Qualified Personal Residence Trust is powerful gifting tool that allows
a person to protect a primary residence from creditors and to minimize
estate taxes by leveraging his or her estate and gift tax credit and
freezing an appreciating asset at its current value.
1. What Is a Qualified
Personal Residence Trust or "QPRT"?
A Qualified Personal
Residence Trust or "QPRT" is an irrevocable trust that holds a personal
residence for a term of years. At the end of the trust term, the
residence is distributed to the beneficiaries named in the trust -
typically children. For example, you could create a QPRT and transfers
your residence to the QPRT for a term of 12 years (or any other term),
with the remainder passing to your children. You would have the right to
live continue living in your residence and to use your residence for the
next 12 years. At the end of the 12-year term, your residence would pass
to your children, although arrangements could be made to lease the
residence back so you could continue living in it.
2. What Are the Major
Benefits of a QPRT?
There are several tax and
economic benefits associated with a QPRT. QPRTs are especially good at
leveraging a person's estate and gift tax credit.
A transfer of property to a QPRT is currently treated as a taxable gift.
The value of the gift is based on the present value of the remainder
beneficiary's right to receive the property at the end of the QPRT term.
For example, if you were age 65, you could create a QPRT, transfer your
residence to the QPRT for a term of 12 years (or any other term), and
have the remainder pass to your children at the end of the 12-year term.
Assuming the residence is valued at $1,000,000 and the transfer is made
in the current month, based on IRS tables, you would be treated as
having made a gift to your children valued at only $346,060. Because the
estate tax rate can approach or even surpass 50%, this would obviously
result in significant estate tax savings. You would have effectively
transferred an asset worth $1,000,000 to your children by using only
$346,060 of your estate and gift tax credit (your gift credit is
currently valued at $1,000,000 as of January 2004, and you estate tax
credit is $1,500,000 as of that date).
Because a QPRT is an irrevocable trust and the residence would no longer
belong to the donor, the donor's creditors would not be able to execute
a judgment lien on the residence. Thus, a QPRT provides excellent asset
3. Are There Any Other Tax
Benefits Offered By A QPRT?
Another tax and economic
benefit is that all of the future appreciation of the residence will be
transferred to the children estate and gift tax-free. A QPRT, as a
result, is a powerful tool for freezing the value of your estate. Based
on the prior example, assuming that the $1,000,000 residence appreciates
at 4% per year for the 12-year term, the residence would be valued at
$1,601,032 12 years from now. All of the appreciation during the 12-year
term would inure to the benefit of your children. Thus, by making a gift
valued for estate and gift tax purposes at $346,060, you would
effectively transfer an asset worth $1,601,032. Assuming your estate is
in the current maximum 48% federal estate tax bracket, this would save
you $602,387 in federal estate taxes!
4. Is a Gift Tax Return
Required When a Gift is Made to a QPRT?
Yes. A Federal Gift Tax
Return Form 709 must be filed in the year in which the gift to the QPRT
is made. Based on the foregoing example, you would be required to
prepare and file a Federal Gift Tax Return to report the gift, which
would consume $346,060 of your estate and gift tax credit. Assuming you
had not made prior gifts that had consumed the rest of your gift tax
credit, no gift tax would be due.
5. Does a Gift to a QPRT
Qualify for the $11,000 Gift Tax Annual Exclusion?
No. A gift to a QPRT is a
gift of a future interest and does not qualify for the $11,000 gift tax
annual exclusion. Only gifts of a present interest qualify for the
$11,000 gift tax annual exclusion.
6. How Does My Age and the
QPRT Term Affect the Tax Consequences of the QPRT?
The term of the QPRT is an
important factor in determining the tax savings freezing of future
appreciation of a QPRT. The longer the QPRT term, the greater your tax
savings and the more future appreciation you can freeze at current
7. What If I Die During
the QPRT's Term?
If you die during the term
of the QPRT, the residence would be included in your estate at its full
fair market value at the time of year death. Although the asset
protection benefits would have been realized, the tax and economic
benefits of the QPRT would be lost. However, you would be no worse off
than if you had not created the QPRT, other than transactional costs in
establishing the QPRT. For example, if you were age 50, created a QPRT
with a 15-year term, transferred your $1,000,000 house to the QPRT, and
then died 14 years and 11 months later when the residence were valued at
$1,800,944, the value of the residence would be included in your estate
at $1,800,944 - just as it would have been had the QPRT never existed.
However, you would still receive the gift and estate tax credit for the
initial gift to the QPRT.
8. How Is the QPRT Term
The term is selected by
the donor. Because dying before the expiration of the QPRT term would
result in losing its tax advantages, typically we consult the donor's
actuarial tables and life expectancy and select a term equal to about
two-thirds of the donor's life expectancy. For example, an average
individual age 65 has a life expectancy of 17.4 years. As a result, we
would typically recommend using a 12-year QPRT term. Obviously, we could
adjust this based on the client's risk tolerance and other issues such
as known health problems, family history, etc.
9. What if I Outlive the
QPRT's Term QPRT and Want to Continue Living in the Residence?
If you outlive the QPRT
term, the residence would pass to the remainder beneficiaries. They
would own the property. You could, however, lease the property back from
the remainder beneficiaries at a fair market value rent. The obligation
to rent your residence back from your children is viewed by some as a
negative QPRT feature. However, many people view it as an opportunity to
transfer additional assets, via rent payments, to their children. IRS
Private Letter Rulings have allowed QPRTs that included mandatory fair
market lease provisions at the end of the QPRT term.
10. My Residence Has a
Mortgage. What Are the Tax Consequences of Transferring the Residence,
Subject to the Mortgage, to a QPRT?
contributed to a QPRT should not be subject to a mortgage. If property
subject to a mortgage is transferred to a QPRT, there are two possible
tax treatments. First, the transfer may be treated as a net gift of the
difference between the fair market value of the property and the amount
of the debt. For example, if a residence valued at $500,000 is
encumbered with a $150,000 mortgage, the value of the underlying
property gifted to the QPRT would be only $350,000. The gift tax
consequences would be based on a $350,000 value. However, each time a
mortgage payment is made and a portion of the principal loan balance is
reduced, the donor would be treated as having made an additional gift to
the QPRT. This could create additional accounting, tax, and
Another approach is to include a provision in the QPRT Trust Agreement
in which the donor agrees to indemnify the Trustee of the QPRT for any
liability associated with the mortgage. Arguably, only the value of the
underlying residence would be considered, the value of the mortgage
would be excluded, and additional mortgage payments would not be
considered. However, we are not aware of the IRS either approving or
disapproving of this approach.
An existing mortgage cannot be refinanced. However, with mortgage rates
apparently on the rise for the foreseeable future, this should not be
much of a drawback.
11. How Are Other Expenses
of Relating to the Residence Handled While the Residence Is in the QPRT?
The donor may pay other
ordinary and recurring expense associated with the residence, such as
real estate taxes, hazard insurance premiums, and minor repairs. The
donor can deposit the funds necessary to pay these amounts with the
QPRT's trustee. A QPRT's trustee is permitted to retain sufficient funds
to pay these amounts. A QPRT is treated as a grantor trust for income
tax purposes and thus the donor can deduct the real estate taxes paid on
his or her personal income tax return just as if the QPRT did not exist.
If the donor were to make any capital improvement to the residence, it
would be treated as an additional gift to the QPRT and the gift amount
would be based on the value of the capital improvement and the remaining
term of the QPRT.
12. Can the Residence Be
Sold While It Is in the QPRT?
Yes. The residence can be
sold and the proceeds can be reinvested in a new residence. Because a
QPRT is a grantor trust, any gain recognized on the sale of a principal
residence should qualify for the $250,000/$500,000 exclusion of gain
from the sale of a principal residence, provided all of the other Code
ß121 requirements are met. The exclusion of gain does not apply to the
sale of a personal residence that is not a principal residence, such as
a vacation home.
If the proceeds of sale are not reinvested in a personal residence, the
QPRT will convert to a Grantor Retained Annuity Trust or "GRAT" and will
pay an annuity to the donor for the balance of the QPRT term. GRATs are
13. What Happens if the
Property Ceases to Be Used as a Personal Residence?
If the property ceases to
be used a personal residence, the trust ceases to be a QPRT and the
Trustee must convert the QPRT to a GRAT. GRATs are discussed below.
14. What Is A GRAT?
A GRAT is a Grantor
Retained Annuity Trust. It provides for the payment of an annuity for a
fixed term with the balance passing to the remainder beneficiaries at
the end of the term. If a QPRT converts to a GRAT, it will pay a fixed
annuity amount to the donor for the balance of the Trust term and will
distribute the balance to the remainder beneficiaries. The amount of the
annuity must be based, at a minimum, on the Code ß7520 rate in effect in
the month the QPRT ceases to be a QPRT.
For example, if you were age 50 and transferred a personal residence
worth $1,000,000 to a QPRT in a month in which the Code ß7520 rate were
8.4% and the term were 10 years, the approximate value of your retained
interest would be $591,650. Five years later, if you sold the personal
residence for $1,500,000 and converted your interest to a qualified
annuity interest in a GRAT, under the formula contained in the
regulations the annuity payable to you must be $92,726 annually. The
annuity amount is computed by dividing $591,650 (the lesser of your
retained interest or the value on the conversion date) by 6.3806 (the
annuity factor at 8.4% for the shorter of 10 years or the life of a
person age 50).
15. I Purchased My
Residence Many Years Ago and Have a Very Low Basis. Will My Children
Receive the Residence with the Same Basis at the End of the QPRT Term?
Yes. Gifts made during
lifetime are subject to a carryover basis. Thus, the basis of the
residence in your hands would be the same in the hands of your children
when they receive the residence at the QPRT's expiration.
16. Is There Any Way to
Take Advantage of the $250,000/$500,000 Gain Exclusion from the Sale of
a Principal Residence and to Provide a Step-Up in Basis to the Remainder
It is possible to
structure a sale shortly before the expiration of the QPRT term to give
the remainder beneficiaries a step-up in basis.
Shortly before the expiration of the QPRT term, the remainder
beneficiaries could purchase the residence from the QPRT at its full
fair market value for a 10% cash down payment and a promissory note for
the balance. As a result of the purchase, they would own the residence
with a basis equal to its full fair market value. When the QPRT
terminates, the remainder beneficiaries would receive the cash and the
promissory notes back and the notes would be extinguished.
The tax consequences to the donor are such that, assuming (i) the gain
recognized on the sale of the property is less than $250,000/$500,000,
(ii) the residence being sold is the donor's principal residence, and
(iii) all other applicable requirements for the Code ß121 exclusion of
gain requirements were met, the donor could exclude up to
$250,00/$500,000 of gain in connection with this sale.
17. Who Should Serve As
The Trustee Of The QPRT?
The donor may serve as the
Trustee of the QPRT during the trust term. This generally keeps
administrative costs and burdens to a minimum. If the trust would
continue after the expiration of the trust term, in order to avoid any
estate tax traps under Code ßß 2036 or 238, the donor should not serve
as the Trustee.
18. Do Any Income Tax
Returns Have To Be Filed In Connection With A QPRT?
A QPRT is typically
considered a Grantor Trust for income tax purposes. Most QPRTs do not
generate any income and an income tax return is not typically required.
If the property generates income, a Grantor Trust Tax Return, Form 1041,
may be required.
our flat fee for preparing a QPRT.