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Pros and Cons of a Qualified Personal Residence Trust

Posted on December 29th, 2020
Posted by Iris Wang, CPA

A  Qualified Personal Residence Trust (QPRT) is an irrevocable grantor trust, which allows an individual to take advantage of the gift tax exemption by putting a personal residence, either primary or secondary, into a trust. There are several pros and cons of establishing a QPRT.

Pros and Cons of a QPRT

The grantor determines how long he will retain possession and use of the residence. Once the term is up, ownership is passed onto the beneficiaries. Ultimately, a QPRT reduces estate tax to the grantor and benefits the grantor’s heirs/beneficiaries.

Pros of a QPRT

  • Removes the grantor’s personal residence from his estate, including any future appreciated value, at a reduced value and reduced gift tax rate.
  • This is possible because the value of the grantor remainder interest is nontaxable and retained by the grantor; the taxable portion of the residence is considered a future interest gift that does not qualify for the annual exclusion.
  • The taxable portion can, however, be minimized by using the estate and gift tax exemption, which is $11.2 million for 2020. The longer the QPRT’s term, the larger the grantor retained interest and the smaller the amount of gift tax exemption used. 
  • Allows the grantor to retain possession and use of the residence. During the term of the QPRT, the grantor, including a spouse and any dependents, can continue to live in the residence without any changes.
  • This means that the grantor can live rent-free and will continue to pay any normal operating expenses applicable to the personal residence. As a result, the grantor can also claim all the appropriate income tax deductions on his tax return, such as the real estate tax deduction.

How QPRT Works?

The grantor transfers the property into an irrevocable trust specifying the number of years the grantor retains the right to use the property. The grantor also specifies the person(s) who receive the property once the term ends (the remainders person or remainder persons).

Gift taxes are due at the time of the gift to the QPRT, but because the remainder person(s) do not receive the property until sometime in the future, the value of the gift is reduced for gift tax purposes.

Cons of a QPRT

The longer the retained interest of the grantor, the larger the gift value discount will be. However, if the grantor dies during the retained interest period, the full value of the house is brought back into the estate for estate tax purposes thus nullifying any tax benefit. So the tax benefit of a long-retained interest period must be balanced against the increased chance of dying during the period.If the grantor outlives the retained interest period, he/she can still use the property by paying fair market rent to the remainder person(s).

This is an excellent way for a wealthy parent to transfer even more money to the children free of gift and estate taxes.

Example

Timothy Lee, age 60, transfers his $1 million family vacation home to a QPRT, sets his retained interest term as 15 years, and names his only child, Amanda, as remainder person. Because Amanda must wait 15 years to receive the house, the value of the gift for tax purposes might be reduced from $1 million to $295,000 using government discount rates.

Mr. Lee is able to save much more of his unified credit exemption than if he gifted the house outright – and he still enjoys use of the house.

Compare this technique to:

i) Outright Gift: Gift value for gift tax purposes would be $1 million, thus Tim would use much more of his unified credit and would lose immediate use of the house.

ii) Bequest At Death: Value of house could rise to $2 million or more by time of death thus increasing his estate and his potential estate taxes. If the residence is expected to appreciate significantly the potential transfer tax savings of a QPRT could be enormous.

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Akram Trust and Estate Team can help you to structure a QPRT after determining your facts and circumstances.


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