QUALIFIED PERSONAL RESIDENCE TRUSTS

Qualified Personal Residence Trusts (QPRTs) can be used to substantially reduce the overall tax costs of transferring a residence to children or other beneficiaries.  A QPRT is an irrevocable trust into which a grantor transfers a residence, while reserving the right to live in it for a term of years.  On expiration of the term, the residence transfers to the named beneficiaries. 

By placing the residence in a trust, a QPRT allows an individual or married couple to reduce estate taxes because the value of the residence(s) is no longer included in the gross estate.  When the owner of the residence creates the trust and transfers his/her residence to trust, this transfer is a gift for federal gift tax purposes.  The value of this gift, and the resulting gift taxes, can be substantially reduced, however, because using a QPRT allows the transferor to value the residence at a lower, actuarially determined value of the beneficiary’s right to receive the residence at the end of the trust term. This value is lower than the current fair market value.  By law, each person is allowed two QPRTs, one of which must be his/her personal residence.

How It Works:

• The creator of the trust (grantor) transfers the residence into an irrevocable trust, reserving the right to remain in the home for a term of years.
• Transfer of the residence to the trust constitutes a gift for federal gift tax purposes.  The gift tax, however, can be substantially reduced by use of an individual’s lifetime gift tax exclusion of $1,000,000.00.  This gift tax is further reduced because the value of the residence is the fair market value of the property minus the value of the grantor's retained right of occupancy, which is calculated by applying the current federally prescribed rate of interest to the full value of the residence.  Therefore, the interest retained by the grantor is treated as having a value equal to the present value of the right, for the term of years, to receive interest at a fixed rate on the full value of the residence at the time the QPRT is established.  These factors combine to create a substantial reduction in gift tax, as well as the estate tax if the grantor’s estate would have exceeded the estate tax exemption had the residence been included in the grantor’s gross estate.
• If the transferred residence has a mortgage, additional gift taxes may be incurred as the grantor makes those payments.  This can be offset by using the grantor’s annual gift tax exclusion amount, which is currently $12,000 per year.
• If the residence in the trust is sold during the grantor's retained term, the proceeds of the sale must be: (1) reinvested in a new residence within two years, (2) converted to a qualified annuity payable to the grantor for the remainder of the stated term, or (3) distributed to the grantor.  The grantor is treated as having made the sale for income tax purposes, and can exclude up to $250,000 (or $500,000 for married couples) of the gain on the sale of a personal residence held in a QPRT.
• If the grantor survives the term of years, the residence passes to the named beneficiary(ies), and the value of the residence will not be included in the grantor’s estate for estate tax purposes.  If, however, the grantor does not survive the stated term of the QPRT, the residence will be included in his/her estate and the grantor is in no worse position than if the QPRT had never been created.
• Clients wishing to transfer a residence to a QPRT should carefully consider the consequences upon termination of the trust term, as suitable living arrangements will need to be made.  If the grantor wishes to remain in the residence past the trust term, fair market value rent must be paid to the new owner/beneficiary.  This payment of rent is subject to income tax on the beneficiaries, however, it will also allow wealthier clients to transfer more property to beneficiaries and will further reduce the size of the taxable estate.