrevocable trust and the residence would no longer belong to the donor, the donor's creditors would not be able to execute a judgment lien on the residence. Thus, a QPRT provides excellent asset protection benefits.
If I have a second home, can I use the QPRT for both homes?
Yes. You can use the same QPRT to gift your primary and secondary residence.
Is a gift tax return required when a gift is made to a QPRT?
Yes. A Federal Gift Tax Return Form 709 must be filed in the year in which the gift to the QPRT is made. Based on the foregoing example, you would be required to prepare and file a Federal Gift Tax Return to report the gift, which would consume $310,380 of your estate and gift tax credit. Assuming you had not made prior gifts that had consumed the rest of your gift tax credit, no gift tax would be due.
Are there any other tax benefits offered by a QPRT?
Another tax and economic benefit is that all of the future appreciation of the residence will be transferred to the children estate and gift tax-free. A QPRT, as a result, is a powerful tool for freezing the value of your estate. Based on the prior example, assuming that the $1,000,000 residence appreciates at 4% per year for the 12-year term, the residence would be valued at $1,800,944 15 years from now. All of the appreciation during the 15-year term would inure to the benefit of your children. Thus, by making a gift valued for estate and gift tax purposes at $310,380, you would effectively transfer an asset worth $1,800,944. Assuming your estate is in the maximum 50% federal estate tax bracket, this would save you $745,282 in federal estate taxes!
What If I Die During the QPRT's Term?
If you die during the term of the QPRT, the residence would be included in your estate at its full fair market value at the time of year death. Although the asset protection benefits would have been realized, the tax and economic benefits of the QPRT would be lost. However, you would be no worse off than if you had not created the QPRT, other than transactional costs in establishing the QPRT. Also, the gift tax credits used initially or any gift taxes actually paid would be restored for use in transferring your estate to your heirs.
Does my age and the QPRT term affect the tax consequences of the QPRT?
The term of the QPRT is an important factor in determining the tax savings freezing of future appreciation of a QPRT. The longer the QPRT term, the greater your tax savings and the more future appreciation you can freeze at current value. Remember that if you do not survive the term of years you establish when setting up the QPRT, the entire value of your residence will be pulled back into your taxable estate. Therefore you should at your life expectancy based on your health, family history and actuarial tables, and select a term of years that is two-thirds to three-quarters your life expectancy. Often this strategy will be combined with an Irrevocable Life Insurance using Term Life insurance for the same term of years. In this way, even if you do not survive the term, the life insurance purchased with cheap dollars will be available to pay the estate tax and eliminate any need to sell the residence to pay the taxes
What if I outlive the QPRT's term and want to continue living in the residence?
If you outlive the QPRT term, the residence would pass to the remainder beneficiaries. They would own the property. You could, however, lease the property back from the remainder beneficiaries at a fair market value rent. The obligation to rent your residence back from your children is viewed by some as a negative QPRT feature. However, many people view it as an opportunity to transfer additional assets, via rent payments, to their children. Renting will also transfer funds from the donor’s taxable estate, because the rents are not subject to gift tax
Can the residence be sold while it is in the QPRT?
Yes. The residence can be sold and the proceeds can be reinvested in a new residence. Because a QPRT is a grantor trust, any gain recognized on the sale of a principal residence should qualify for the $250,000/$500,000 exclusion of gain from the sale of a principal residence, provided all of the other applicable tax code requirements are met. The exclusion of gain does not apply to the sale of a personal residence that is not a principal residence, such as a vacation home.
If the proceeds of sale are not reinvested in a personal residence, the QPRT will convert to a Grantor Retained Annuity Trust or “GRAT” and will pay an annuity to the donor for the balance of the QPRT term.
Will my children receive the residence with step up in basis at the End of the QPRT Term?
No. Gifts made during lifetime are subject to a carryover basis. Thus, the basis of the residence when your children receive the residence would be your original purchase price plus the amount of any capital improvements you made while owning the property. This could result in ordinary or capital gains tax if the children sell the home, however, they would benefit by limiting their tax, for example to the 15% capital gains rate, as opposed to paying the 50% estate tax rate.
Do any income tax returns have to be filed in connection with a QPRT?
A QPRT is typically considered a Grantor Trust for income tax purposes. Most QPRTs do not generate any income and an income tax return is not typically required. If the property generates income, a Grantor Trust Tax Return, Form 1041, may be required.