Maximizing Estate Planning with a Qualified Personal Residence Trust

A Qualified Personal Residence Trust (QPRT) can be a powerful planning tool to minimize estate and gift taxes. Taxpayers who own a personal residence – whether a primary residence, second home or vacation property – and expect to have a taxable estate might want to consider a QPRT.

Example – The Beach Cottage              

Fred and Sue own a beach cottage that they use as a second residence. They are in their 70s and have accumulated significant wealth. They originally purchased the beach cottage for $500,000. Today it’s worth $2 million. They expect to pay 40% estate tax on the cottage when they die, or $800,000.  They have one son who will inherit the property.  The son has no plans to sell the cottage and expects to pass it down to his own children one day.

Setting up a QPRT

A QPRT is an irrevocable arrangement where the grantor gifts a personal residence to the trust. The grantor retains the right to use the property during the QPRT term.

During the fixed term, the grantors are responsible for the upkeep and maintenance costs.  At the end of the QPRT, ownership transfers to the named beneficiary(ies).

The QPRT typically does not need to file a separate income tax return, but the grantors will need to file a gift tax return to report the initial transfer to the QPRT. It is essential that the trust be created with the help of an experienced attorney.

Example – Fred and Sue Gift the Beach Cottage to a QPRT

Fred and Sue decide that they will likely only use the beach cottage for about another 10 years. Rather than gift the property to their son, Sonny, outright, they decide to set up a 10-year QPRT.  Fred and Sue have full use of the cottage for the 10-year period, and are responsible for the property taxes, maintenance, and insurance.  After 10 years, the QPRT ends and the cottage passes to Sonny.

Valuing a Gift to a QPRT

Because the grantor retains an interest in the property, the value of the gift to the QPRT is much lower than the property itself. There are several levers that adjust the actuarial value of the gift – IRS prescribed interest rates, length of the QPRT term, the value of the property transferred, and potential discounts for transfers of partial interests.

Example – Fred and Sue file a Gift Tax Return

Although the beach cottage is worth $2 million, the actuarial value of the gift to the QPRT is only $1.1 million. Fred and Sue had to hire an attorney to create the QPRT and prepare the deeds, hire an appraiser to value the property, and ask their CPA to file a gift tax return.  But the $900,000 ($2 million less $1.1 million) reduction in value effectively saves $360,000 ($900,000 x 40%)  in estate tax.  And this is only the savings based upon current value. Any increase in value over the 10-year QPRT term is out of Fred and Sue’s estate.

Additional Considerations

Like any lifetime gift, the QPRT property will not receive a step-up in tax basis at the death of the grantor.  The beneficiary who inherits the property will have the same tax basis as the original owners (Sonny’s cost basis in the beach cottage would be $500,000 in our example).  There are also property tax reassessment considerations.

The length of the QPRT term is another important factor. The grantor has to outlive the term, or the property will still be included in the grantor’s estate for estate tax purposes.  And, if the grantor wishes to use the property after the QPRT ends, they may be required to pay rent.

Conclusion

In the right circumstances, QPRTs can significantly leverage use of lifetime gifting as part of a broader estate plan. The current combination of higher interest rates and slowing home values makes QPRTs especially effective.  Please reach out to our Family Wealth & Individual Tax Planning Group if you are interested in discussing QPRTs or any other estate and gift tax strategies.

 

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