Qualified personal residence trust

In the 1990s and early 2000s when interest rates were higher relative to today, a popular estate planning technique was a Qualified Personal Residence Trust (QPRT). Experienced Southern Florida estate attorney Michael Gross discusses below.

What is a Qualified Personal Residence Trust?

A QPRT is an irrevocable trust to which you, as the grantor, may transfer your principal residence, and retain the ability to use the residence for a certain term of years.  For this purpose, a principal residence is defined as either: (1) the principal residence; or (2) one other residence such as a vacation home; or (3) undivided fractional interest in either of the foregoing. Thus, the regulations limit a grantor to creating only two personal residence trusts and, if two such trusts are created, one must consist of the grantor's principal residence.

During that term of years, you would continue to pay the expenses of the residence (e.g., insurance, and property taxes), and receive any available income tax deductions with respect to those payments.  At the end of the selected term, the residence would pass by gift in a manner you would provide in the trust instrument.

After the initial term of the trust has expired, you would no longer have the retained right to reside in the residence, and the residence may pass in trust for the benefit of your spouse if you are married.  The trust for your spouse would provide the right to live in the residence for the remainder of his or her life. Upon the death of your spouse, the home will pass to the remainder beneficiaries as designated in the trust instrument.  However, you may rent the property from the beneficiaries at fair market value. A benefit of these rental payments is that they would further reduce your gross estate without adverse estate or gift tax consequences, although the rent may be taxable income to the trust.
The advantage of a QPRT is that, for gift tax purposes, you can deduct from the value of the gift the value of your retained use of the residence for the chosen term of years.  This will substantially reduce the amount of the gift relative to the property’s fair market value.

The taxable value of the gift will be based on the term of the trust, your age, and the interest rate (set by the IRS) in effect for the month of the transfer.  As interest rates continue to rise, the QPRT again becomes an attractive estate planning vehicle. For example, the applicable federal rate in June 2017 was 2.4%. The taxable gift for a 10-year QPRT created by a 65-year-old individual gifting a $2,000,000 residence was $1,238,800. The rate in June 2018 is 3.4% and the taxable gift under the same circumstances is $1,124,080; a difference of $114,720.

Potential Disadvantages of a Qualified Personal Residence Trust

There are, however, some disadvantages to a QPRT.  Typically assets transferred on the death of an individual are entitled to a "step-up" in basis to the asset's fair market value on the date of death.  The effect of this basis step-up is to eliminate any taxable gain on the property, thereby resulting in substantial income tax savings. This "step-up" is lost if your residence is transferred to a QPRT and you survive the initial retained term. However, if you die during the trust term, the transaction is treated for estate tax purposes as if it had never occurred, thereby removing the potential benefit. In that case, the costs of the transaction would be the cost of setting up the trust and any trust administrative expenses.

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