Qualified Personal Residence Trust
1. What is a Qualified Personal Residence Trust?
A Qualified Personal Residence Trust (“QPRT”) is created when a personal residence is transferred to an irrevocable trust, but the grantor retains the right to live in the home for a fixed term of years. At the end of the term, the home will pass to the trust beneficiaries, usually the grantor’s children.
After the home passes to the trust beneficiaries, the home is fully excluded from the grantor’s estate for estate tax purposes. Thus, any further appreciation of the home is also excluded.
2. What are the tax consequences of establishing a Qualified Personal Residence Trust?
When establishing a QPRT, the home must be appraised in order to determine the present value of the remainder interest. This value is equal to the projected value of the residence when the term expires less the value of the retained right to live in the home for a term of years. It is reported as a taxable gift by the grantor. The amount of the gift is calculated by using a special interest rate issued monthly by the IRS called the Section 7520 rate. The gift amount will be smaller when the annuity term is longer or the Section 7520 rate is higher.
After the term of years has expired, the grantor no longer has any ownership interest in the home. Thus, its value is fully excluded from the grantor’s estate for estate tax purposes.
However, if the grantor dies before the fixed term of years has expired, then the full value of the home is brought back into the grantor’s estate. The QPRT will only provide its intended benefit if the grantor survives the duration of the term.
A potential tax disadvantage is loss of the step-up in basis for income tax purposes. Since the home will already be owned by the beneficiary, it does not qualify for a step-up in basis when the grantor dies.
3. How does a Qualified Personal Residence Trust work?
For example, assume Parent transfers a home valued at $800,000 into a Qualified Personal Residence Trust and retains a right to live in the home for 10 years. The present value of the remainder interest would be calculated using the Section 7520 rate (e.g., $530,168). The parent would report a $530,168 taxable gift to the IRS. Assuming Parent lives for at least 10 years, the entire value of the home – perhaps now worth $1,250,000 – is excluded from Parent’s estate for estate tax purposes. Effectively, the “cost” of transferring the $1,250,000 home was only $530,168.
After the 10 year term expires, Parent should continue to pay rent to the children. Failure to do so jeopardizes the entire plan because the IRS could treat the transaction as if the trust never existed. The good news is that each rent payment is essentially a tax-free gift as it reduces the size of Parent’s taxable estate. The bad news is that each rent payment is treated as income to the children.
4. What are other benefits of the Qualified Personal Residence Trust?
By transferring a home into a QPRT, the grantor acquires peace of mind knowing that the home will definitely be distributed to the intended beneficiary. This is especially important in second marriages when, perhaps, the grantor wants the home to be distributed ultimately to the grantor’s child, not the spouse’s family.
There is a strong argument that a home is protected from the grantor’s creditors while owned by a QPRT. This may be true, but in most states a creditor could attach the grantor’s right to use the home for the remainder of the term of years. After the term of years has expired, then the home is fully protected from creditors of the grantor.
5. What are the disadvantages of using a Qualified Personal Residence Trust?
The QPRT is not a good option for homeowners who do not want to relinquish control of their home. The trust is irrevocable.
In addition, once the fixed term of years has ended, the grantor no longer owns the home at all. The grantor will either have to move out or start paying rent to the trust beneficiaries. Whether the homeowner is amenable to this arrangement will likely depend on family dynamics.
6. What constitutes a personal residence?
A QPRT may also work for transfer of one vacation home, provided the grantors actually use the home for a minimum time period each year. Adjacent property may also be included as part of a personal residence.
About the Author
Thomas J. Bouman provides legal counsel in the areas of estate planning, estate settlement, and asset protection. He brings a highly systematic approach to the practice of law, which is critically important when wading through the complex, and often bizarre, legal requirements associated with estate and trust law. Mr. Bouman is author of the Arizona Estate Administration Answer Book and a prominent member of Wealth Counsel, LLC, the nation’s premiere organization of estate planning attorneys.
A Qualified Personal Residence Trust (“QPRT”) is created when a personal residence is transferred to an irrevocable trust, but the grantor retains the right to live in the home for a fixed term of years. At the end of the term, the home will pass to the trust beneficiaries, usually the grantor’s children.
After the home passes to the trust beneficiaries, the home is fully excluded from the grantor’s estate for estate tax purposes. Thus, any further appreciation of the home is also excluded.
2. What are the tax consequences of establishing a Qualified Personal Residence Trust?
When establishing a QPRT, the home must be appraised in order to determine the present value of the remainder interest. This value is equal to the projected value of the residence when the term expires less the value of the retained right to live in the home for a term of years. It is reported as a taxable gift by the grantor. The amount of the gift is calculated by using a special interest rate issued monthly by the IRS called the Section 7520 rate. The gift amount will be smaller when the annuity term is longer or the Section 7520 rate is higher.
After the term of years has expired, the grantor no longer has any ownership interest in the home. Thus, its value is fully excluded from the grantor’s estate for estate tax purposes.
However, if the grantor dies before the fixed term of years has expired, then the full value of the home is brought back into the grantor’s estate. The QPRT will only provide its intended benefit if the grantor survives the duration of the term.
A potential tax disadvantage is loss of the step-up in basis for income tax purposes. Since the home will already be owned by the beneficiary, it does not qualify for a step-up in basis when the grantor dies.
3. How does a Qualified Personal Residence Trust work?
For example, assume Parent transfers a home valued at $800,000 into a Qualified Personal Residence Trust and retains a right to live in the home for 10 years. The present value of the remainder interest would be calculated using the Section 7520 rate (e.g., $530,168). The parent would report a $530,168 taxable gift to the IRS. Assuming Parent lives for at least 10 years, the entire value of the home – perhaps now worth $1,250,000 – is excluded from Parent’s estate for estate tax purposes. Effectively, the “cost” of transferring the $1,250,000 home was only $530,168.
After the 10 year term expires, Parent should continue to pay rent to the children. Failure to do so jeopardizes the entire plan because the IRS could treat the transaction as if the trust never existed. The good news is that each rent payment is essentially a tax-free gift as it reduces the size of Parent’s taxable estate. The bad news is that each rent payment is treated as income to the children.
4. What are other benefits of the Qualified Personal Residence Trust?
By transferring a home into a QPRT, the grantor acquires peace of mind knowing that the home will definitely be distributed to the intended beneficiary. This is especially important in second marriages when, perhaps, the grantor wants the home to be distributed ultimately to the grantor’s child, not the spouse’s family.
There is a strong argument that a home is protected from the grantor’s creditors while owned by a QPRT. This may be true, but in most states a creditor could attach the grantor’s right to use the home for the remainder of the term of years. After the term of years has expired, then the home is fully protected from creditors of the grantor.
5. What are the disadvantages of using a Qualified Personal Residence Trust?
The QPRT is not a good option for homeowners who do not want to relinquish control of their home. The trust is irrevocable.
In addition, once the fixed term of years has ended, the grantor no longer owns the home at all. The grantor will either have to move out or start paying rent to the trust beneficiaries. Whether the homeowner is amenable to this arrangement will likely depend on family dynamics.
6. What constitutes a personal residence?
A QPRT may also work for transfer of one vacation home, provided the grantors actually use the home for a minimum time period each year. Adjacent property may also be included as part of a personal residence.
About the Author
Thomas J. Bouman provides legal counsel in the areas of estate planning, estate settlement, and asset protection. He brings a highly systematic approach to the practice of law, which is critically important when wading through the complex, and often bizarre, legal requirements associated with estate and trust law. Mr. Bouman is author of the Arizona Estate Administration Answer Book and a prominent member of Wealth Counsel, LLC, the nation’s premiere organization of estate planning attorneys.