A qualified personal residence trust (QPRT) is one of the most effective estate planning techniques available to wealthy families. A QPRT allows an individual to make greater use of his or her $5,450,000 lifetime exemption from gift and estate tax. It is a particularly attractive technique for individuals who are already maximizing their $14,000 annual exclusion gifts to family members. Moreover, with a QPRT, an individual may make a significant gift to his or her loved ones without adversely affecting his or her income.
Using a QPRT, an individual may put a primary residence or vacation home in trust for the benefit of a beneficiary (his or her children or a loved one), while retaining the right to use the residence for a specific term of years. Each individual may create up to two QPRTs. For gift tax purposes, the value of the beneficiary’s remainder interest is determined after subtracting the value of the grantor's right to use the residence for the term of years. This valuation procedure allows a grantor to substantially discount the value of the gift made to the beneficiary, and also removes all post-gift appreciation in the value of the residence from the grantor’s estate. Assuming that the grantor survives the trust term, the residence either passes outright to the beneficiaries of the trust or can remain in trust for their benefit. Essentially, a successful QPRT allows a grantor to reduce the gift or estate tax cost of transferring a residence by leveraging the $5,450,000 gift tax exemption.
The length of the grantor’s term interest in the trust is not limited and the longer the term interest, the lower the value of the beneficiary's remainder interest (and, hence, the lower the gift tax). The term interest should be kept short of the grantor’s life expectancy, since if the grantor dies before the termination of the term interest, the full value of the residence would be included in the grantor’s estate for estate tax purposes, while the earlier taxable gift is removed (thereby defeating the purpose of the trust). Essentially, though, a QPRT is an estate planning technique with virtually no downside estate planning risk.
EXAMPLE: A 60 year old transfers his $3,000,000 home to a QPRT. He retains the right to utilize the home as his residence for 25 years. Assuming he outlives the twenty-five year trust term, the house would pass to his children. If the statutory interest rate in the month of the gift is 1.8% (April 2016), the initial taxable gift would be valued at about $755,790. As long as the grantor is able to apply his $5.45 million lifetime exemption amount towards the gift, no federal gift tax would be payable. In any event, if the grantor survives for the full trust term, the residence will pass to his children with no additional gift or estate tax inclusion. Assuming the property value increases at a rate of 5% per year, the value of the property will be $10,159,065 at the end of the twenty-five year term. In that event, the grantor will have transferred his home valued at potentially $10,159,065 (using only $755,790 of his lifetime exemption amount), and will have saved approximately $4,701,638 in Federal and New York State estate taxes.
Although the QPRT is irrevocable once created, the trustee retains the power to sell the residence and to purchase a new one. Accordingly, the grantor's ability to change residences is not hampered by the use of a QPRT. If the residence is indeed sold during the trust term, the sale proceeds must be reinvested in a new residence within two years, or the QPRT will either have to (i) terminate and distribute assets to the grantor or (ii) convert to a grantor retained annuity trust (GRAT).
If, at the end of the grantor's term of years, the grantor desires to remain in the residence, the QPRT may give the grantor an option to lease the residence for the rest of his or her life. The lease payments must be a fair market rental, but the lease payments themselves present an additional estate planning benefit, especially if the beneficiary’s marginal income tax bracket is lower than the grantor’s marginal estate tax bracket. Thus, further assets are removed from the grantor’s estate, at a lower tax cost.
For income tax purposes, the grantor is treated as the owner of the residence for the stated trust term. Accordingly, he or she is eligible to deduct real estate taxes and the interest portion of any mortgage. A sale of the residence during the trust term may also qualify for the home sale exclusion of gain if the applicable home sale ownership rules are satisfied. Because a QPRT transfer is treated as a gift, the beneficiary's basis is generally equal to the grantor's basis. Therefore, the potential income taxes due on sale by the beneficiaries must be weighed against the potential estate tax savings.
It should be noted that, while an individual can transfer a residence with a mortgage to a QPRT, it does complicate the tax benefits significantly. Where a residence subject to a mortgage is transferred to a QPRT, the grantor has made a gift of only the equity in the property and not the full market value. As subsequent principal payments are made on the mortgage, the grantor would be treated as making additional taxable gifts that would be measured by a specific calculation method. The interest portion should remain deductible, in most cases, under income tax rules. Nonetheless, in order to alleviate the future gift tax consequences, it is generally best to transfer a non-mortgaged residence to a QPRT.
Because a QPRT does not adversely impact a grantor’s income, it is frequently a favored vehicle for intra-family transfers. A QPRT is ideal for vacation or second home transfers and affords significant upside from a wealth transfer perspective, with virtually no downside risk.
LARA M. SASS is the Managing Attorney at Lara M. Sass, PLLC,
a boutique firm, located in Roslyn (Long Island) and Manhattan, New York,
dedicated exclusively t
o the practice of trusts and estates law.
Please call (917) 628-8007 or visit
www.newyorkwillsandtrustslaw.com for more information.