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If you are a homeowner who wants to reduce the estate or gift tax burden on your residence, then a qualified personal residence trust (QPRT) may be a good solution. Qualified personal residence trusts are irrevocable trusts that allow a trustor to reside in and maintain an interest in a residence while removing it from their estate.
As a result, the trustor can reduce the potential tax burden on the property. Read on to discover how a QPRT functions so you can consider whether it is a good choice for you.
Qualified personal residence trusts (QPRTs) are irrevocable trusts that allow a trustor to move their real primary or secondary residence out of their taxable personal estate. This allows the trustor to live in their house for a period of "retained interest," which reduces the gift tax accrued when the "remainder interest" is signed over to a beneficiary.
While the trust is in effect, the minimum market value of the property may appreciate. The property’s gift value is less than its fair market value, resulting in a lower gift tax. This tax can also be reduced using a unified credit, which establishes a limited amount of money that can be given to beneficiaries tax-free.
Suppose you would like your spouse, child, or children to inherit the home you currently own. You expect that the value of your residence will increase as you continue to live in it, which means that applicable gift taxes will also increase. Setting up a QPRT lets you, the trustor, keep owning and living in your house while you reduce your future tax burden.
If you set up a 12-year QPRT that expires before you die, your named beneficiary will claim ownership of the home, while any applicable taxes will be determined based on the home’s value at the time the trust was created. If the property doubles in value while you are alive, this increase will not be taxed.
If you die before the trust expires, your home will be subject to estate tax. In the ideal case, the trustor will die just before the trust expires. Since younger trustors are statistically more likely to live longer, they are more likely to benefit from a long-term QPRT that will be active for several years.
Imagine that you are a parent who wants to continue living in your house and then pass it on to your son or daughter when you die. The house is currently worth $400,000, so you set up a 12-year QPRT to reduce the potential tax burden on your estate. During this time, the house's value increases to $700,000.
This $300,000 increase is not taxable, so when the trust expires, you only need to pay gift tax on the $400,000 value of the house that is secured within the trust. When the term ends and your beneficiary assumes ownership of the house, you must vacate the premises or start leasing the house from your son or daughter.
If you die before the trust expires, the home becomes part of your estate, and estate taxes on the home will be assessed at the full current property value.
The primary benefit of setting up a qualified personal residence trust is a reduction in the estate or gift tax burden. Since the value of the trustor’s estate falls when their home is disincluded and subsequently placed into the trust, their overall estate taxes should decrease so long as the house is passed on to the named beneficiary. A trustor should also consider potential benefits and disadvantages when choosing between a QPRT and other types of trusts, such as a living trust, personal residence trust, or charitable remainder trust.
Setting up a QPRT can provide several advantages, including:
QPRTs reduce taxes for the trustor and their beneficiary or beneficiaries.
QPRTs allow trustors to cede their house to their beneficiary or beneficiaries while reducing the gift tax. The IRS discounts the value of the house by allowing it to maintain its value at the time the trust was established while the trust is in effect.
If the trust expires before the trustor dies, the full current property value, including any appreciation, will be excluded from the value of the estate when ownership passes to the beneficiary or beneficiaries.
While the trust is in effect, the trustor maintains a partial interest in the house, which allows them to live in and enjoy the property until the trust expires. When the term ends, the trustor can remain onsite if the beneficiaries choose to rent the property back to them at a fair market rental rate.
The trustor or trustee of the QPRT maintains control of the house throughout the trust’s duration.
Qualified personal residence trusts can have some disadvantages:
QPRTs are irrevocable. According to QPRT rules, the trust cannot be canceled and its terms cannot be changed once it becomes active. The trust will only end prematurely if the trustor dies before the term ends.
QPRTs carry inherent risk because the duration of the trust term is arbitrary. If the trustor dies before the trust expires, then the property reverts to being part of the estate, and any tax benefits will be lost.
QPRTs are most beneficial to trustors who fully own their homes. Once property is placed in a QPRT, it cannot be used as collateral or refinanced. Mortgage payments are not exempt from gift tax.
The suitability of a qualified personal residence trust is best discussed with an experienced estate-planning attorney. When you are ready to consider taking the next steps in your estate planning process, call (800) 662-0882 today to find out if creating a QPRT is right for you and your family.
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