The Tricks and Traps of Using Qualified Personal Residence Trusts (QPRTs)
With real estate values on the rise, now may be a good time to transfer your treasured family home to a Qualified Personal Residence Trust (QPRT). While using QPRTs can help reduce estate taxes, the ins and outs are complex. Here’s a guide to help answer some of the questions that may arise.
What is a QPRT?
A QPRT is a trust in which you transfer your personal residence (either a primary or, preferably, a secondary residence), retain an interest for a term of years, and gift the remainder at the end of the trust term to your children. Because the gift is of a remainder interest, the transfer takes place at a discounted value. The caveat is that you must outlive the trust term in order for the QPRT to work.
What are the requirements for setting up the QPRT?
First, in order to draft a QPRT document, you must determine the trust term. The term is the number of years in which you retain the right to use the residence. Since the gift is the actuarial value of the remainder interest, the longer the term, the smaller the gift. For example, the gift tax value on a $1,000,000 residence transferred by a 60-year-old to a QPRT with a ten-year term is $687,000.
Next, you would pick the beneficiaries – or whom you want to receive the residence at the end of the trust term. After that, you would have the home appraised and file a gift tax return to report the gift of the remainder interest. Don’t worry, your attorney or accountant will help guide you through the appropriate requirements of the QPRT agreement and tax filings.
What happens next?
During the trust term, you can live in the residence and use it whenever you want without paying rent. You would pay all of the expenses and also personally deduct the real estate taxes and mortgage interest.
At the end of the trust term, the residence will pass to the beneficiaries, who now are the legal owners. You may not like the idea of being a tenant in your own house, but paying rent is actually a good way of getting additional cash out of your estate.
What are some traps for using a QPRT?
Although a QPRT can be an excellent move to transfer the future appreciation of your residence out of your estate and save estate taxes, there are some traps that you should be aware of:
- There is no step-up in basis at death and this could be costly. Your heirs take the same basis in the residence that you had, so when the house is sold, they will have to pay a capital gains tax.
- In order for the QPRT to work, you must survive the QPRT term.
- Any improvements you make will be an additional gift.
- Since the gift is a future interest, no gift tax annual exclusion is allowed.
- At the end of the trust term, you become a tenant and must pay rent and sign a lease agreement. Otherwise, you risk including your house in your taxable estate when you die.
- After the trust term, if the house is sold, there is no income tax exclusion of the gain on sale.
- If naming multiple beneficiaries, you risk that they may not all agree on what to do with the residence after your death.
What are some tricks for using a QPRT?
Fortunately, there are a few tricks you can use when setting up your QPRT:
1. Transfer a fractional interest (such as 50% tenancy-in-common) to two QPRTs with different terms or split between spouses in order to:
- Reduce the mortality risk – there is a better chance of surviving the trust term.
- Obtain a partial interest discount for fractional interests for additional estate tax savings.
2. Use a “grantor trust” as the remainder beneficiary at the end of the trust term. If you do:
- Name your spouse as a beneficiary of the trust and you can continue to live there rent free during his or her life.
- There should be no income tax reporting even though you are paying rent.
- You can still take advantage of the exclusion of the gain on sale of your principal residence even after the end of the trust term.
- You can buy back the house for fair market value in order to pull the house back in your estate and get a step-up in basis.
- You centralize control of the residence after your death and provide asset protection for your heirs.
Should you use a QPRT?
A QPRT is an excellent tool to move the value of your residence and future appreciation out of your estate at a discounted value. But this may not be for everybody, especially if you have low basis in the residence and your estate is under the federal exemption ($5.43M or $10.86M for married couples). The QPRT does work well for individuals with taxable estates in which the residence makes up a large part of the estate and there are no other assets to give, who don’t want to part with the cash or who just want to make sure they keep the treasured home in the family. In any case, before setting up a QPRT, you should evaluate the potential estate tax savings against the income tax cost.
The tricks and traps of QPRTs should be considered for each individual scenario. Talk to your advisor, accountant and attorney to make sure they are working in sync, so you can get the most out of your QPRT.