The use of a Qualified Personal Residence Trust (QPRT) provides an opportunity to remove a primary and (or) an occasional residence from your taxable estate.
How Does Qualified Personal Residence Trust Work
When creating a QPRT, “an individual would transfer the title [of an eligible home] to a QPRT trust” (Michaels & Twomey, 2015, p. 52). Additionally, the individual would retain the right to live in the home for a set period of time, such as ten years. Should the individual live beyond the 10-year period, “the home would pass to his children free of estate tax” (Michaels & Twomey, 2015, p. 52) but the grantor could stay in the home if he agreed to pay a market rate of rent to his children.
Through the paying of rent, the high net-worth individual could pass additional amounts to their children without estate or gift tax implications (Michaels & Twomey, 2015, p. 53). However, as the children would pay ordinary income tax on the rental income (net of expenses), an option exists to instead have the home transferred to a grantor trust for the benefit of the children at the end of the ten-year term.
“In this case, rental payments would be made to the trust. Grantor trust status means that, for income tax purposes, the grantor is treated as the owner of the income” (Michaels & Twomey, 2015, p. 53). In this situation, the rental payments would not be subject to income tax.
Gift Tax Consequences
While the transfer to the QPRT would be considered a taxable gift, it would be discounted from the value of the home as the grantor has the right to live in the home for a ten-year period of time, in this example.
Using the IRS-provided tables, the current value of the gift would be calculated. With the high gift tax exemption limit currently in place, most discounted values would be significantly below the level requiring the payment of gift tax. The future appreciation of the property (after transfer to the QPRT) would be “passed to the children tax-free” (Michaels & Twomey, 2015, p. 53).
Should the grantor die before the set term expired, the entire value of the property would be included in his estate. Thus, nothing would have been accomplished with the use of the QPRT, but there was no cost either as the amount originally allocated to the gift would be restored and available for estate tax purposes (Michaels & Twomey, 2015, p. 53).
If the individuals involved are married, there are additional planning opportunities available as each can set up a QPRT for their one-half interest in their properties.
Is Now the Time for a QPRT?
A QPRT is “an excellent technique for transferring substantial assets at a discount with minimal impact on the client’s standard of living” (Michaels & Twomey, 2015, p. 54). Admittedly, with the elevated level of current Federal estate tax exemption, few people would have the need for such a product. However, some would have estates in excess of the exemption amount.
Further, as history has shown, the estate tax exemption is subject to change at any time, potentially making a Qualified Personal Residence Trust a worthwhile consideration for more people in the future.