QUALIFIED PERSONAL RESIDENCE TRUST
A qualified personal residence trust ("QPRT") is a special type of trust, detailed by Internal Revenue Service regulations. It should not be confused with a Revocable Inter Vivos Trust (a "Living Trust"). QPRTs are sometimes called QPRGRITs, "house GRITs," or "personal residence GRITs." (The term "GRIT" is an acronym for "Grantor Retained Interest Trust".) A QPRT takes advantage of certain provisions of the law to allow a gift to the QPRT by its creator (the "settlor") of his or her personal residence, usually for the ultimate benefit of children, at a "discounted" value. This, in turn, may remove the asset from the settlor's estate, reducing potential estate taxes on the settlor's death. If a trust conforms to all of the requirements set forth in the regulations, it is not subject to certain special valuation provisions of Internal Revenue Code which limit such discounts, and the retained and remainder interests will be valued under traditional gift tax valuation rules.
The qualified personal residence trust (QPRT) allows the grantors to remove their home from their estate while incurring significantly lower gift taxes than would ordinarily accompany such a transfer.
When a grantor’s home is transferred to a QPRT, he or she may continue to retain an interest in the residence for a period set forth in the trust document. Because the home is “burdened” with a retained interest at the time of its transfer to the trust, it is considered to be worth less than if the trust had assumed free-and-clear ownership. Since the grantor’s home’s value is reduced, less gift tax is owed (if any) on the transfer. The longer a person’s interest in the entrusted property lasts, the lower its value for gift tax purposes.
After the transfer takes place, the grantor retains full right to use the home for the duration of his or her interest in the property. As soon as the interest expires, however, the grantor loses all rights to the residence; the trust assumes 100% ownership and control. Once this occurs, the residence can be turned over to the trust’s beneficiaries, or the grantor can elect to remain in the home, as long as rent is paid to the trust. The IRS requires that fair market rent be paid for use of the home, otherwise, the transfer of the home to the trust will not be considered legitimate.
The QPRT does have its drawbacks. First of all, the transfer is irrevocable: once the property is placed in trust, there is no turning back. Also, should the grantor die before his interest in the home expires, the house will be includable in his estate. Establishing the trust will end up having been an exercise in futility, although the estate is no worse off than it would have been had the QPRT never been established. If the trust is to do its job, then, a grantor’s interest in the property must expire before death.
Another factor that may limit the value of the QPRT is capital gains taxes. If the house is placed in a trust, and the trustees ever decide to sell it, the sale will incur greater capital gains taxes than it would if the property been part of the estate. The cost basis of property owned at the death of the owner is stepped up to the value at the date of death. The cost basis of property put in a trust, on the other hand, is not accorded a step-up in basis above its value when put in trust. Of course, if the home remains in the estate rather than in trust, the estate incurs greater estate taxes.
Additionally, transfer to a QPRT immediately uses part of your $2 million exemption, preventing that from being utilized elsewhere.
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