Qualified Personal Residence Trust
A home is often times a person’s most valuable and long term asset. That being said in today’s very litigious society it is very important that people protect any and all valuable assets especially their homes. The Qualified Personal Residence Trust is an excellent way to protect your primary residence and even extends to secondary residences and even vacation homes (depending on certain tax code conditions). In addition to the asset protection properties of the Qualified Personal Residence Trust it also has several tax benefits.
What is a QPRT?
A Qualified Personal Residence Trust is a type of irrevocable living trust that is designed to reduce the amount of gift and estate tax that is incurred when transferring an asset to a beneficiary. The asset protection in a Qualified Personal Residence Trust comes into effect partially because it is an irrevocable trust. As a trust it is designed to protect any assets that will be passed on to your beneficiaries. The law sees it as a valid legal method to protect an individual’s assets for their beneficiaries and protects those assets accordingly from creditors and judgments. The trusts irrevocable status means that the conditions of the trust cannot be changed in anyway while the trust is in effect. That means once an irrevocable trust is put into effect no one can change it or is legally obligated to comply with order an individual to change it. This helps to ensure that a judge cannot simply order a person to hand those protected assets to creditors or change the conditions of the trust making one’s enemies at law the beneficiaries of the trust.
The Qualified Personal Residence Trust (QPRT) allows for a person to places the ownership of his or her home into this type trust. The transferee(s) retain(s) the right to live in that home for a set number of years. During this time when the owner is living in the house he would not be paying rent. He would be responsible for all housing expenses like repairs, real estate taxes, and maintenance fees which is covered by Revenue Procedure 2003-42 [2003-23 IRB 993 section 4 Art. II (B) (2)]. If the owner is alive after that predetermined number of years the trust automatically transfers ownership of the home to the owners’ beneficiaries without having to pay estate tax. Now I know what you may be thinking, “I outlived the trust and now I do not have a house to live in because it belongs to my beneficiaries.” This is easily solved by having the beneficiaries rent the home out to the original owner of the house. The attractive part is that paying rent after the Qualified Personal Residence Trust has ended a person is transferring additional assets to their beneficiaries without having to pay any gift or estate tax. There is nothing stopping the kids from paying the rent money back to Mom and Dad or using this money to cover their parent’s expenses. Plus if the house is sold, the proceeds from the sale can be utilized to purchase another residence, and/or other items for the parents, as the beneficiaries see fit.
The Qualified Personal Residence Trust offers the benefits of a trust to protect a residence while allowing the owner to still live in the house while the trust is in effect. This means while the residence is held within the QPRT it is protected from judgments and creditors for however many years the property owner has set. The owner is also allowed to live in the residence during the duration of the QPRT and is able to maintain control of the residence. This means that the owner can still remodel or update the home without any restrictions placed on them because of the trust.
The protection of the home is not the only benefit of the Qualified Personal Residence Trust. The Qualified Personal Residence Trust’s main advantage is the tax benefits it provides to the property owner and the beneficiaries of the trust. When the home is transferred to the Qualified Personal Residence Trust it counts as a gift but a typical IRS gift tax is not applied. Instead the IRS calculates a modified gift tax based on published tables and the amount of time the home stays in the Qualified Personal Residence Trust, which is applied to the value of the home. Once the predetermined amount of time, which is agreed upon when creating the QPRT, has passed and the owner is still alive then the home is passed on to the beneficiaries free of any gift or estate tax.
So, how does the gift tax apply when the house is passed on to the beneficiaries? If the home has appreciated in value since its initial appraisal, the gift tax would be based on the initial value of the home – based on the IRS calculations – and not on the final value of the home. This would save the beneficiaries a great deal of money because they would have to pay a gift tax on the initial value of the home and not on the appreciated value. If the home’s value did not increase or stayed the same then the beneficiaries would not have to pay any gift tax on the home.
So now you may be thinking, “After passing my home to my heirs I may still want to live in it.” As mentioned above, the Qualified Personal Residence Trust allows for the original owner to pay rent, at a fair market rate, on the property. This seems like a strange notion but there is a tax benefit. By paying rent, the original homeowner is transferring assets to his beneficiaries without having to pay any sort of gift or estate tax on those assets. In a Qualified Personal Residence Trust the homeowner is essentially betting that they will live longer than the lifespan of the Qualified Personal Residence Trust. But what happens if the owner dies before the trust ends? In that case the grantor (the homeowner) of the Qualified Personal Residence Trust will have protected his/her home from being seized in lawsuits during his/her lifetime. Taxwise, the modified gift tax percentage on the property would be placed back into it and normal tax laws would apply. The return of the property to the deceased homeowner’s estate is governed by IRC section 2036(a)(1).
Another benefit of the Qualified Personal Residence Trust is the tax benefits can be enhanced if a husband and wife own the home jointly. According to Treasury Regulations section 25.2702-5(c)(2)(iv) a husband and wife can both transfer half their ownership in the home into two separate Qualified Personal Residence Trust. Each separate Qualified Personal Residence Trust allows the husband and wife owners to live in the residence for a set number of years based on the conditions of each Qualified Personal Residence Trust. In the case of one of the homeowner’s death before the Qualified Personal Residence Trust ends, the half that was in the trust would be put into the estate and be subject to estate and gift taxes.
So what happens if you want to sell the house that is under a Qualified Personal Residence Trust and buy a new home? The trustee of the Qualified Personal Residence Trust would simply sell the old home and buy a new one in the name of the Qualified Personal Residence Trust. If the new home is worth more than the old one then the trustee would have to pay out of pocket for the difference and would retain ownership of that percentage of the home. If the new home’s value is less than the old one then Treasury Regulation section 25.2702-5(c)(7) and (8) would go into effect. In this case the excess funds would go back to the Qualified Personal Residence Trust grantor, but this would defeat the purpose of much of the tax benefits. The other option is to place the excess funds into the trust and convert those specific assets into a Grantor Retained Annuity Trust, which would provide the trust’s grantor an annuity payment until the Qualified Personal Residence Trust ends.
Setting Up A Qualified Personal Residence Trust
The first step in a Qualified Personal Residence Trust is to have a professional write up the irrevocable trust agreement. You and your professional would decide who the trustees and the beneficiaries are and how long you would retain the right to live in the residence before it is transferred to the beneficiaries. This initial planning stage is very important because as an irrevocable living trust it is very difficult if not near impossible to change its conditions once it goes into effect.
The second step is to fund the Qualified Personal Residence Trust with your residence. This is accomplished by creating a new deed that transfers the home from the owner’s name to the Qualified Personal Residence Trust’s name, which will be recorded in the land records for the property.
The third step is to get your residence appraised on the date it is transferred into the Qualified Personal Residence Trust. This is done to get the fair market value of the property to determine the gift tax.
The fourth step is to report the gift to the IRS. This is done by filling out a Form 709, United States Gift and Generation-Skipping Transfer Tax Return. This form must be completed and filed with the IRS on April 15th of year the property was transferred into the Qualified Personal Residence Trust.
The fifth step is by far the easiest and that is to reside in the home and live your life as usual.
The sixth step occurs once the predetermined number of years for the Qualified Personal Residence Trust ends. The property is transferred to beneficiaries as detailed in the Qualified Personal Residence Trust. This is accomplished by recording a new deed that transfers the residence from the trust’s name to the beneficiaries name and documenting it in the land records for the property.
The seventh and final step is to pay a fair market rent for the property if the former owner wants to continue living there. The rent will transfer more assets to the beneficiaries free of gift taxes and will reduce the size of the taxable estate.