Qualified Personal Residence Trust (QPRT)
If you own a home and expect to have a large taxable estate, you may want to consider this popular estate planning tool that can minimize federal gift tax and eliminate federal estate tax.
What is a qualified personal residence trust (QPRT)?
A qualified personal residence trust (QPRT, pronounced “Q-Pert,” and sometimes referred to as a grantor retained interest trust, or GRIT) is an irrevocable trust into which you transfer a primary residence or vacation home while retaining the right to live there rent free for a specified number (term) of years. At the end of the term of years, the property passes outright to your children (or whomever you’ve named as the trust beneficiaries).
Tax advantages of a QPRT
When you transfer a home into a QPRT, you’re considered to have made a taxable gift to the trust beneficiaries. However, the value of the gift isn’t the full fair market value of the home, as it would be with an outright transfer. Rather, the gift can be discounted to reflect your retained interest (i.e., your right to live in the home).
Note: You can leverage your $1 million lifetime gift tax exemption, to the extent it has not already been used, to offset any gift tax that is due.
Another tax benefit of a QPRT is that, as long as you outlive the term of years, the value of the home (plus any appreciation) will avoid estate tax because, when you die, it won’t be includable in your gross estate.
Finally, you get to keep all the income tax benefits of homeownership during the term of years.
Deciding on the term of years
One disadvantage of a QPRT is that if you die before the term of years ends, the full fair market value of the home at the time of your death will be includable in your gross estate.
So, deciding on the term of years becomes a tradeoff. The longer the term of years, the smaller the gift to the beneficiaries (and the smaller the gift tax), but the greater the likelihood you won’t outlive the term, defeating the purpose of the QPRT.
One further consideration: If you decide to continue living in the home after the term of years ends, you may do so, but you’ll be required to execute a written lease and pay fair market rent to the beneficiaries.
Capital gains tax savings tradeoff
If your beneficiaries were to receive the home at your death, they would receive an income tax basis that is “stepped up” to fair market value. With a QPRT, however, because your beneficiaries receive the home at the end of the term of years, they’ll receive a carryover basis (i.e., your basis). If the home has appreciated substantially in value, the increased capital gains tax your beneficiaries will owe upon the sale of the home may offset any gift tax savings you will enjoy.
QPRT rules
To qualify for beneficial QPRT tax treatment, the trust must conform to many rules and regulations, including:
1. Can’t transfer more than one home to a QPRT
You can’t transfer more than one home to a single QPRT. However, you’re allowed to set up two QPRTs, transferring one home (a primary residence or vacation home) to each trust.
2. Home must be occupied by you, your spouse, or your dependents
You, your spouse, or your dependents must occupy the home for the entire term of years. The home must be used as a residence at all times, and generally can’t be sold or used for any other purpose.
3. No other property can be held by the QPRT
Generally, a QPRT can’t hold any property other than the home (and related buildings and land reasonably appropriate for residential use). However, a QPRT can hold cash, subject to certain conditions, for limited purposes, such as the initial purchase of a home, the replacement of an existing home, or the payment of certain related expenses.
Plus, asset protection
A QPRT can help minimize gift and estate taxes, and because the trust is irrevocable, it can also be used as an asset protection tool, even if taxes are not a concern. If you’re interested in learning more about QPRTs, talk to your financial professional.