How Does a Qualified Personal Residence Trust Work to Reduce Your Estate?
Leveraging the Use of Your Gift and Estate Tax Exemptions
The main benefit of a Qualified Personal Residence Trust, or QPRT for short, is the removal of the value of a primary or secondary residence from your estate at a reduced gift tax value. This, in turn, will remove the value of the property from your estate for estate tax purposes. But before you can understand how a QPRT works to reduce your taxable estate, you'll first need to understand what a QPRT is and what happens during each phase of this type of advanced Trust: What is a Qualified Personal Residence Trust?
Once you understand the different phases and terms associated with a QPRT, you will be ready to understand its benefits.
Calculating the Value of the Gift into a QPRT
When you transfer your family homestead or vacation property into the name of your QPRT, you are deemed to have made a gift to the ultimate beneficiaries of the QPRT for gift tax purposes. But how is the value of the gift calculated?
Since you'll retain the right to use the residence for the retained income period of the QPRT before ownership is transferred over to the final beneficiaries of the QPRT, the value of the gift can't possibly be equal to the fair market value of the property on the date of the transfer. In other words, you'll be making a gift to the trust beneficiaries that they won't be able to take full ownership of for many years. Thus, the value of your gift will be calculated at a fraction of the fair market value of the property.
This calculation depends on your age at the time of the gift, interest rates during the month of the transfer, and the number of years you choose for the retained income period. All of this adds up to leveraging the use of your lifetime exemption from gift taxes since, for example, a house worth $650,000 may only cost you $200,000 of your lifetime gift tax exemption when you transfer it into a QPRT.
Removing the Value of the Residence from Your Estate
When the retained income period of your QPRT ends, ownership of your family homestead or vacation property will be transferred over to the final beneficiaries you've named in the QPRT. Thus, you will no longer have any ownership rights in the property. In turn, the IRS can't assess an estate tax against something that you no longer own, so by establishing a QPRT and outliving the retained income period; you'll have effectively leveraged the use of your gift and estate tax exemptions.
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.