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If you anticipate that the value of your residence will appreciate significantly in the years to come or if you would like to continue the legacy of your family’s multi-generation vacation house without having to worry about the impact of estate and gift taxes, establishing a Qualified Personal Residence Trust (QPRT) may provide a compelling solution.
The QPRT is a commonly used strategy that was created by Congress to facilitate the generational transfer of family residences by providing a tax-efficient way to transfer your residence to your heirs. The primary benefit of such a strategy is that the property is valued for gift tax purposes at the time the trust is created, and this amount is reduced by the value of your right to live in the house for a specified number of years. Furthermore, by transferring the property to your heirs now, the future appreciation is not subject to gift or estate tax later on.
How It Works...
Assume that a 65-year-old grantor contributes a $4 million residence to a 15-year Qualified Personal Residence Trust for her children.
For the next 15 years, the grantor continues to live in her house as she always has. 1 At the end of the fifteen year term, the residence would be transferred gift tax free to her children, who could choose to rent the residence back to their mother if they wish. The rent payments would have the further benefit of allowing the grantor to pass on more wealth to her children without incurring gift taxes.
Although the house is worth $4 million, the value for gift tax purposes would only be about $1.5 million because of the $2.5 million deduction for the value of the grantor's right to live in the house for the 15-year period. So, the grantor was able to keep the $4 million house in her family (worth perhaps $7.0 million at her death), but only incurred gift taxes based on a gift of $1.5 million. Such a plan could be expected to provide an estate tax savings of almost $3.0 million.2
Some very important considerations should be thoroughly explored with your advisors when determining whether a QPRT strategy is right for you:
When a QPRT is used as part of a comprehensive wealth transfer plan, it can help to minimize estate taxes by transferring your residence to your beneficiaries at a reduced value. However, the irrevocable decision whether to create a QPRT requires balancing potential tax savings with important personal considerations.
1Note that payments for mortgage principal and capital improvements will most likely be considered taxable gifts to the trust beneficiaries. However, these gifts will be discounted based upon the number of years remaining in the trust term.
2 "NumberCruncher 2001" software was used for these calculations, based upon the following assumptions: life expectancy: 21 years; Internal Revenue Code §7520 rate: 6.20%; transfer date: August, 2006; 15-year term with reversion provision; after tax asset growth rate: 4%.
Updated: January 1, 2013
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.
© 2013 Wilmington Trust Corporation.