Cummings & Lockwood Estate Planning FAQs

The Qualified Personal Residence Trust (“QPRT”) can be an effective means of transferring one’s residence to one’s children or other beneficiaries at a reduced transfer tax cost:  the owner of a personal residence transfers it to a trust, but retains the right to live in the residence for a specified period of years.  At the end of that period of years, the children (or other designated beneficiaries) become the owners of the residence.  Thereafter, the residence will no longer be a part of the former owner’s taxable estate.

The tax advantage of the QPRT technique comes primarily from the way in which the value of the gift to the trust is calculated for gift tax purposes.  The value of the gift is not the full value of the residence on the date of the gift.  Instead, the taxable gift is only the value of the children’s right to take possession of the residence at the end of the specified period of years, which can be far less than the current value of the property.  For example, a $1,000,000 home can be gifted to a QPRT, removing $1,000,000 from the donor’s taxable estate, but the taxable gift may be as little as 10 or 20 percent of the value of the residence.  By keeping the gift tax value of the QPRT transfer below the donor’s remaining lifetime federal gift tax exemption amount, the donor can avoid paying federal gift tax on the gift.

While the concept of a QPRT is simple, the decision to create one should not be made without a fairly complex tax calculation to determine the value of the taxable gift which will result.  This value is a function of (i) the age of the donor; (ii) the number of years during which the donor will retain the right to occupy the property; (iii) the current appraised value of the property; and (iv) the current IRS actuarial tables and interest rates used to calculate future values. 

• The trust would continue for a specified number of years, after which the property would be transferred either outright to children (or other beneficiaries) or in further trust for their benefit.  Selection of the QPRT term of years requires careful thought since the tax benefits are lost if the donor dies before the QPRT ends.  A longer trust term increases the tax advantages, but also increases the risk that premature death will erase those advantages.

• During the term of the QPRT, the donor is entitled to all rights of occupancy, and will be responsible for all costs of maintenance.

• If the residence is sold during the term of the QPRT, another home can be purchased.  If a replacement home of equal value is not purchased, the unused cash proceeds must either be distributed back to the donor (thus forfeiting the tax benefit), or the cash must be invested and the donor will be paid an annuity for the balance of the QPRT term (thus reducing, though not necessarily entirely eliminating, the tax benefit). 
• During the QPRT term the donor can be the sole Trustee or a co-Trustee of the QPRT, and make all management decisions.

Estate taxes.

The objective of the QPRT is to reduce estate taxes by removing the residence from the donor’s estate.  If the donor’s death occurs after the QPRT has ended, the calculation of the donor’s taxable estate for federal estate tax purposes will only take into account the value of the original gift (the children’s future interest in the residence when the trust was created), and all appreciation in value after the date of the gift will have been removed from the donor’s estate. If the donor dies before the completion of the term of years specified in the QPRT, the trust will end and the property will be distributed to the donor’s estate to be disposed of by the donor’s Will.  The tax advantages will be lost, but there will be no tax detriments—taxes will be calculated as though the QPRT had never been created.

Capital gains.

On the downside, if the donor has survived the QPRT term, the residence will not receive a “step‑up” in its income tax cost basis to estate tax value because the residence will not have been taxed in the donor’s estate.  For this reason, the QPRT is best suited for a home likely to stay in the family until the children’s deaths, when the residence will get the desired step‑up in basis (although there will be no basis step-up if the residence remains in a trust for children).  However, even if the property is later sold by the children or other trust beneficiaries, the capital gains tax (at least under current tax law) will be less than the estatetax that would have been due had the QPRT not been created.

Income taxes.

During the QPRT term, the donor will be treated for income tax purposes as if he or she were still the owner of the property; e.g., the donor can deduct real estate taxes on his or her personal income tax return.  If the property is sold by the QPRT, a capital gains tax will be due in the same amount as if the donor still owned the property.  The donor must pay any such capital gains tax out of his or her own funds, which can produce a good estate tax result because payment of the tax further reduces the donor’s taxable estate if the proceeds of the sale are reinvested by the Trustee in another personal residence.