A Qualified Personal Residence Trust takes advantage of certain provisions of federal law that allow you to make a gift to the trust of your personal residence, for the ultimate benefit of the remainder beneficiaries at a discounted value.
Assume that the remainder beneficiaries are your children – the most common situation for most QPRT planning. Either your principal residence or a vacation home can be transferred into a QPRT. This removes the asset from your estate, reducing potential estate taxes at your death.
For gift tax purposes, the original transfer will be treated as a gift to the children, but not a gift of the current fair market value. Instead, it’s a gift of the value of your children’s future right to the residence at the end of the QPRT term (called the “remainder interest”). You must file a gift tax return at the time the residence is transferred to the trust.
The value of the remainder interest is derived by first determining the fair market value of the entire property, and then subtracting the value of the right you retain to live in the residence (your “retained interest”). In general, the longer the term of the trust, the longer you get to live in the property and the larger the value of your retained interest. As the value of your retained interest increases, the value of your children’s remainder interest decreases. This results in a smaller taxable gift by you.
If you haven’t previously used your lifetime federal gift tax exemption amount, the amount of gift tax due may be offset by that amount, thus possibly eliminating the need to pay any gift tax on the transfer of the residence to the QPRT. Of course, if the residence is appreciating quickly, the potential savings can be even greater in a shorter period of time.
If you live to the end of the specified period, the residence, including all post-gift appreciation, passes to the children free of any additional federal estate or gift taxes.
However, one disadvantage is that if you die before the end of the period, the value of the residence, as of the date of death, will still be includible in your estate for federal estate tax purposes. The result in that case is the same as if you had never created the QPRT. Therefore, for maximum benefit and results, you need to outlive the term of the trust.
A second disadvantage of the QPRT is that if the house continues to be a part of the trust after the initial term ends, it will pass to the remainder beneficiaries with your original income tax basis.
If you have any questions, please feel free to contact our office.