Do you want to give your home to your children without including its value in your estate for state and federal tax purposes? Do you want to be able to gift property to your heirs while still retaining the ability to live in it and hold an ownership interest for a set amount of years? Are you more interested in your primary residence as a point of legacy for your family for generations to come rather than a vehicle for wealth and potential liquidation? Then you might be interested in a qualified personal residence trust.
This type of irrevocable trust is specialized to help facilitate the transfer of a residence into the ownership of a beneficiary while retaining certain rights and privileges for the grantor for a set period, called the “retained income period.” But to understand a qualified personal residence trust, you must first understand how irrevocable trusts work and why they affect estate taxation.
A qualified personal residence trust is an irrevocable trust. This means that once it is created, it cannot be amended to change unless completely undone by all interested parties. As a grantor, you cannot do much to affect an irrevocable trust once it is set in motion, meaning you must be sure about when and why you execute it.
Qualified personal residence trusts are ideal for people who wish to minimize the impact that the transfer of a massive residential property might have on their taxes. An estate can reach a certain individual value before the IRS demands evaluation and taxation.
The estate tax is progressive, reaching a tax rate of 40 percent at its peak. While current federal estate tax exemptions are high – over $12.9 million per individual in 2023 – that can change in the coming years. As such, massive assets – like a home – can significantly impact the size of your estate and leave you with a greater tax liability.
Furthermore, a qualified personal residence trust allows the trust's grantor – and the previous property owner – to continue to use the property as their own for the duration of the retained income period and take the applicable tax deductions. Of course, there are benefits and disadvantages to a QPRT, the same as any other estate planning arrangement.
Aside from the central argument – being able to transfer property to a loved one or heir while still making use of it for an agreed-upon term – there are other distinct advantages to utilizing a qualified personal residence trust.
First and foremost, it allows an individual to minimize the tax impact of appreciation. If your home is slated to increase significantly in value, placing it in an irrevocable trust effectively removes it from your estate. If you die after the term has ended, it will not count toward the value of your estate.
Because a transfer may incur a gift tax – even if the property is transferred into a trust – your lifetime exemption will be impacted. The current individual gift tax exemption is historically high, so taking advantage of it is a good idea. Your lifetime gift tax and estate tax exemption are one and the same.
However, there are also disadvantages to using a qualified personal residence trust.
For one, if you survive the term, you will have to pay rent on the property you no longer own. You will also lose certain property tax benefits, as the home may be reassessed for its current market value. Unless your heir claims it as its primary residence, your home may lose its homestead status for state and federal tax considerations. Furthermore, selling a home tied up in a QPTR is notoriously difficult. It is not a trust designed to facilitate liquidation.
As a trust agreement, there are a few working parts a person must set up before the trust can be put into motion. First, the prerequisite situation for a qualified personal residence trust is that the party wishing to transfer property to a beneficiary while minimizing the amount of gift tax incurred must own the property outright.
From there, setting up the agreement requires the right wording. A qualified personal residence trust is irrevocable, which means there is no way to un-ring the bell once it has been rung. No amendments, no codicils, and no other means of changing the trust outside of working with everyone involved to nullify it outright.
Next, once the right document has been drafted, it must be witnessed and notarized. The trust document becomes valid upon notarization, but the property must be funded into the trust for the arrangement to take effect.
As mentioned earlier, there are risks associated with a qualified personal residence trust. Setting up a QPRT can be costly, as is any other trust. But the tax benefits of a QPRT are null and void if you happen to die before the end of your retained income term.
On the other hand, if you outlive the term, then your beneficiaries may have the right to charge you rent. You cannot pay a nominal fee, either – you can be forced to pay the fair market rent that the property is worth. Dying too soon or outliving the trust’s term come with their fair share of issues worth considering.
Ultimately, a QPRT is ideal in situations where the aim is to keep a home within the family while minimizing the amount of gift tax owed on the transfer of the property and preserving the property’s tax basis. For individuals who would rather transfer their primary residence to their children or grandchildren before death rather than after, a QPRT can be a great choice.
But it becomes a less-than-ideal choice if the goal is to liquidate the home, either now or to preserve it as a form of value for your children.
There are other ways to minimize or even eliminate capital gains taxes when transferring property to your descendants – certain trusts can be structured to re-establish the basis of the transferred property so that your beneficiaries do not need to pay capital gains taxes when selling property based on the property’s value when you acquired it, but instead based on its value when they acquired it.
What type of trust agreement may be best for you and your heirs? Get in touch with our estate planning professionals to find out more. Discuss your options with an estate professional at Werner serving areas such as Newport Beach, Oxnard, Pasadena, and Santa Barbra.
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