The Pros and Cons of Qualified Personal Residence Trusts
A Qualified Personal Residence Trust (QPRT) is a special type of irrevocable trust designed to remove the value of your primary residence or a second home from your taxable estate, at a reduced rate for federal gift tax and estate tax purposes.
Creating a QPRT and transferring ownership of your residence into that trust is a complex maneuver, that cannot easily be undone. Therefore it is essential to contemplate the pros and cons of using a QPRT before you commit to incorporating one into your estate tax plan.
Benefits of Using a QPRT
- Removes the value of your primary or secondary residence, and all future appreciation, from your taxable estate at cents on the dollar. If a home is worth $500,000, depending on interest rates, a homeowner's age, and the retained income period chosen for the QPRT, the homeowner could use as little as $100,000 of his or her lifetime gift tax exemption, to remove a $500,000 asset from his or her taxable estate. This is particularly beneficial if the value of the house increases significantly, say, to $800,000, by the time the homeowner dies.
- Allows continued use of the residence and tax benefits. During the retained income period of the QPRT, the homeowner can continue living in the residence rent-free and may take all applicable income tax deductions.
- Hedges against possible decreases in lifetime gift tax exemption and estate tax exemption. If the value of your home is significant, then the current lifetime gift tax exemption of $5,340,000 will let you establish a QPRT without having to pay any gift taxes. And if in the future the estate tax exemption is reduced significantly, say down to $1,000,000, then you will have locked in the value of your residence for gift and estate tax purposes, and you consequently won't have to worry about how much the house will appreciate in value or what the estate tax exemption will be, at the time of your death.
- Creates a legacy for your family. If you want your home to remain in the family for generations to come, a QPRT will let you to pass on the residence to your heirs in a manner that will encourage them to hold on to it for the long haul.
- Paying rent at the end of the retained income period will help to further reduce your taxable estate. When the retained income period of the QPRT ends, you must pay fair market rent to your heirs, in order to continue using the residence. While this may initially seem like a downside to using QPRT's, it actually allows you to give more to your heir—without using annual exclusion gifts or more of your lifetime gift tax exemption.
Risks Associated With Using a QPRT
- Selling a home owned by a QPRT can be difficult. If circumstances change and you want to sell the residence owned by the QPRT, this could get thorny. You either must either invest the sale proceeds into a new home or take payments of the sale proceeds in the form of an annuity, if you don't wish to purchase a new home.
- Heirs will inherit the residence with your income tax basis at the time of the gift into the QPRT. An heir who sells the home after the retained income period ends will owe capital gains taxes based on the difference between your income tax basis at the time of the gift into the QPRT, and the price of the sale. This is why a QPRT is ideal for a residence the heirs plan to keep in the family, for many generations. But keep in mind: with the estate tax rate currently at 40% and the top capital gains rate currently at 20%, the capital gains impact may be significantly less than the estate tax impact.
- When the retained income period ends, you'll have to pay rent to use the residence. Once the retained income period ends, ownership of the residence passes to your heirs, removing your right to live in the residence rent-free. You must instead pay your heirs fair market rent if you wish to continue occupying the residence for an extended period of time. But, as mentioned above: this potential drawback can be turned into a benefit, by letting you give more to your heirs in a gift tax-free manner.
- When the retained income period ends, you may lose property tax benefits. Once the retained income period ends, there may be negative property tax consequences. For example, the home will be reassessed at its current fair market value for real estate tax purposes. Also, you would lose any property tax benefits associated with owning and occupying the property as your primary residence. In Florida, the home may lose its homestead status for both creditor protection and property tax purposes, unless one or more of the heirs make the home their primary residence.
- If you die before the retained income period ends, the QPRT transaction will be completely undone. If you die before the retained income period ends, the entire QPRT transaction will be undone and the value of the residence will be included in your taxable estate at its full fair market value on the date of your death.
The information contained in this article is not tax or legal advice and is not a substitute for such advice. State and federal laws change frequently, and the information in this article may not reflect your own state’s laws or the most recent changes to the law. For current tax or legal advice, please consult with an accountant or an attorney.