A “Qualified Personal Residence Trust”, or “QPRT” for short, is an irrevocable trust that allows someone to remove their personal residence from his or her estate. The goal is to reduce the gift tax when transferring assets to your beneficiaries. The main benefit of the QPRT is by giving your residence away you avoid gift tax liability.
With a QPRT, you have the right to live in your residence for the duration of the terms outlined in the trust without paying rent. After the terms are up, the beneficiary takes control of the property. The main benefit or goal of this type of trust is that since you are not the owner of the residence at time of death, it is removed from estate taxes.
How Does A Qualified Personal Residence Trust (QPRT) Work?
With a basic understanding of what a qualified personal residence trust is, now we can review how it works. We can also review the steps needed to create one. Let’s dive in.
How QPRTs Work
A QPRT removes the personal residence from the trustor or grantor’s estate. This includes all future appreciated value, at a reduced value and gift tax rate. A QPRT is useful when the trust expires after the trustor dies.
The risk lies in trying to determine the ideal length of the trust agreement. If the trustor dies before the end of the term then the property will be included in the estate and shall be taxed accordingly. In theory, a longer-term trust would benefit from a small remainder interest given. This would reduce the gift tax, to the beneficiaries.
The period of time you are allowed to live in the property with a “retained interest” in the house. Once that time is complete, the interest remaining transfers to the beneficiaries as “remainder interest”.
- “Retained Interest” is future, unpaid (currently), interest that adds the remainder of the principal of a loan to come up with a payout amount if the loan is terminated prior to the completion of the original terms
- “Remainder Interest” is someone with a future interest in an asset. In this type of trust, it is contingent interest when the owner of the property surrenders their claim to the estate
How Do You Create A QPRT?
Now that we understand what a QPRT is, we can explore how to create one. In order to create a QPRT, there are several steps that you must take. The steps are outlined below:
- Draft the irrevocable trust agreement. You must determine who beneficiaries and trustees are and decide how long you would retain the right to live in the residence, prior to transferring to the beneficiaries.
- Fund the QPRT with your residence. You must create a new deed that transfers ownership from the owner to the QPRT trust, essentially placing your home in the trust.
- Appraise your home in order to get fair market value for the home to determine the gift tax.
- Report to IRS and fill out the form 709 (Transfers subject to the federal gift and certain generation-skipping transfer (GST) taxes. Allocation of the lifetime GST exemption to property transferred during the transferor’s lifetime.)
- Reside in your home until terms of the trust agreement are concluded
- Transfer to beneficiaries after the terms of the agreement come to an end. The transfer is detailed by the QPRT. A new deed from QPRT to the beneficiary’s name will be needed at this point.
Bonus Step: You can rent out to the person living in the home. This will give more assets to the estate, free from the gift tax.
Pros And Cons Of QPRTs
Whether to include a QPRT in your estate planning depends on your, as well as your family’s, financial circumstances. A QPRT can serve a great purpose for you and your beneficiaries. Some of the notable benefits and disadvantages include:
Pros Of A QPRT
The biggest pro of a qualified personal residence trust is the estate tax benefits. Some tax benefits related to using a QPRT as a gifting mechanism include the following, in addition to other pros:
- The trustor’s taxable estate will avoid the gift tax. The gift tax value is determined at the time it is transferred
- You have a reduced taxable estate instantly, since your residence and any appreciation on it are removed from your estate
- The property transfer into a QPRT is treated as a currently taxable gift. The value is based on the present value, so the longer the trust term, the more the gift is discounted
- Continued tax free usage of the property
- You avoid probate court process upon death
Cons Of A QPRT
You must be careful with the terms of the QPRT. You must make sure that you do not need to make any changes prior to setting this up. It becomes very costly if the terms are not met, and also changes are not allowed. Some of the other cons for this type of trust include:
- This is an irrevocable trust, therefore you cannot make any changes once you place your residence in this trust
- You cannot mortgage the property after you create the QPRT. Additional mortgage payments after the trust is created will be considered as additional gifts (and taxed as such)
- If the trustor dies during the terms that were specified in the trust, the benefits are lost. The beneficiary may be liable for the taxes on the assets. The tax cannot be paid with the property however
Final Thoughts: Start Planning Your Estate
Why should you choose a qualified personal residence trust? If you want to take advantage and reduce your taxable estate, this could be a good tool to accomplish this. It is, however, an irrevocable trust. You need to make sure you have the terms set up correctly when creating this. It is best to check with a financial advisor prior to doing so if you have any questions or issues that need to be addressed.