10.8.12

“Qualified Personal Residence Trusts (QPRTs)” by Debbie Peetrone, CPA, MTax, CGMA | Senior Manager – Tax

Qualified personal residence trusts are an estate planning technique used to remove a portion of the value of an individual’s personal residence from their taxable estate for federal estate tax and gift tax purposes. They are appropriate for transferring a residence that is likely to appreciate. The owner of the personal residence transfers her ownership to an irrevocable grantor-type trust for the benefit of the remainder beneficiaries (the children) while retaining the right to use and occupy the residence for a term of years. It is very important to choose a reasonable term of years based on the life expectancy of the grantor. If the grantor is not alive at the end of the term of years, the value of the residence will be pulled back into the estate defeating the whole purpose of the QPRT. The QPRT is considered a “split-interest” type trust. A split-interest trust has a current use period and a remainder use period.

A formal appraisal should be obtained to substantiate the value of the residence on the date of the transfer to the trust. The grantor (Mom) makes a taxable gift to the trust. That gift’s value is the fair market value of the transferred residence reduced by any interests retained by the grantor. Because the gift is a gift of a “future interest” it will not qualify for the $13,000 annual exclusion. The value of the gift is determined by using the Internal Revenue Service actuarial tables. In years 2011 and 2012, gifts not subject to the annual exclusion can be transferred to remainder beneficiaries subject to the current unified exemption of $5,000,000 per person. As of January 1, 2013, that exemption falls to $1,000,000 per person.

The QPRT governing document must provide all of the following requirements:

  • The trust must be prohibited from holding any asset other than:
    • One personal residence of the grantor–either the personal residence or a vacation home.
    • Qualified proceeds, such as insurance, or other amounts payable as a result of damage or involuntary conversion of the residence.
  • Any income of the trust must be distributed to the term holder at least annually.
  • Distributions of principal to anyone other than the transferor during the period of any term interest is prohibited.
  • The trust must prohibit the prepayment of the grantor’s interest.
  • The trust can hold cash, but not in excess of what is needed for improvements and expenses (such as mortgage payments or real estate taxes).
  • The residence cannot be occupied by any person other that the spouse or dependent of the term holder.
  • The trust must prohibit the sale or transfer of the residence to the grantor during the trust term.

When the trust term expires, title to the residence passes to the remainder beneficiaries (the children). If the grantor wants to remain living in the residence after the end of the trust term, she must lease the residence from those remainder beneficiaries at a fair rental value. The beneficiaries will report the income and expenses including depreciation. Because the QPRT acquired the property by gift, the trust’s basis will be the grantor’s carryover basis.

EXAMPLE

Mom wants to maximize the amount of inheritance to her children, but is concerned about losing control while she is living.

Mom transfers her personal residence appraised at $800,000 to a QPRT in 2012.

She chooses a term of 10 years to occupy and live in the residence based on her life expectancy.

Even though the value of the residence is $800,000, the gift is much less because Mom has retained the right occupy the residence. The actual amount of the gift is based on IRS tables.

Because she has not used up her $5,000,000 lifetime exemption, the gift of the residence is not taxable although a gift tax return must be filed. It is not subject to the annual exclusion.

If Mom survives the 10 year term of the QPRT, the residence will pass to the children with no further estate tax. If the property appreciates, Mom will have transferred the appreciated asset with no tax.

If Mom wishes to remain in the residence after the 10-year term, she must pay fair value rent to her children.

If Mom does not survive the 10-year term of the QPRT, the residence will be pulled back into her estate and may be subject to federal estate taxes in effect at her date of death.