Qualified Personal Residence Trusts: The Perfect “Shelter” For Your Home

By Drew Grey, CPA, Partner
dgrey@srgcpas.com

Congress added qualified personal residence trusts (“QPRTs”) to the Internal Revenue Code almost 25 years ago.  Since then QPRTs have become the preeminent way to (i) pass the equity in your home on to the next generation at the lowest possible gift and estate tax cost; and (ii) protect the equity in your residence from some future creditor.  Also, due to favorable IRS rulings starting in 2008 (and continuing to this day), QPRTs are even more attractive than when they began.

Here’s an example of how a QPRT is used to pass the equity to the next generation at a very low gift tax cost.  Assume Dad is a widower, age 65, and has a home worth $1,000,000 that is debt free.  He creates a QPRT for a 20 year term.  That means that he can live in the home rent free until he is 85 years of age.  If he survives to age 85, the QPRT ends and the home is transferred to an irrevocable trust for the benefit of his children.  At that point he would have to start paying rent to the children’s trust.  What is the gift Dad has made to his children?  The gift is not $1,000,000 because the children have to wait 20 years to get the residence.  The time value of money reduces the gift from $1,000,000 to $861,450.  The reason the gift is so much is because current interest rates are so low (we use 1% right now for this calculation).  The gift is further reduced (down to $343,580) because there is some chance Dad may not survive the 20 year term.  In other words, the QPRT has a $1,000,000 gift by $656,420.

What if Dad survives the term but does not want to pay rent?  The IRS rulings, which began in 2008, allow the children to grant Dad a continued term to live in the house rent free.  This so-called “reverse QPRT” is a gift from the children back to Dad.  However, the value of the gift is usually about 40% of the cost that Dad would pay in rent.  It is such an attractive result that many people who might have otherwise hesitated to establish QPRTs are now more comfortable with them.

What if Dad does not survive the 20 year term?  The home is included in his estate and the children will inherit it under Dad’s estate plan.  In that case the QPRT did not work to pass the residence free of estate tax.  However, the family is no worse off than had Dad not set up the QPRT in the first place.

What about creditor protection?  Once the home has been in the QPRT for four years, if Dad gets sued and loses a lawsuit, the judgment creditor will have difficulty getting anything of value from the residence.  QPRTs are an excellent way to motivate a creditor to settle for pennies on the dollar.

QPRTs are not for everyone, of course.  They have significant advantages, and a few disadvantages.  However, in most cases the disadvantages can be minimized and the advantages are overwhelmingly attractive.

The above is not tax advice for any client or matter; it is provided as a topic of general interest to our readers and should not be used for tax planning purposes.  Each client’s situation contains unique facts.

If you are interested in exploring how these rules could benefit you, please contact Drew Grey at (818) 995-0090 or at dgrey@srgcpas.com to receive advice on your specific matter. 

 

 

 

 

October 3, 2012 Posted in Estate Tax Planning, Tax