A qualified personal residence trust (QPRT) is an irrevocable trust used to achieve estate and gift tax savings. The basic idea behind a QPRT is to transfer the equity in a qualified residence out of a person’s estate and to their heirs while reaping lower transfer tax consequences.
A QPRT can also be used to prevent creditors from accessing equity in the residence and allow for the gradual transition of assets to other family members, should these be among a person’s concerns. Assuming specific rules are met, a QPRT can be used for a primary residence or secondary residence, such as a vacation home.
How Do Qualified Personal Residence Trusts Work?
If, after consultation with an attorney, it appears a QPRT could benefit you, it works as follows:
- You transfer the title of a residence to an irrevocable trust and retain the right to use the residence and receive any income from it for a fixed period (known as the trust term).
- If you, as the trust grantor, pass away prior to the expiration of the trust term, it is common for the residence to revert back to you (in compliance with 26 U.S. Code § 2036). The residence will then be included in your estate and will be dealt with according to the terms of your estate plan. In addition, the value of the gift will be reduced due to the reversion.
- If you, as the trust grantor, are living when the trust term comes to an end, your interest in the trust will expire, and the residence passes to those that have been designated your beneficiaries. If the trust is constructed correctly, there should be no additional transfer tax on the appreciation of the value of the residence. In addition, the property in the QPRT will avoid any complications that may come with going through the probate process.
Special QPRT Rules
A QPRT must follow specific rules to comply with limitations imposed by the IRS:
- A grantor cannot have term interests in more than two QPRTs.
- Property transferred to the QPRT must be either:
- The grantor’s principal residence,
- A residence that is used for personal purposes for at least 14 days of the year, or, if more than 14 days, then for 10 percent of the number of days per year that it is rented, or
- An undivided fractional interest in one of these types of residences.
- If a grantor pays any expenses of the property that arguably should be paid for by the beneficiaries, this payment may constitute an additional taxable gift. Language can be crafted to address this issue, but it must be done with care and attention to how it is written.
- If the property in the QPRT is no longer used as a qualifying residence, the QPRT must terminate, subject to certain exceptions.
- If a QPRT ceases to qualify as a QPRT, the trust assets must go to the trust grantor, or the QPRT must be converted into a Grantor Retained Annuity Trust (GRAT) within a fairly short timeframe, often as soon as 30 days.
It should be noted that the above rules are not exhaustive. There are many other rules and technicalities that are beyond the scope of this article.
Gift Tax Benefits of QPRTs
A QPRT has unique gift tax benefits. Once set up, the trust grantor is treated as having made an immediate gift to their beneficiaries. This means that the gift tax value is calculated as of the time of the transfer of the property into the QPRT.
However, this gift is discounted by the amount of the trust grantor’s retained interest in the residence. This is usually the value of the right to use or collect income from the property. The values and discounts are determined using actuarial tables published by the IRS.
Once the trust term ends, and assuming the grantor survives the term, the residence will pass on to the beneficiaries. They will not pay any further transfer tax above any tax that may become due on the discounted gift amount. If the residence has appreciated in value during the trust term, this appreciation will not be subject to transfer tax.
If the trust grantor passes away before the expiration of the trust term and there is a reversion clause, QPRT property will be brought back into the grantor’s estate. In this scenario, the grantor will not be in any worse position than they would have been had they not created the QPRT.
You May Be Able to Stay in Your Home Longer Than You Think
Many become nervous when they learn that they may only retain an interest in a personal residence subject to a QPRT for a certain amount of time.
However, one way to continue to have access to the property even after the term ends is to provide that the residence will stay in the trust and give the person’s spouse the right to live there rent-free until they pass. As long as the grantor remains married to their spouse, there is no reason why they cannot live there as well during this time.
Some Drawbacks
QPRTs are not a perfect solution for everyone. For example, it will not be possible to mortgage the property after it is put into the trust. In addition, it may be necessary to pay off any mortgage against the property prior to the transfer to avoid complications, such as a possible mortgage acceleration or other difficulties.
Setting up a QPRT can also be an expensive endeavor, as a good amount of time and effort by qualified professionals will be required to set it up correctly. This can include attorney’s fees, several appraisals, and title expenses.
Finally, a QPRT is irrevocable and may not allow someone to engage in other gift and estate tax planning. An analysis will have to be made to determine if a QPRT makes the best use of a person’s available gift and estate tax exclusions.
Consult With an Attorney
This article only covers some of the rules that must be followed or technical considerations that should be considered when setting up a QPRT or determining if it is the right option for your situation. The Elder Law attorneys at Mandelbaum Barrett PC are here to consult with you before creating a QPRT.