The Qualified Personal Residence Trust
By: Lewis W. Dymond, Esq.
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For many individuals, their residence is the single most valuable asset they
own. By putting his residence into a qualified personal residence trust
("QPRT") during his life, an individual can transfer the residence to his children
at a significantly lower transfer tax cost than he would incur if he left the
residence to them in his will.
A QPRT (sometimes called a "residence GRIT") is specifically authorized by
the Internal Revenue Service Section 2702 of the Code. Close attention to the
requirements of the IRS regs for that section of the Code is essential in planning
to use a QPRT.
Let me describe how a QPRT can reduce the gift and estate tax costs of
transferring a personal residence to family members. I will discuss the non-tax
considerations which should be addressed in deciding whether to create a
QPRT.
How a QPRT can reduce transfer tax costs:
An individual (grantor) creates a QPRT by transferring his personal residence
to a trust and retaining the right to use the residence without the payment of
rent for a specified period of time.
At the end of that period, the residence either passes outright to beneficiaries
designated by the grantor (usually members of his family) or continues in trust
for their benefit. The grantor may continue to occupy the residence after his
retained interest terminates, but if he does so he must pay fair market value
rent.
When the grantor transfers his residence to the trust, he is treated as having
made a gift to the family members who will receive the residence when his
retained interest terminates. The value of the gift is the fair market value of the
residence, reduced by the present value of the grantor's retained interest (the
right to live in the residence rent free for the specified period of time). The
present value of the retained interest is determined by using the IRS valuation
tables and the Code Sec. 7520 interest rate for the month of the transfer.
This method of valuation is advantageous to the grantor because the value of
his retained interest, determined under Code Secs. 7520, will usually be greater
than the rental value of the residence based on market conditions. The result is
an unrealistically high discount for gift tax purposes--but one that IRS can't
challenge, because use of the IRS valuation tables is mandated by Code Secs.
7520.
When the grantor's retained interest terminates, the residence passes to the
family members free of additional gift tax, even if it has appreciated in value
since the trust was created. Thus, use of a QPRT "freezes" the value of the
residence at its market value when the trust is created. This means that the
transfer tax savings that can be achieved with a QPRT are especially high if the
trust is created at a time when real estate market values are low.
If the grantor is still living when his retained interest terminates, the residence
won't be includible in his gross estate for estate tax purposes (unless he
continues to live in the residence without paying fair market value rent). If the
grantor dies during the term of his retained interest, the residence will be
includible in his gross estate under the retained life estate rule. But he won't be
any worse off than he would have been if he hadn't created the trust in the first
place.
As previously stated, for a QPRT to work, the grantor has to survive the term of
his retained interest. But if he does, that means that ownership of his residence
will pass to the remainder-men of the trust (usually the grantor's children) while
he's still alive, and he will have to pay rent to them if he wants to continue to
occupy the residence. If he continues to occupy the residence without paying
fair market value rent, the residence will be includible in his gross estate and
the transfer tax savings potential of the QPRT will be lost.
Many people feel uncomfortable about the prospect of living in a residence
owned by--and paying rent to--their children. For some people, the potential tax
savings offered by a QPRT will outweigh the anxiety they feel about giving up
ownership of their residence to their children. But others will be willing to
forego the tax savings for the sake of continuing to own their own home until
they die.
The decision is such a personal one that it should be made by you alone, with
no pressure in either direction from the planner. The planner's job is to provide
you with all the information you need to make a fully informed decision. To
that end, make sure you are aware of the following points:
1. A vacation home can qualify as a personal residence for purposes
of the QPRT rules. If you aren’t willing to put your primary residence into a
QPRT, you may be willing to do so with your vacation home, because
anxieties about children owning the residence may not be as strong where
a vacation home is concerned.
2. If you plan to move out of your residence at some foreseeable time in
The future, a QPRT can be set up so that your retained interest terminates
at the time you intend to move. For example, if a 55-year-old client who
lives in Colorado and plan to retire at age 65 and move to Arizona, you could
put your Colorado residence in a QPRT and retain the right to live in the
residence rent free for ten years. When your retained right terminates, the
Colorado residence will pass to the children, but since you will be living in
Arizona by that time, you need not be concerned about living in a residence
owned by your children.
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