A Qualified Personal Residence Trust (“QPRT”) is a special type of irrevocable trust which serves you by removing your primary residence and/or one additional home you own from your estate at a reduced rate for federal gift and estate tax purposes. Simply put, the QPRT allows you to continue enjoying substantially the same benefits from your home while ensuring that your home will not be included in your estate, reducing your taxable estate.
Like with all tax and estate planning tools, there are many factors to consider whether a QPRT is an optimal strategy for your estate. A QPRT is especially beneficial if you own a high-value primary residence, or high-value vacation property, whereas it may be the wrong choice if you aren’t planning to stay at the same residence for a substantial period of time.
QPRTs are set up as irrevocable trusts, and the grantor’s primary or secondary residence funds the trust. IRS rules permit an individual to have up to two, and married couples up to three QPRTs. Each QPRT trust can contain only one residence, and the residence cannot be used for any non-residential purpose, such as an office or rental property.
The grantor funds the QPRT with residential property for the “Initial Term”. The Initial Term is the time period during which the grantor retains the right to full and complete enjoyment of the property. During this time the grantor is entitled to live on the property and use it for any non-commercial purpose. This interest held by the grantor is referred to as “The Retained Interest”. The total value of this retained interest is calculated based on IRS applicable interest rules. If the grantor is alive at the end of the Initial Term, the QPRT distributes the property to the beneficiary. The interest inherited by the beneficiary is referred to as the “Remainder Interest”, and is equal to the fair market value of the property the day the QPRT was created less the retained interest, adjusted for the likelihood that the grantor survives the initial term.
The length of the Initial Term is up to the grantor and is an extremely important decision. If the grantor dies during the Initial Term, the residence held by the QPRT is returned to the grantor’s estate, and no tax benefit is achieved. The estate tax benefits of a QPRT only take effect if the grantor outlives the Initial Term.
At the end of the Initial Term, a QPRT will provide the grantor with the right to rent the house for as long as they are still alive. At this point the house has changed ownership and is the property of the beneficiary, but the grantor has a contractual right to rent the property. The rent charged must be fair market value in order to avoid tax pitfalls. If your financial liquidity does not provide you the means to pay rent on the house, a QPRT may not be a good solution for your estate.
Qualified Personal Residence Trusts are an effective estate planning tool for many people who are looking to protect their assets and limit the amount of taxes to be paid on their estate. QPRTs provide protection for the grantor and beneficiaries when properly set up and when the grantor lives beyond the term of the trust.
Every asset protection and estate planning strategy has positives and drawbacks. It is important to tailor your estate plan to your estate’s particular nuances, and whether a QPRT is right for your specific needs is an important conversation to have with your attorney. Below are some of the pros and cons of QPRTs to consider when consulting your attorney.
A Qualified Personal Residence Trust is not right for all estate plans; however, if you only plan on staying in your home for the foreseeable future and want to remove it from your taxable estate, a QPRT may be right for you. Having an experienced attorney review your estate plan goals is the first step to determining whether a QPRT is right for you. Call Mile High Estate Planning today for a complimentary consultation to have our highly qualified team review your plan and help decide what is best for your goals.
The calculation for remainder interest is complex and depends on a variety of IRS published values. Let’s take a deeper dive.
The first step is to calculate the retained interest based on the §7520 interest rate and the length of the initial term. This is an upward adjusted value of the Applicable Federal Midterm Rate, and it reflects the future discounted value of the house.
For example, a house worth $1,000,000 placed in a QPRT for an initial term of 20 years when the §7520 applicable rate is 1% has a remainder value of $819,544. This is the first step of the discounting process.
The second step is to adjust the remainder value based on the IRS published mortality factor tables. Let’s continue with the example above and assume that the grantor is 60 years old. The IRS mortality tables estimate that the grantor has a 58% chance of surviving the initial term, and therefore we multiply the retained value by a further 0.4755 to arrive at the taxable value of the gift: $475,466.
There are three major factors that affect the effectiveness of your QPRT: the §7520 interest rate, the age of the grantor at the time of the gift, and the length of the initial term. Let’s look at some illustrations at the table below.
|Property Value||§7520 Rate||Age of Grantor||Initial Term||Value of Gift||Total Reduction in Gift Value|
As you can see, the §7520 Rate can have a large impact on the total savings, but the biggest tax savings are attained in scenarios where the initial term ends when the grantor is near or past the IRS life expectancy age (~80). Thus, regardless of whether you are in your 40s and planning ahead, or are securing your estate in your 60s, a well crafted plan can attain you significant savings.
The short answer is yes – sort of. You can sell a house that is held by a QPRT, but what happens to the trust depends on what you do with the money. There are two possible outcomes. Either you do not purchase a second house to replace the original, and the trust converts to a grantor retained annuity trust (GRAT), or you use the proceeds of the sale to purchase a new home that will stay in the QPRT. If there is money left over after the purchase that money is distributed to the grantor.
If the grantor survives the initial term of the trust, then the home held in the QPRT is distributed outright to the beneficiaries. Otherwise, if the grantor does not survive the initial term, the assets held within the QPRT are distributed back to the grantor’s estate.
A QPRT is an irrevocable trust, and as such, cannot be easily unwound once created. Because the grantor cannot be the trustee or make changes to the trust document itself, once the QPRT is established it cannot be revoked.
IRS rules permit an individual to have up to two, and married couples up to three QPRTs.
Yes! You can put your vacation property into a QPRT. You can put one other residence in addition to your primary residence into a QPRT. There are some limitations, however. For a residence to qualify for a QPRT, you must either:
(a) Use the property as a residence for 14 days during the calendar year, or,
(b) if the property is rented out for a portion of the year exceeding 140 days, you must use the property as a residence for a number of days at least equal to 10% of the number of days it is rented out. See Treas. Reg. § 25.2702-5(c)(2)(i)(B).
Yes! Once your property is moved into a QPRT, it is no longer part of your estate or reachable by your creditors. Until the end of the initial term, neither your creditors nor your beneficiaries’ creditors can reach the property. Once the initial term is concluded, the property is owned outright by your beneficiaries and the asset protection ends.
The tax savings of a QPRT can be significant. As we discussed in the table above, you can reduce the taxable value of your gift by up to 80% using a well structured QPRT. If you own a particularly valuable primary residence or vacation home, you can realize enormous tax savings. Assuming a modest 60% reduction in tax valuation, by placing a pair of homes worth $5,000,000 into QPRTs, you can reduce your estate tax bill by up to $1,200,000.