ESTATE PLANNING, WILLS & TRUSTS
QUALIFIED PERSONAL RESIDENCE TRUSTS
Creating Two Interests With a Qualified Personal Residence Trust
A Qualified Personal Residence Trust ("QPRT") is an estate planning technique used to transfer a residence out of a Grantor's estate at a low gift tax cost and is sanctioned by regulations promulgated by the Internal Revenue Service. Once a QPRT is created, a deed is prepared to transfer the residence to the Trust. The terms of the QPRT express a length of time or term of years (the "retained interest") that the Grantor may continue to reside in the residence. At the end of that period of time, the ownership of the residence transfers to the beneficiaries (the "remainder interest").
A taxable gift occurs when the original transfer of the residence is made to the trust. The value of the gift is equal to the remainder interest and is derived by first determining the fair market value of the entire property, and then subtracting the value of the retained interest. The Grantor must report the gift by filing a gift tax return for the year the residence is transferred to the trust.
Valuation and Terms of Trust
The value of the retained interest is a function of the length of the trust term, calculated in conjunction with interest rates published by the Internal Revenue Service for making present value calculations. Other factors being equal, the longer the retained interest of the trust, the larger the value of the retained interest, and the smaller the value of the remainder interest or gift. The amount of gift tax due will generally be offset by some portion or all of the Grantor's unified credit (equivalent to the tax on $11,400,000 in 2019). So there should not be any actual tax paid, but the Grantor's unified credit amount will instead be reduced.
If the Grantor dies before the end of the retained term of years, the entire value of the residence, calculated at the date of death of the Grantor, will be included in the Grantor's taxable estate. This means the purpose of setting up the trust will be essentially defeated. If the Grantor survives the retained term of years, however, the residence will be distributed to the beneficiaries without further transfer tax. Although the gift amount reduces as the retained interest increases, the risk that the Grantor may not survive the term increases as well.
Use of Residence Upon Expiration of Term
At the end of the term of the retained interest, the surviving spouse may be given a lifetime right to live in the residence. Co-occupancy by the Grantor with the spouse does not amount to a retained interest by the Grantor which would cause inclusion of the residence in the Grantor's taxable estate. The Internal Revenue Service has also confirmed that mandatory leases back to the Grantor will not cause estate tax inclusion. Therefore, the Grantor, in the trust document, may be given the right to lease the residence at the end of the term of the retained interest so long as the Grantor pays rent at the fair market value.
Sale of Residence Prior to Expiration of Retained Term
The exclusion of gain on the sale of a principal residence can also be utilized if the Trustee decides to sell the residence to a third party during the retained interest of the Grantor, provided the residence is still used as the Grantor's personal residence and otherwise qualifies. The proceeds can be used to fund an annuity to the Grantor for the remainder of the term of the retained interest. This provision is particularly useful if the Grantor contemplates future downsizing or when additional income may be necessary for a stay in an intermediary care facility or retirement home.