Property values in Santa Barbara and on the Central Coast have, for the most part, recovered from the Great Recession. Property values are generally rising. For many families, primary residences, vacation homes and vacation rentals are their most valuable assets, and therefore worthy of some thought to protect and leverage them. There are good estate planning techniques available to take advantage of these properties. One of the more straightforward of these techniques is the use of a Qualified Personal Residence Trust, otherwise known as a "QPRT". Gifting a primary residence or a second home to a QPRT is a clear-cut way for grantors to significantly reduce the value of their taxable estate with minimal disruption to their daily lives, and to ultimately pass more assets along to their heirs.

How Qualified Personal Residence Trust Works (QPRT)

Your attorney will first draft a trust using appropriate Qualified Personal Residence Trust language which specifies (among other things) how long the trust will be in existence and what happens to the assets held in trust when that term is over. You will then need to obtain an independent third-party appraisal on the property you intend to contribute to the QPRT. Once the trust document is drafted and you have the appraisal, you will transfer title of the home to the QPRT for a term of years specified in the trust document. During that term, you can continue to use and enjoy the property held in trust as you always have; nothing really changes.

At the end of the term, the home will then pass—either outright or in trust—to the designated beneficiaries who will become the new property owners. Even though you are no longer the property owner, you can still have use of the property after the term ends, but you will need to pay reasonable rent to the new owners for that right. If you do not survive through the term of the QPRT, the home would be pulled back into your taxable estate and nothing would have been accomplished. As such, it’s important that you be expected to outlive the term of the trust.

The utilization of a QPRT has multiple benefits from a gift and estate tax planning perspective. It’s important to understand that a taxable gift is made to the beneficiaries at the time the property is gifted to the trust. However, for gift tax valuation purposes, the value of the home is not the fair market value at the time of transfer; rather it is the projected residual value of the property at the end of the term. This means that for tax purposes, the value of the gift could be much less than current market value. If the value of the gift is determined to be less than your lifetime gift tax exemption amount, then the exemption is applied and no out-of-pocket cash will be due to cover the gift tax liability.

The use of a QPRT will also freeze the value of the home at the time the gift is made, meaning that any future appreciation on the property will happen outside of your estate. If property values continue to rise, the fact that the value of the home was frozen for estate tax purposes will be a huge advantage for the beneficiaries of the QPRT and will greatly leverage the tax exemption that you utilized in making the gift.

In addition, both spouses could establish their own QPRT, granting an undivided one-half interest in the property to each of their own trusts. This could result in additional discounting of the amount of the gift and further leverage any amount of tax exemption used. The establishment of a separate QPRT for each spouse also increases the likelihood that at least one spouse will survive the term of the trust. The last tax benefit comes upon the termination of the trust when the property passes outright to the children—assuming that the children were the beneficiaries of the trust. At this point, the grantors can still use the property, but they will have to pay the new owners fair market rent. These cash payments will further reduce the amount of your taxable estate as the payments are made to the children over the years.

Things to Consider About QPRT

As stated above, a QPRT often makes great sense from a tax and estate planning perspective. However, there are also many subjective concerns prior to entering into this transaction. For most, the primary concern should probably be whether or not you are ready to pass ownership of the property on to the next generation. Do you feel that your children are ready to become owners of an expensive property and able to effectively handle a co-ownership arrangement? These questions must be considered, and answered, when you begin contemplating the establishment of a QPRT.

Another point of deliberation is that some don’t like the idea of leasing a primary residence that they once owned. For this reason, it can make more sense to gift a second or vacation home to a QPRT rather than the primary residence. Once the property is gifted to the trust, you can no longer remodel or alter the property at will. As such, you should think carefully about all the implications before establishing a QPRT.

Maximixing the QPRT

A QPRT generally provides the greatest benefit if you and your heirs intend to hold onto the property at least through the term of the trust. A home held within a QPRT can be sold, but a sale introduces additional complexity to the arrangement and could result in a diminished benefit for estate tax planning. Oftentimes, the sale of a home will defeat the original purpose of the tax planning that was done. Furthermore, a home within a QPRT can be subject to a mortgage, but a mortgage also introduces an additional layer of complexity and most find it preferable to transfer a home free of debt.

As an example of how a QPRT works: Suppose husband and wife, both age 65, own a primary residence in town and a vacation home at the beach. The vacation home is appraised at $1 million. The house at the beach is filled with wonderful family memories and has become a cherished property for the children and the grandchildren. In 2013, the couple transfers ownership of the beach home to a QPRT. The QPRT has a 10-year term and names the couple’s two children as the trust beneficiaries. Based on the current IRS discount rate of about 2 percent, the residual value of the home at the end of the 10-year term, and thus the value of the taxable gift, would be approximately $820,000 (or $410,000 per spouse). Assuming no prior taxable gifts, this amount is below each grantor’s lifetime gift tax exemption, meaning that no out-of-pocket tax liability will be due. Further, suppose that over the 10-year term of the trust, the $1 million home appreciates in value to $2 million. By using $820,000 of their estate tax exemption, husband and wife have passed a $2 million asset to their heirs. In addition, the couple will not notice any appreciable change in their enjoyment of the property, either during the term of the trust or afterward, as long as reasonable rent is negotiated and paid to the new owners.

In summary, while family dynamics must be carefully considered prior to placing the home in trust, QPRTs can be an excellent way to reduce estate tax liability and to leverage the value of a gift to heirs while ensuring that a beloved property remains in the family. The benefits of this leveraging can be even greater when interest rates increase, thus increasing the IRS discounting rate.

Originally posted to by Venita Zavidny- 06/20/2015 

- The Estate Planning Team
  Rogers Sheffield & Campbell, LLP


This article is not intended to provide legal advice. For legal advice on any of the information in this post, please use the form to the right or contact us by phone at 805-963-9721.


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