What You Should Know About Qualified Personal Residence Trusts

As you navigate the complexities of securing your family’s future, understanding the various strategies at your disposal becomes paramount. One such strategy is creating a Qualified Personal Residence Trust which, while often poorly understood, can be a particularly powerful estate and tax planning tool. Our goal at Cona Elder Law is to demystify Qualified Personal Residence Trusts, explore their benefits, and explain how they can play a pivotal role in preserving your home for future generations while minimizing estate and gift taxes.

What is a Qualified Personal Residence Trust (QPRT)?

A Qualified Personal Residence Trust (QPRT) is an irrevocable trust established under federal law designed to provide estate tax savings by transferring a personal residence at a reduced gift and estate tax cost from one generation to another. A QPRT is created to hold title to your personal residence for a period of years, after which time title to the property passes to your designated beneficiaries, either outright or in further trust.

How Does a Qualified Personal Residence Trust (QPRT) Work?

To qualify as a QPRT, the trust must comply with the requirements set forth in the Treasury Regulations, namely that the property held in the trust must be the primary residence of the creator of the QPRT and, with limited exceptions, the trust cannot hold any asset other than the residence for the entire term of the trust.

When a QPRT is created, you 1) appoint a trustee, 2) choose a term of years during which you have the right to reside in the property, and 3) name the beneficiaries who will receive the residence at the end of the specified term of years. The term is typically between 5 and 20 years, although the regulations do not impose a minimum or maximum term. By transferring the property to the QPRT, you are making a completed gift for gift tax purposes in the amount of the fair market value of the property at the time of transfer, less the value of your retained right to use the residence (as determined by IRS actuarial life expectancy tables).

The result is that the amount of the taxable gift is a mere fraction of the full fair market value of the property. If you survive the trust term, the full value of the residence, and all subsequent appreciation, will pass to your beneficiaries at a substantially discounted estate and gift tax cost. The amount of the taxable gift you make will depend on your age at the time of the gift, the term of your retained interest, the value of the house, and the federal midterm rate for bonds in the month in which the QPRT is established. However, the discount for gift tax purposes by using a QPRT can be upwards of 75%. After the term expires, the residence will either be distributed to the designated beneficiaries outright or in further trust.

What are the Benefits and Downsides of a Qualified Personal Residence Trust (QPRT)?

The main risk of a QPRT is the failure to survive the term of the trust. If this occurs, the entire value of the house will be brought back into your estate for estate tax purposes. However, the property would have been included in your taxable estate anyway if you had never created the QPRT in the first place, so you are not made any worse off. Another potential drawback in establishing a QPRT is that, if you survive the term, your beneficiaries receive your cost basis in the property. If they instead inherited the property at your death, they would receive a stepped-up basis. However, since the federal and New York State estate tax rates currently range from 46% to 56% and the federal and New York State capital gains rate is currently 19% to 27%, the estate-tax savings can often outweigh the potential increase in taxable capital gains.

It is important to note that after the trust term, the property then belongs to your named beneficiaries and legally, you do not hold title or have a legal right to continue living in the residence. However, you can rent the residence back from your beneficiaries (e.g. your children) for fair market rental value. This is yet another estate and gift tax strategy because the lease agreement effectively allows you to transfer additional funds to your children free from gift and estate tax, over and above the annual gift tax exclusion amount.

Want to Learn More About Qualified Personal Residence Trusts?

The knowledgeable estate tax planning attorneys at Cona Elder Law have extensive experience establishing Qualified Personal Residence Trusts (QPRT) as well as various other types of trusts for our clients that can be custom-tailored to your particular goals and needs. If you have questions or are ready to minimize your estate taxes, contact us today.