While recent estate tax law changes may significantly reduce estate taxes, the estate tax will be with us for several more years. In the meantime, persons with substantial estates should consider taking advantage of every available opportunity to reduce estate taxes. One such opportunity is the qualified personal residence trust (“QPRT”). Under the right circumstances, a QPRT offers an opportunity to significantly reduce estate taxes.
A QPRT is a specialized trust created by a grantor for the purpose of holding title to the grantor’s personal residence. A QPRT is an irrevocable trust to which the grantor transfers his or her residence, but retains the right to live in the residence rent-free for a fixed term. At the end of the term, the trust terminates and the residence is distributed to the remainder beneficiaries – usually the grantor’s immediate family members, such as children or grandchildren.
The transfer of the property to the QPRT is subject to the gift tax, but the value of the gift is only the value of the remainder interest – the value of the rental term retained by the grantor is not included in the value of the gift. Thus, the primary tax advantage of a QPRT is to leverage one’s $1,000,000 unified credit because the taxable gift is only of the remainder interest and not of the entire property.
Among the other advantages are: if there is a mortgage on the residence, the grantor may continue to deduct interest on the mortgage on his or personal income tax return; because the valuation discount is based on IRS tables it is not subject to challenge by the IRS; no tax return need be filed for the trust; the ownership of the residence by the trust may provide some protection against claims of creditors; and the grantor may sell the property and purchase another residence to be owned by the QPRT.
While the advantages of a QPRT are many, it is not a foolproof method to avoid estate taxes. First, the benefits of the QPRT are not guaranteed: if the grantor dies before the fixed termination date of the trust, the entire value of the residence will be included in the grantor’s gross estate. Second, the planning of a QPRT’s termination date is tricky, as the term of a QPRT should be as long as possible – to allow the lowest possible gift value – while attempting to avoid the death of the grantor before the trust terminates, thereby resulting in the inclusion of the entire value of the residence in the grantor’s gross estate. Finally, if at the end of the term the grantor desires to continue to live in the residence, he or she must rent it from the new owners, usually children or grandchildren, which may cause “personal” discomfort.
Properly planned and under the right circumstances, a QPRT may transfer to future generations the grantor’s residence at a fraction of its true value, resulting in substantial estate tax savings. However, as with most estate planning, careful drafting is essential to ensure a QPRT complies with the highly technical estate tax regulations. Please do not hesitate to telephone us to discuss the inclusion of a QPRT in your estate plan.