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< TAXES & TAXATION

IS A QPRT RIGHT FOR YOUR ESTATE PLAN?

For those of us who own a principal residence or a vacation home, and if our estates may be subject to estate taxes, a QPRT may be worth considering as part of our Estate Plan.

A Qualified Personal Residence Trust (QPRT), sometimes known as a “personal residence GRIT” or a “house GRIT” (GRIT stands for Grantor Retained Interest Trust), should not be confused with a Revocable Living Trust. A QPRT is an irrevocable trust into which a Trustor or Grantor* transfers ownership of either a primary residence, vacation home or an undivided fractional interest in either a principal residence or vacation home. A vacation home is defined, according to the Internal Revenue Code pertaining to this planning, is a property used the greater of fourteen days annually or 10% of the days rented to others annually.

The property is transferred to a trust which allows the Grantor to retain the right to use the property for a term of years (as established by the trust), after which ownership of the property passes to the named beneficiaries of the trust (usually children) or remains in trust for the benefit of the named beneficiaries.

The Benefits of a QPRT. The QPRT’s main benefit to the Grantor and the Beneficiaries is the eventual reduction of estate taxes.

- A QPRT allows the Grantor to transfer the property to children at a reduced gift tax value. Because the gift is of a “future interest” in the property (meaning the beneficiaries can only actually own it at some future date) the value is discounted for gift tax purposes.

- If the Grantor or Grantors live beyond the term of the trust, the full market value of the property, including any appreciation during the term of the trust, is removed from the Grantor’s estate.

- The Grantor or Grantors can continue to use and enjoy the possession of the property during the term of the trust. If the Grantors live beyond the term of the Trust, the beneficiaries can “rent” the property back to the Grantors for fair market rent and this will keep the property from reverting back to the Grantor’s estate for estate tax purposes.

- The Grantors can serve as Trustees of the QPRT and thereby control the property during the term of the Trust.

Example:

A Mother, age 75, has a vacation home with a current value of $500,000. She transfers the home to a QPRT and retains the right to use the vacation home for ten years. At the end of ten years, the trust terminates and distributes out to her son. Assuming an 8% applicable federal interest rate (according to the Internal Revenue Code), the present value of the future gift of the property to the son is $170,600. At the end of the ten year term, the property has appreciated to $1 million. The Mother has, thereby, used only $170,600 of her $1 million applicable gift tax exclusion to transfer $1 million dollar’s worth of property to her son. She has also enjoyed the property for 10 years - or beyond if she decides to “rent” the property beyond that from the new owner, her son. Had the property remained in Mom’s estate, it could be taxed up to 47% of the fair market value at the time of her death - that would be tax of $470,000, instead of $170,600 (approximate figures).

The Drawbacks of a QPRT.
As any estate planning tool, you must discuss the plan with your attorney. Some of the drawbacks of a QPRT include:

- The trust and transfer of property are irrevocable. Once in, if is difficult, if not impossible and expensive to reverse the trust.

- If the Grantor dies during the term of the trust (10 years in our above example), the property is brought back into the Grantor’s estate as if the QPRT never existed and all tax savings are lost. It’s important to note, however, that we would have had the same result had the Grantor never established the trust.

- Without a QPRT, when we die owning property that is passed to beneficiaries, that property’s basis is “stepped-up” to the fair market value at the time of our death. This step-up is lost when using a QPRT. What this means is that if I buy a property during my lifetime for $340,000 and when I die 15 years later (without a QPRT) and the property’s fair market value at the time of my death is $1 million, the property passes to my son with an income tax basis of $1 million. If he sells it later for $1.2 million, he pays capital gains tax on only $200,000 (taking into consideration the usual adjustments for cost of sale, capital improvements or depreciation). If we use a QPRT and the property passes to the beneficiaries according to the terms of the trust, the step-up on date of death is lost. The beneficiary receives the property with the income tax basis of the Grantor, increased by any gift tax the Grantor paid when he or she established the QPRT.

- Once the term of the trust expires, the Grantor loses the right to occupy the property. The beneficiaries, however, can rent the property back to the Grantor for fair market rent.

- Also upon expiration of the trust term and when the property passes to the beneficiary, the property becomes subject to the creditors of the beneficiary - since it is now the beneficiary’s property. If the beneficiary is in a high risk profession and has not done planning to protect assets, the property could be subject to any liens or seizure of the beneficiary.

Frequently Asked Questions Regarding QPRTs:

- Is an appraisal required? Yes, the property must be appraised when the QPRT is established.

- Can I place mortgaged property into a QPRT? There are some special considerations regarding placing mortgaged property into a QPRT and should be discussed with your attorney, but it can be done.

- Can I obtain a loan on the property or refinance once it is placed into a QPRT? The answer is yes, but again this should be discussed with your attorney. Banks, however, are not usually willing to loan on property that is held in an irrevocable trust. The one Bank in our area that is currently (upon qualification) loaning to trustees of irrevocable trusts is First National Bank of Central California in Monterey (contact Liza Horvath in the Wealth Management Division at 831-657-1156).

- Who pays the expenses on the property during the term of the trust? During the term of the trust, the Grantor continues to pay the customary expenses such as maintenance, taxes, repairs, etc.

- How are “deductions” treated? The Grantor is treated like the owner for income tax purposes. Therefore, income, deductions and credits associated with the property pass through the trust to the grantor.

- How long should the term be? There is no minimum or maximum term required by the IRC. Your age is one important consideration for the term of the trust. Remember that you must survive the term of the trust for the planning to accomplish your intent. Discuss the term with your attorney. The longer the term the most likely the savings will be greater - remember the value is lower for tax purposes if the term is longer and also, all appreciation is “free” from tax in your estate.

- If I die before the trust terminates, will I receive credit for the gift tax paid when I established the trust? Generally speaking, any gift tax paid is credited against the resulting estate tax liability. This is a technical question that should be discussed with your attorney or tax advisor.

- If I lease the house back from my children, will this be income taxable to my children? Yes, it will most likely be taxable income to your children. Remember, however, that by paying fair market rent, you are basically transferring more of your assets to your children and, given the current marginal estate tax rates from41% to 47%, it may be a less expensive way to transfer the wealth to your children.

- What if my children won’t rent the property back to me? The IRS (in PLR 9249014) approved a QPRT that continued to hold the property in trust and obligated the new trustee to lease the property to the grantor for fair market rent upon the termination of the Grantor’s term interest. So, discuss the option with your attorney. You may be able to include language in your trust that would obligate your beneficiaries to rent the property back to you, if you so desire.

- Can I buy the house back from the Trust? IRS regulations specifically prohibit the sale of a personal residence from a QPRT to the Grantor.

- How many QPRTs can I set up? Each person can set up no more than two QPRTs - one for a personal residence and one for a vacation home.

The QPRT may be a useful tool for a taxable estate. The above is a brief discussion of the Qualified Personal Residence Trust and many changes and additions can be made to the plan to make the QPRT more effective in your estate. With this, as with all estate planning, an experienced, knowledgeable attorney and CPA should be consulted.



* A Trustor or Grantor is the person or persons who make a Trust and these terms are used interchangeably.


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