Transferring family wealth has been limited by legislation so that may traditional estate planning techniques are no longer available. However, one of the remaining techniques which involves your personal residence has become increasingly popular. The use of a grantor retained interest trust has the potential to save you substantial estate taxes. The reader should read our basic articles on Wills and Trusts and on Life Insurance Trusts before reading further.
You can transfer your wealth to your children or others and retain the use of your home for a fixed number of years. By using a qualified personal residence trust (QPRT) you can avoid estate and gift taxes on any future appreciation in the value of your home and you can make this transfer as a relatively small taxable gift. The value of your gift is the value of the future interest of your residence. This will depend on the current value of the home, the current interest rates and the number of years you wish to retain your interest in the home. A QPRT can be used for your personal residence as well as a vacation home.
If the transferor survives the term of the trust the full value of the residence is excluded from his estate. If he dies before the trust ends the full value of the property is included in the estate and all benefit is void. But, nothing ventured, nothing gained.
Personal residence trusts can be very flexible. The transferor can continue to deduct the real estate taxes and personal residence interest on his or her tax return during the term of the trust. One can also sell the home and use the tax deferred rollover provisions to buy a new home. The transfer may also qualify for the home owner’s capital gain exclusion on a sale if otherwise qualified.
At the end of the term of the trust the transferor can rent the house at fair market rental from the new owners or they may prefer to purchase the house at fair market value before the trust ends. There should not be any prearranged plan to repurchase the home or the IRS may challenge the trust.
Remember when the residence is transferred to a QPRT a taxable gift is made. Gift tax returns must be filed. The donor may use part of his/her estate and gift tax exclusion to offset the tax.
A QPRT may be the appropriate technique to save you and your heirs estate taxes. If you think it may be useful in your estate plan discuss the qualified personal residence trust with your tax and legal advisor.
Tax and Nontax Benefits
. • Can be used to transfer ownership of a residence to your children with little or no gift or estate tax cost
. • You can retain the right to use the residence for a fixed term
. • You can arrange to rent the residence at the end of the trust term
. • Can be used to transfer a second home (e.g., a vacation home) in addition to a primary residence
Examples of How it Works
If you are like many people, your home may be one of your most rapidly appreciating assets. Transferring your home to a QPRT is a way to remove it (and its future appreciation) from your taxable estate with little or no gift or estate tax cost. You would retain the right to live in the home for a stated number of years. At the end of that term, ownership of the home would be transferred to the trust’s remainder beneficiaries—presumably your children. However, you can arrange beforehand to rent the house from them for the remainder of your life at its fair rental value, and any rent you pay your children will further reduce your estate. If you outlive the stated term of the trust, the house (including any appreciation in its value) would be excluded from your taxable estate. The gift you made to your children would be relatively small, as seen in the following example.
Example – Arthur and Paula, both 50 years old, own a house worth $750,000. They transfer the house to a qualified personal residence trust, retaining the right to live in the house for 20 years. At the end of the 20-year term, the house is distributed to their children. Arthur and Paula will be treated as making a gift of only $164,339 (based upon IRS published interest rates at the time the trust is created), which is well within the amount they can give their children without incurring gift tax. If the house appreciates at the rate of 5% per year, the house will be worth $1,989,973 by the end of the term, possibly saving their children over $821,535 (= 45% x ($1,989,973 - $164,339)) in estate taxes. Arthur and Paula can also enter into an agreement with the trustee, before the end of the 20 year term, to rent the house from the children for its fair rental value beginning at the end of the 20 year term.
. • The full value of the house will be included in your estate if you do not survive for the entire term of the trust (but your estate will not pay any more tax than if you had not created the trust).
. • If you rent the house at the end of the trust’s term, the rental you pay will be income to the remainder beneficiaries (e.g., the children), even though it's not deductible by you. However, your beneficiaries’ income should be offset, at least partially, by allowable deductions for depreciation and maintenance of the residence.
Frequently Asked Questions
• May a qualified personal residence trust hold any assets other than a personal residence?
The only other asset the trust may hold besides a personal residence is a limited amount of cash—enough to meet up to three months of trust expenses.
• What if I no longer wish to live in the same house?
The trustee is permitted to sell the house and purchase a replacement residence within two years of the sale.
• What if I want to move to a rental community during the trust term?
The trust may provide that the house may be sold and the proceeds used to provide you with an annual payment—called a “qualified annuity interest”—for the remainder of the trust’s original term.
• If the trust holds my principal residence and sells it at again, can the trust avoid capital gain tax on the gain just as I could if I sold it myself?
Yes, probably. A qualified personal residence trust can usually be designed so that it qualifies for the same capital gain tax advantages that the grantor would enjoy if he or she retained ownership of the residence.
• I have heard that the estate tax has been repealed. Why should I bother to put my home into a trust?
The estate tax has been repealed only for people dying in 2010—not for anyone dying before or after that year. It will take an act of Congress to continue repeal beyond 2010. In light of the uncertainty of repeal, it may still make sense to take advantage of available tax saving techniques if you have sufficient wealth to be concerned about estate taxes. See our Newsletter Number 9 for an explanation of the Estate Tax “Repeal.”