A qualified Personal Residence Trust (QPRT) is an excellent tool for persons with large estates to transfer a principal residence or vacation home at the lowest possible gift tax value. The general rule is that if a person makes a gift of property in which he or she retains some benefit, the property is still valued (for gift tax purposes) at its full fair market value. In other words, there is no reduction of value for the donor’s retained benefit.
In 1990, to ensure that a principal residence or vacation residence could pass to heirs without forcing a sale of the residence to pay estate taxes, Congress passed the QPRT legislation. That legislation allows an exception to the general rule described above. Lentor Hills Residences As a result, for gift tax purposes, a reduction in the residence’s fair market value is allowed for the donor’s retained interest.
For example, assume a father, age 65, has a vacation residence valued at $1 million. He transfers the residence to a QPRT and retains the right to use the vacation residence (rent free) for 15 years. At the end of the 15 year term, the trust will terminate and the residence will be distributed to the grantor’s children. Alternatively, the residence can remain in trust for the benefit of the children. Assuming a 3% discount rate for the month of the transfer to the QPRT (this rate is published monthly by the IRS), the present value of the future gift to the children is only $396, 710. This gift, however, can be offset by the grantor’s $1 million lifetime gift tax exemption. If the residence grows in value at the rate of 5% per year, the value of the residence upon termination of the QPRT will be $2, 078, 928.
Assuming an estate tax rate of 45%, the estate tax savings will be $756, 998. The net result is that the grantor will have reduced the size of his estate by $2, 078, 928, used and controlled the vacation residence for 15 additional years, utilized only $396, 710 of his $1 million lifetime gift tax exemption, and removed all appreciation in the residence’s value during the 15 year term from estate and gift taxes.
While there is a present lapse in the estate and generation-skipping transfer taxes, it’s likely that Congress will reinstate both taxes (perhaps even retroactively) some time during 2010. If not, on January 1, 2011, the estate tax exemption (which was $3. 5 million in 2009) becomes $1 million, and the top estate tax rate (which was 45% in 2009) becomes 55%.
Even though the grantor must forfeit all rights to the residence at the end of the term, the QPRT document can give the grantor the right to rent the residence by paying fair market rent when the term ends. Moreover, if the QPRT is designed as a “grantor trust” (see below), at the end of the term, the rent payments will not be subject to income taxes to the QPRT nor to the beneficiaries of the QPRT. Essentially, the rent payments will be tax-free gifts to the beneficiaries of the QPRT – further reducing the grantor’s estate.
The longer the QPRT term, the smaller the gift. However, if the grantor dies during the QPRT term, the residence will be brought back into the grantor’s estate for estate tax purposes. But since the grantor’s estate will also receive full credit for any gift tax exemption applied towards the initial gift to the QPRT, the grantor is no worse off than if no QPRT had been created. Moreover, the grantor can “hedge” against a premature death by creating an irrevocable life insurance trust for the benefit of the QPRT beneficiaries. Thus, if the grantor dies during the QPRT term, the income and estate tax-free insurance proceeds can be used to pay the estate tax on the residence.