TOP QUALITY RESIDENCES Shortcuts – The Easy Way

A Qualified Personal Residence Trust (QPRT) is an excellent tool for persons with large estates to transfer a principal residence or vacation home at the lowest possible gift tax value. The general rule is that if an individual makes something special of property in which he or she retains some benefit, the house continues to be valued (for gift tax purposes) at its full fair market value. Put simply, there is no reduction of value for the donor’s retained benefit.

In 1990, to make certain a principal residence or vacation residence could pass to heirs without forcing a sale of the residence to cover estate taxes, Congress passed the QPRT legislation. That legislation allows an exception to the general rule described above. Consequently, 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, includes a vacation residence valued at $1 million. He transfers the residence to a QPRT and retains the proper 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 benefit 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), today’s value into the future gift to the children is only $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 value of the residence upon termination of the QPRT will undoubtedly be $2,078,928.

Assuming an estate tax rate of 45%, the estate tax savings will undoubtedly be $756,998. The web result is that the grantor could 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 during 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 (perhaps even retroactively) a while 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 (that was 45% in ’09 2009) becomes 55%.

Even though the grantor must forfeit all rights to the residence by the end of the term, 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), by the end of the word, the rent payments will never be subject to taxes to the QPRT nor to the beneficiaries of the QPRT. Essentially, the rent payments will undoubtedly be tax-free gifts to the beneficiaries of the QPRT – further reducing the grantor’s estate.

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 since the grantor’s estate may also receive full credit for just about any gift tax exemption applied towards the initial gift to the QPRT, the grantor is no worse off than if no QPRT had been created. Moreover, the grantor can “hedge” against a premature death by creating an irrevocable life insurance coverage trust for the benefit of the QPRT beneficiaries. Thus, if the grantor dies through the QPRT term, the income and estate tax-free insurance proceeds may 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 as the owner of the QPRT for income tax purposes. Therefore, during the term, all property taxes on the residence will undoubtedly be deductible to the grantor. For exactly the same reason, if the grantor’s primary residence is transferred to the QPRT, the grantor would qualify for the $500,000 ($250,000 for single persons) capital gain exclusion if the primary residence were sold during the QPRT term. However, unless all 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 every year during the remaining term of the QPRT.

A QPRT isn’t without its drawbacks. First, there is the risk mentioned above that the grantor does not survive the set term. Second, a QPRT can be an irrevocable trust – once the residence is positioned in trust there is absolutely no turning back. Third, the residence will not receive a step-up in tax basis upon the grantor’s death. Instead, the basis 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 mentioned 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. Ki Residences Singapore Sixth, a QPRT is not an ideal tool to transfer residences to grandchildren because of generation skipping tax implications. Finally, at the end of the QPRT term, the house is “uncapped” for property tax purposes which, based on state law, could result in increasing property taxes.

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