A Qualified Personal Residence Trust (“QPRT”) is a trust into which you transfer a personal residence.
The QPRT document gives you (and often your spouse) the right to live in the house for a set number of years. At the end of the term, the rights to occupy the residence vest in someone else — typically your children. A QPRT is irrevocable and you cannot later change its terms.
The sole benefit of a QPRT is its offer of gift tax “leverage.” Leverage in a QPRT can take several forms.
One form of leverage is appreciation in the value of the residence used to fund the QPRT. In today’s real estate market, it is difficult to determine the likelihood of appreciation. But suppose you transferred a $200,000 residence to a QPRT. If the retained interest (the right to live there for X years) were worth $150,000 (using the IRS actuarial tables), then the transfer would be a taxable gift of only $50,000, rather than $200,000. The retained right to live in the house worth $150,000 is not a taxable gift because that right was not transferred. The gift of the remainder interest in the residence is also a gift of all of the future appreciation in the value of the residence. At 4% annual appreciation, after 20 years a $200,000 residence could be worth nearly $440,000. Thus, this kind of gift would shield approximately $390,000 from federal estate tax ($440,000 minus the $50,000 taxable gift).
A second form of “appreciation” occurs when you begin with a favorably low value now, due to depressed market values or a particularly good deal on a new property. If you believe the market value will recover or increase, this low valuation alone could make a QPRT a favorable strategy – a classic buy low, sell high scenario. Dividing joint marital property into two separate fractional interests is another good way to reduce starting value.
Usually, the QPRT allows you to lease the residence from the trustee for its fair rental value after the expiration of the term of years. In this way, you can continue to use the property, pass it on to your children at a cost of the estate tax credit used to make the original gift, and reduce your taxable estate with each rental payment. The rental payments are neither taxable gifts by you nor taxable income to your children.
The main catch to the QPRT is that you must outlive the term of years you choose (At age 50, life expectancy is about 30 years). If you die during the term of the trust, then your retained interest in the trust will cause the residence to be fully taxed in your estate at its date-of-death value. Although from a tax standpoint you end up no worse off as your tax credit used to make the gift is restored.
A secondary catch of the QPRT is its sensitivity to interest rates. This sensitivity is a function of the assumed rates of return used in calculating the taxable gift. A lower interest rate decreases the value of the retained interest, and increases the value of the remainder, and therefore the taxable gift. Conversely, a higher interest rate has the opposite effect. This dynamic tends to make the QPRT more attractive when rates are high.
A final catch with the QPRT is its inability to be effectively used in conjunction with a generation-skipping transfer directly to grandchildren.
The QPRT should be weighed against other available strategies with your tax counsel to determine which strategy best accomplishes your individual goals.
