Jackie, a 70-year-old widow, has an $18 million estate. She owns a home valued at $3 million. She has two married daughters and 12 grandchildren. Jackie wants to reduce her estate taxes and pass her home to her daughters as joint owners. She would like to live in the home until she dies.
Qualified personal residence trusts (QPRTs) are used to reduce estate taxes. Jackie can transfer her home into an irrevocable QPRT while retaining the right to live there for a specified number of years. Once Jackie transfers ownership of her home to the QPRT, it will no longer be part of her estate. After the QPRT terminates, the title and ownership of Jackie’s home will be passed to her daughters.
What is a QPRT?
A QPRT is a type of specialized trust that removes the grantor’s personal residence from their estate to reduce estate and gift taxes that would be incurred when the residence is transferred to the beneficiaries upon the owner’s death.
A QPRT allows the homeowner to continue living in their home for a specified number of years, usually between 5 and 20. This is their retained interest in the home. Once the QPRT expires, the title and ownership of the home are transferred to the beneficiaries as the remainder interest.
While Jackie lives in her home, she is responsible for paying property taxes, mortgage payments, and maintenance expenses on the property.
Because the owner retains a fraction of the home’s value by living in it for many years, the gift value of the home is lower than its fair market value.
How do you establish a QPRT?
Start with talking through your estate planning options with your attorney. An overview of the steps for forming a QPRT includes:
- Write an irrevocable trust agreement.
- Identify the trustee and successor trustee for the trust.
- Determine the length of the QPRT term.
- Fund the trust with the residence by recording a new deed in the trust’s name and filing it with the land records where the property is located.
- Have the home appraised by a licensed real estate appraiser. This value is used to determine the fair market value of the home for gift tax purposes.
- File a gift tax return with the IRS and with your state, if required.
How long does a QPRT last?
Jackie is 70 years old. Ideally, she would like to live in her home for the rest of her life. The term of a QPRT can vary.
If Jackie dies before the QPRT term expires, her home will be included in her estate and will be subject to estate taxes. The key is determining how long to make the QPRT term, so Jackie maximizes the time spent in her home while weighing the risk that she will die within the term.
By making the term length longer, theoretically, Jackie has a higher retained interest in the home. This decreases the remainder interest, which in turn reduces the gift tax.
How does the QPRT reduce gift and estate taxes?
Jackie decided to make the term of her QPRT 10 years. If the value of her home appreciates from $3 million to $4 million, the $1 million in additional home value will be tax free. The home’s value also depreciates over ten years while Jackie lives in it.
If Jackie dies before the ten-year term expires, the fair market value of the home when she dies will be included in her estate. Jackie’s home will be valued based on the date of her death, not the value when the trust was established.
What happens when the QPRT terminates?
Once the QPRT expires, the title and ownership of Jackie’s home passes to her two daughters. Jackie no longer owns her home. She must either move out or enter into a lease agreement with her daughters.
Entering into a lease agreement with her daughters is another way Jackie can transfer part of her wealth to the next generation without using annual exclusion gifts or more of her lifetime gift tax exemption.
If Jackie’s daughters plan to keep the family home, a QPRT could be ideal. If they sell the family home once they inherit it, they will owe capital gains taxes based on the difference between the home’s value when it was gifted into the QPRT and its current value. However, capital gains taxes are lower than estate taxes.
A QPRT can be the ideal estate planning tool if you plan to pass your primary or secondary residence to your heirs and would like to minimize your estate taxes and continue living in the home.
A QPRT has several variations; once the irrevocable trust is established, it is difficult to change your mind. You must also wager on whether you will outlive the term of the QPRT.
The current U.S. federal estate tax exemption for 2023 for individuals is $12.92 million. The combined exemption amount for married couples is $25.84 million. For most people, these high exemption amounts mean they do not need to be concerned about federal estate taxes.
This generous law, however, will expire in 2025, and it is currently unknown what the estate tax exemption will be after the law changes. A QPRT is an estate planning tool that can assist in mitigating the effects of potential future changes in the estate tax exemption.
Talk to an estate planning attorney at Katzner Law Group to determine whether a QPRT is the proper estate planning tool for you.