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Qualified Personal Residence Trusts
Qualified Personal Residence Trusts
By: Wilmington Trust

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

Be Careful...
Some very important considerations should be thoroughly explored with your advisors when determining whether a QPRT strategy is right for you:

  1. The term of the trust should be set short enough so that the grantor is very likely to live longer than the trust term. Of course, the shorter the trust’s term, the smaller the tax benefits. However, if the grantor does not outlive the term, the house would just revert back to her as though the strategy had never been put in place.
  2. If you and your spouse jointly own your home, you should consider re-titling the house as “tenants in common” and creating two separate QPRTs. Doing so should simplify the administration of the trusts and further discount the value of the gift.
  3. Because of the way the gifts are valued, the best time to fund a QPRT typically is when interest rates are high.
  4. A QPRT may not be as advantageous if you bought your house for much less than it is now worth, since the children would NOT get a step-up in basis.
  5. It is best not to use a QPRT to give your residence to your grandchildren.3
  6. If you have a mortgage on your house, this may add complexity to the minimizing of the tax consequences. Therefore, many advisors recommend paying off the mortgage before transferring the property to the trust.
  7. At the end of the trust term, title to your house is transferred to your beneficiaries. They may rent the house back to you, but you cannot have any pre-arrangement with them to this effect. Thus, it is important that you are comfortable with the idea of giving up ownership of your home and with the possibility of renting it from your children. Because many people are not comfortable with giving up their primary home, a QPRT can be an excellent way to transfer a second residence, such as a vacation home.

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%.

3Please consult with your financial advisor about the Generation-Skipping Transfer Tax.

 

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.

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