Qualified Personal Residence Trusts

by Stuart A. Rader

The Qualified Personal Residence Trust ("QPRT") is an Irrevocable Trust. You direct the trustee to pay you the income from the trust for a specified number of years or allow you possession of the trust's property. When your interest terminates at the end of the years you've selected, the property in the trust is distributed to family members or the other individuals you have chosen. In some cases, the trust continues for their benefit or makes a distribution to a uniform transfer to minors account (UTMA) or Section 2503(c) trust.

When you put cash or assets into the trust, you made what is called a "future interest" gift. The value of that gift is the excess of the value of the property you transferred over the value of the interest you kept. The value of your retained interest is actuarily determined based upon the current IRS interest rate at time of the transfer and the appraised value of the residence. As interest rates climb, the value of the QPRT technique is enhanced because the value of the remainder interest or gift is reduced.

Illustration. Five year QPRT with home appraised at $400,000, interest rate at 6.4%, and 50% marginal gift tax rate:

Current Value of Residence $400,000

Value of Five-Year Term .3403 ($400,000)

Equals Retained Value $136,120

Value of Gift (Remainder) $263,880

Times Marginal Gift Tax Rate .50

Gift Tax on Transfer of Remainder $131,940

As the above numbers indicate, the present value of the home five years from now is $263,880. Ordinarily, there would not be any gift tax due at the time of the transfer, but you would have to file a Gift Tax Return and reduce your lifetime exemption of $1,000,000 by the value of gift $263,880. Essentially, this allows you to reduce the value of the gift based upon the current value of the five-year term. It also has the impact of "freezing" the value of the home based upon current valuations. Accordingly, any and all appreciation on the property passes "tax free" provided that you survive the QPRT term. In order to properly implement a QPRT, an appraisal of the home by a qualified appraiser is necessary. Further, one must live until the end of the term interest to place the property outside of your taxable estate. Also, the Trust can only hold the real property. The tangible property (furnishings, etc.) remains outside the Trust. Accordingly, the property and casualty insurance will need to be properly endorsed prior to the funding of any QPRT. QPRTs work best if the mortgages are paid off prior to transferring the home into the Trust. If this is not a viable option, then every six months you must fund into the Trust the next six months of mortgage payments. Whether or not there is a mortgage, you may transfer to the QPRT, the next six months anticipated operating expenses of the residence, such as taxes, insurance, and assessments.

Perhaps the biggest advantage of the QPRT is that after the five-year term, the Trust can continue as a "Grantor Trust", whereby you remain responsible for the income tax ramifications of the Trust, although it is a completed gift. This is critically important because you could then rent the home from the Trust at fair market rent and there would be no income tax consequences to the beneficiaries of the Trust (your children ) and you. If the fair market rental value of the residence on an annual basis was $25,000, then you would be able to transfer $25,000 per year to the Trust with no income tax, gift or estate tax consequences. Accordingly, if you rented the home for ten years, then the net rent ($250,000 less taxes, insurance and expenses) could be transferred to the Trust free from taxes. The Trust could provide for discretionary distributions to your children whereby, on an annual basis, the net rent would then filter " tax free" from the Trust pro rata to the children.

You may select the term of the QPRT, but the longer term you specify the larger the value of the interest you have retained - and the lower the value of the gift you have made.

Not intended as legal advice but rather a general discussion.  No transaction should be entered into without competent legal and tax advice.