A Surprising Tool To Help You TOP QUALITY RESIDENCES

A Qualified Personal Residence Trust (QPRT) is a wonderful tool for persons with large estates to transfer a principal residence or vacation home at the lowest possible gift tax value. The overall rule is that if an individual makes something special of property in which she or he retains some benefit, the property is still valued (for gift tax purposes) at its full fair market value. In other words, there is no reduced amount of value for the donor’s retained benefit.

In 1990, to ensure a principal residence or vacation residence could pass to heirs without forcing a sale of the residence to pay estate taxes, Congress passed the QPRT legislation. That legislation allows an exception to the general rule described above. Due to this fact, for gift tax purposes, a decrease in the residence’s fair market value is allowed for the donor’s retained interest.

For example, assume a father, age 65, has a vacation residence valued at $1 million. He transfers the residence to a QPRT and retains the right to utilize the vacation residence (rent free) for 15 years. At the end of the 15 year term, the trust will terminate and the residence will undoubtedly be distributed to the grantor’s children. Alternatively, the residence can stay in trust for the advantage of the children. Assuming a 3% discount rate for the month of the transfer to the QPRT (this rate is published monthly by the IRS), the present value of the future gift to the children is $396,710. This gift, however, can be offset by the grantor’s $1 million lifetime gift tax exemption. If the residence grows in value at the rate of 5% each year, the worthiness of the residence upon termination of the QPRT will be $2,078,928.

Assuming an estate tax rate of 45%, the estate tax savings will be $756,998. The net result is that the grantor will have reduced the size of his estate by $2,078,928, used and controlled the vacation residence for 15 additional years, utilized only $396,710 of his $1 million lifetime gift tax exemption, and removed all appreciation in the residence’s value through the 15 year term from estate and gift taxes.

While there is a present-day lapse in the estate and generation-skipping transfer taxes, it’s likely that Congress will reinstate both taxes (maybe even retroactively) time during 2010. If not, on January 1, 2011, the estate tax exemption (which was $3.5 million in 2009 2009) becomes $1 million, and the most notable estate tax rate (which was 45% in ’09 2009) becomes 55%.

Even though the grantor must forfeit all rights to the residence by the end of the word, the QPRT document can give the grantor the right to rent the residence by paying fair market rent once the term ends. Moreover, if the QPRT was created as a “grantor trust” (see below), at the end of the term, the rent payments will not be subject to taxes to the QPRT nor to the beneficiaries of the QPRT. Essentially, the rent payments will be tax-free gifts to the beneficiaries of the QPRT – further reducing the grantor’s estate.

Ki Residences Singapore The longer the QPRT term, the smaller the gift. However, if the grantor dies during the QPRT term, the residence will be brought back into the grantor’s estate for estate tax purposes. But because the grantor’s estate may also receive full credit for just about any gift tax exemption applied towards the original gift to the QPRT, the grantor is no worse off than if no QPRT have been created. Moreover, the grantor can “hedge” against a premature death by creating an irrevocable life insurance trust for the benefit of the QPRT beneficiaries. Thus, if the grantor dies during the QPRT term, the income and estate tax-free insurance proceeds can be used to pay the estate tax on the residence.

The QPRT could be designed as a “grantor trust”. This means that the grantor is treated because the owner of the QPRT for income tax purposes. Therefore, through the term, all property taxes on the residence will be deductible to the grantor. For the same reason, if the grantor’s primary residence is used in the QPRT, the grantor would be eligible for the $500,000 ($250,000 for single persons) capital gain exclusion if the principal residence were sold during the QPRT term. However, unless each of the sales proceeds are reinvested by the QPRT in another residence within two (2) years of the sale, a portion of any “excess” sales proceeds should be returned to the grantor each year through the remaining term of the QPRT.

A QPRT is not without its drawbacks. First, there’s the risk mentioned above that the grantor does not survive the set term. Second, a QPRT is an irrevocable trust – after the residence is positioned in trust there is absolutely no turning back. Third, the residence does not receive a step-up in tax basis upon the grantor’s death. Instead, the foundation of the residence in the hands of the QPRT beneficiaries is the same as that of the grantor. Fourth, the grantor forfeits all rights to occupy the residence at the end of term unless, as stated above, the grantor opts to rent the residence at fair market value. Fifth, the grantor’s $13,000 annual gift tax exclusion ($26,000 for maried people) cannot be used in reference to transfers to a QPRT. Sixth, a QPRT isn’t an ideal tool to transfer residences to grandchildren because of generation skipping tax implications. Finally, by the end of the QPRT term, the house is “uncapped” for property tax purposes which, based on state law, you could end up increasing property taxes.

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