What is a Qualified Personal Residence Trust?
A Qualified Personal Residence Trust (“QPRT”) is an irrevocable trust that holds either a Grantor’s personal residence or occasional residence for a certain term, then distributes the property to named beneficiaries at the end of the term.
How does a QPRT work?
Each person is entitled under the tax code and regulations to create a QPRT for a primary residence and an occasional residence. The Grantor makes a gift of his or her personal or occasional residence to the QPRT to hold for a certain number of years, at which point the QPRT will terminate and the residence will be transferred to named beneficiaries. This gift of the Grantor’s residence, however, is subject to the Grantor’s retained right to use the residence for the duration of the term.
Just as any residence with a tenant residing rent free would have a reduced value on the real estate market, the value of the gift transferred by the Grantor is significantly reduced. The federal discount rate is used to determine the interest retained by the Grantor, so this method works particularly well in higher interest rate environments. The amount of the gift made by the Grantor equals the value of the property at the time the trust is created minus the interest retained by the Grantor. The Grantor therefore makes a discounted gift to the QPRT, using his or her lifetime gift tax exemption, and retains a right to use the property owned by the QPRT.
What are the advantages of a QPRT?
Transferring a personal or occasional residence to the QPRT will remove the value of the residence from the Grantor’s gross estate, giving the Grantor significant estate tax savings. By reducing the total amount of his or her gross estate, the Grantor is able to pass more wealth on to his or her children without incurring heavy taxation at rates as high as 40%.
In addition, the Grantor will have zero or a reduced gift tax liability based on the discounted value of the property. Many people have significant unused gift tax exemption amounts remaining on their lifetime federal exemption. QPRTs provide an excellent opportunity to use this exemption to pass a larger asset to the next generation.
Will I still be able to exercise my rights of ownership while the QPRT owns my property?
Yes. Your use of the property will remain essentially the same, and you will be responsible for all costs of maintaining the property during the term of the trust. As with any trust, it is important to choose fiduciaries you trust and feel comfortable working with to ensure a well-coordinated administrative process.
A QPRT is still a “grantor trust” for income tax purposes, which means that all income, deductions and credits are attributable to the Grantor.
What happens at the end of the QPRT term?
Once the QPRT terminates and the beneficiary becomes the owner of the property, the Grantor can pay rent in exchange for the use of the property. The transfer of rent payments from the Grantor to the beneficiary is another way to transfer wealth from the estate of the Grantor to the beneficiary without paying estate or gift tax, as the payment of rent is a for value transaction (the Grantor must be mindful that the rent received by the beneficiary is taxable income, however). If the beneficiary is the Spouse of the Grantor, the Grantor is permitted to reside in the property rent free following the end of the QPRT term.
What if I want to sell my real property while it is owned by the QPRT?
As long as a new property is purchased by the QPRT within 2 years of the sale date, the sale of real property held in a QPRT will not cause a termination of the trust. It is also possible to complete a §1031 exchange with property held in a QPRT.
If the property is sold and a new property is not purchased within the two year timeframe, the proceeds must be returned to the Grantor or the QPRT can be structured to turn into a Grantor Retained Annuity Trust (GRAT), and the Grantor would begin to receive a qualified annuity amount each year.
What if I do not survive the term?
The worst case in a QPRT scenario is that the property will revert back to the Grantor’s gross estate, which simply brings everything back full circle – no penalties are imposed or other repercussions are involved, especially where a QPRT is part of a comprehensive estate plan. Nothing would be accomplished if the Grantor died before the end of the term, yet nothing would be lost.
Can the beneficiary be another trust, or must it be a specific person?
Many Grantors choose to have another trust as the beneficiary of the QPRT, enabling the property to pass through to their heirs with the benefit of further estate tax reductions for future generations and creditor protection for their heirs. For example, passing a family vacation home through a QPRT to a long-term trust can ensure creditor protection and the preservation of a valuable family asset for generations.
The additional benefits to having a grantor trust as a beneficiary:
- The payment of rent to the trust is not taxable income imputed to the beneficiary, but rather to the grantor trust, which is the Grantor – therefore the payment of rent is not a taxable event.
- The Grantor can still benefit from the income tax exclusion for the sale of a personal residence if the property is sold while owned by the grantor trust beneficiary.
- The Grantor, not the children-beneficiaries of the grantor trust, would be responsible for the payment of any capital gains taxes if the residence is sold.
When carefully drafted as part of a well-orchestrated estate plan, a QPRT can be an extremely beneficial vehicle for the discounted transfer of wealth to your loved ones. The technical nature of these transfers requires careful consideration and discussions with your estate tax professionals.