Wealth management is an important issue for those with substantial assets to protect. Many people incorrectly assume that their estates will escape federal estate tax as a result of underestimating what their principal residence will be worth when they die. Often, our homes are our most valuable assets. The Qualified Personal Residence Trust (QPRT) provides a means for significantly reducing the estate tax consequences of the family home and one vacation home. The QPRT also provides an excellent asset protection vehicle since you no longer own the property once the trust is established.

The following is a summary of the benefits and features of a Qualified Personal Residence Trust.

What is a Qualified Personal Residence Trust?

A QPRT is an irrevocable trust created by the Grantor (yourself) for your own benefit. The Grantor transfers a primary or secondary residence into the trust and retains the continued right to use the residence for the term of the trust. You, as Grantor, select a term of years that the trust will exist. After the trust ends, the residence will pass to the named trust beneficiaries.

How is a QPRT established?

A formal appraisal should be obtained to substantiate the value of the residence on the date of transfer to the trust. The Grantor makes a taxable gift to the trust. The taxable gift is the fair market value of the transferred residence reduced by the value of the interests retained by the grantor. Because the remainder is a future interest, it will not qualify for the $10,000 annual exclusion. The taxable gift will be determined by using the actuarial tables in IRS Publication 1457 to value the remainder, taking into account the two values retained by the grantor, i.e. (i) the right to income for the term of the trust, and (ii) the right to receive the property back if the grantor dies during the trust term. The table determines the rate by taking into account the term of the trust and your age at the time of the gift to the trust.

How is a QPRT Operated?

The trust document must prohibit the sale of the residence held in the trust to the Grantor, the grantor’s spouse, or any entity controlled by either of them. The trust should also be prohibited from holding any asset other than a residence used by the Grantor as a personal residence. Personal property, such as furnishings, may not be held in the trust. The document must require that net income be distributed annually to the grantor. The document may permit the sale of the residence and may permit the trust to hold proceeds from the sale of the residence, in a separate account.

You, as Grantor, will have unlimited access to and use of the residence. You have the right to occupy the property, have guests join you at the property, receive the rental income if the residence is rented to third party persons, and sell and purchase other substitute property. You are responsible for paying all expenses relating to the property.

Cash additions may be held in a separate account in an amount that does not exceed the amount needed to pay trust expenses, mortgage payments, or improvements within the next six months. While expenses may be paid from the trust, it will generally be easier for you to pay them directly. The trust is permitted to hold insurance on the property, as well as any proceeds as a result of damage to the residence that are intended to be used for repair or replacement. The proceeds must be held in a separate account.

If you intend to continue residing in the residence after the trust expires, a fair market value rental will have to be paid to the children to avoid estate inclusion.

How do I Terminate a QPRT?

If the term of the trust expires during your lifetime, the residence will pass from the trust to the remainder beneficiaries. The terms of the trust can state that you have the right to rent the residence. IF you fail to survive the term of the trust, the trust will end. Your interest in the QPRT will be includable in your estate. Your estate would get credit for any gift tax that had been paid.

What are the Tax Consequences of a QPRT?

The advantage of the QPRT is the reduced estate and gift taxes on the gift of the property. The transfer of the residence to the trust is subject to gift tax and will consume the unified credit to the extent of the taxable gift. A gift tax return will be required no matter how small the remainder is because it will not qualify for the annual exclusion. However, the taxable gift will be significantly less than the value of the property, since the taxable gift is only a percentage of the value of property transferred to the QPRT based on your age and the terms of the trust.

The full value of the trust assets are exempt from estate tax if you survive the term of the trust. The full value of the trust assets are taxed in your estate if you fail to survive the term of the trust.

All income and deductions are reported to you, as grantor. A separate income tax filing is not required if you are also the trustee. Your children, as remainder beneficiaries, will receive a basis in the property equal to your basis in the property.

California does not impose a property transfer tax when a QPRT is established because it is a gift transaction. Recording fees for the new deed will be imposed.

As an example, if the residence is valued at $1,000,000 and you transfer the property to the QPRT at age 60, for a term of ten years, the following will result:

Property Value $1,000,000

Grantor Age 60 years

Trust Term 10 years

Federal Rate 8%

Value of Taxable Gift $377,565

Value of Retained Interest $622,435

The values would obviously change as any factors change.