Qualified Personal Residence Trusts
A device to remove the value of your personal residence from your estate and reduce your estate tax exposure is a particular type of irrevocable trust known as a QPRT or qualified personal residence trust. The QPRT removes the value of a residence from your estate at a greatly reduced gift tax cost.
Taking advantage of the benefit of a QPRT requires the transfer of your residence to the trustee during your lifetime. The transfer of the residence to the trust is a taxable gift but you can subtract the value of your right to live rent-free in the residence for the term from the fair market value of the residence. Hence, the amount of the taxable gift should be substantially less than the fair market value of the residence.
The QPRT terms will allow you to continue to live in the dwelling for a fixed period of time stated in the trust document. In determining how long the term of years should be, take your life expectancy into account. Your “life expectancy” in this context means your life expectancy based on your age and health at the time the trust is created. The term should be the projected time you are likely to live. The expenses of the property would continue to be paid by you and include expenses such as insurance, the real estate taxes, expenses for repairs and maintenance and mortgage payments. You continue to deduct the real estate taxes and mortgage interest on your income tax return. When the term ends, the residence is transferred to your named beneficiaries, typically your children.
If you do not survive the term, the entire value of the property will be considered part of your estate. At the end of the term, if you have not died, the value of the property will not be included in your estate for estate tax purposes.
If you want to remain in the residence at the end of the term, you can continue to use the dwelling by use of various. If you are married the dwelling can be retained in a trust for your spouse’s lifetime (and the residence will be available to you) or you can enter into a lease with your children and pay a fair market value rent.
The advantage of the QPRT is that it can reduce transfer taxes of your estate by taking the asset from your estate at a significantly reduced cost of gift tax.
One disadvantage of a QPRT is the loss of ownership of the property if you survive the term. Also, when the property passes to the remainder beneficiaries, they don’t get a step up in basis which they would have had the property passed to them by reason of your death. This means they will need to pay income tax on appreciation in value when the property is sold. Nor would you be able to get a mortgage on the residence as you are no longer the owner. In some states, transfer to a QPRT will result in the loss of a property tax exemption. However, in California, there is no change in ownership on the creation of and transfer of real property into a QPRT. However, at the expiration of the term (or at your death if you die before the expiration of the term if the property is transferred to the named beneficiaries rather than to your estate), there is a change in ownership of the real property, and property taxes is due unless an exclusion applies.
Whether a QPRT will work for you is a very personal decision. You will need to weigh the benefits of having the asset removed from your estate and reducing your transfer tax liability against the possibility of living in a home owned by your children and paying them rent.