Qualified Personal Residence Trust

A qualified personal residence trust (QPRT) is a popular estate planning tool designed to allow the owner of a primary residence or vacation home (often parents) to make a future gift of one or both of them to beneficiaries (often children) in a way that avoids or reduces gift taxes.  Moreover, the owner can maintain control of the home and live in it for a term of years before the beneficiary receives it.

Currently, individuals are entitled to give away up to a total of $1,000,000 in assets during their lifetimes without paying any gift taxes (read more about lifetime gifts and valuable exceptions to this limit).  For any gifts over and above this credit amount, a gift tax of 45% of the value of the gift must be paid.  For example, if you gave away your home valued at $1,500,000, you would pay a gift tax to the IRS of $225,000 ($1,500,000 - $1,000,000 gift tax credit = $500,000 x .45 gift tax for a total tax of $225,000).  A QPRT will allow you to reduce or eliminate this gift tax.  If your home is not worth more than $1,000,000, a QPRT will allow you to save as much of the credit as possible for other gifts.   

A trust is created and the home (or cash to purchase a home) is transferred to it.  You may serve as the trustee of the trust in order to control the management of the home.  In addition, you may continue to live in the house for a term of years.  The length of the term is chosen by you and your attorney based upon your age and health.  After the term of years has expired, the house is transferred to the recipient of the gift.  

The reason these trusts are popular is that the value of the gift for gift tax purposes will be less than the actual present value of the house.  Since the beneficiaries of the gift do not receive the home for the term of years during which you will live in it, the value of the gift to the recipient is diminished.  For example, if you have a home worth $1,500,000 and chose to remain in it for 10 years, the gift tax will not be calculated based upon its $1,500,000 present value.  Instead, gift tax will be based upon the present value of the future gift to the beneficiary of the trust.  In other words, since the recipient of the gift has to wait for 10 years to receive the home, it is not worth $1,500,000 to her.  The longer the term during which you occupy the house, the less value it has for gift tax purposes.  If, for example, the term you remain in the house is only 2 years, the beneficiary would not have to wait as long and the value of the house for gift tax purposes would be higher (resulting in higher gift taxes). 

The IRS has tables to determine the value of the gift, but in our example of a 10 year term, the value will be closer to $1,000,000.  In the final analysis, you may give away a home worth more than the $1,000,000 gift tax credit without paying any taxes.  For a home with a value of less than the $1,000,000 tax credit, you will save a large portion of the credit for other gifts. 

If you wait until you pass to give away the house, the full $1,500,000 value of the house plus any appreciation will be included in your estate and possibly be subject to estate (death) taxes. 

There are some important characteristics of QPRT's that must be considered:

  § If you pass before the end of the chosen term (10 years in our example), the entire value of the home will be included in your estate and be subject to estate (death) taxes.  This would be the case had you not created a QPRT, but you will have wasted the time and cost associated with creating the trust; 

  § Once the term of years during which you choose to remain in the home expires, legal ownership will pass to the beneficiary and you will not be legally entitled to live in it.  If the beneficiary is agreeable, one option is to continue to stay in the home and pay rent.  Although paying rent for a home that was previously owned by you does not sound compelling at first glance, it is another way to make tax-free cash gifts to the beneficiary;

  § QPRT's are irrevocable (noncancelable).  Once the trust is created and the home is transferred to it, you will not legally own the home and may not sell it and use the money to support yourself;

  § The recipient of a gift receives it with the same tax basis you have.  If you paid $100,000 for a house and put it in a QPRT, the beneficiary will take it with a carry-over basis of $100,000.  If he later sells it for $1,000,000, he will have a capital gain of $900,000 upon which income taxes may be owed.  If you instead kept the home and passed it after death, it would be received by the beneficiary with a stepped-up basis of $1,000,000, so the sale will not result in any income taxes.  However, the entire $1,000,000 will be included in your estate and be subject to estate (death) taxes.  A CPA should be consulted to assist in determining whether a QPRT makes sense for a particular home.