What is a Qualified Personal Residence Trust (QPRT) and How Does it Work?
A QPRT is typically used to transfer ownership of a primary residence or second home to your family with estate and gift tax savings. If you are considering ways to transfer assets to your heirs in a tax-efficient manner and would like your primary residence and/or vacation home to remain in the family, holding your home in a QPRT may be a strategy that makes sense for you.
When you transfer your property to a QPRT, you (as “Grantor”) retain the right to remain in the home for a specified period, after which the residence becomes the property of your named trust beneficiaries. When the property is initially transferred to the trust, the transfer is treated as a currently taxable gift. The value of the gift is calculated by subtracting the value of the retained interest (i.e., the right to live in the residence) from the current fair market value of the property. The longer the trust term, the more the gift is discounted. Additionally, based on the way the retained interest is calculated, in higher interest rate environments, as we are currently experiencing, the transfer results in a lower calculated gift tax.
Potential Benefits of a QPRT
The main goal of establishing a QPRT is to save on gift and estate taxes. When you transfer property to a QPRT, the asset is removed from your taxable estate, and the value of the property is “frozen” at the time of the transfer for gift and estate tax purposes. Any future appreciation in value will not be taxed as part of your estate. The 2022 federal combined gift and estate tax exemption is $12.06MM for an individual ($24.12MM per married couple). This will increase in 2023 to $12.92MM per individual ($25.84MM for a married couple). The amount of your estate that exceeds the exemption amount is typically taxed by the federal government at a tax rate of 40%. These amounts, which were enacted as part of the 2017 Tax Cut and Jobs Act, are set to sunset at the end of 2025. If the higher exemption amounts are not extended, the exemption amount will return to $5MM in 2026 (adjusted for inflation). By removing a valuable asset from your estate and “locking in” the value of the residence, you may be able to reduce your estate and gift tax liability, even if exemption amounts do revert to pre-2018 levels. Finally, you can continue living at your residence without paying anything for the term of the retained interest period. At the end of the QPRT period, you will have to pay fair market value rent to the trust beneficiaries. However, this results in the removal of additional assets from your estate (free of gift tax) as the rent is paid.
Considerations in Deciding on a QPRT
While the QPRT does have tax advantages, there are several points to consider before making a decision.
It’s irrevocable. A QPRT is an irrevocable trust, which means that once it has been established and the property has been transferred into the trust, the trust cannot be undone or changed.
It reverses if the grantor dies. If the grantor dies during the retained interest period, the property returns to the taxable estate at its current market value, as if you hadn’t created the trust No penalties are imposed or other repercussions are involved.
The residence must be occupied. The grantor must continue to use the residence for a specified period in order to maintain its qualified status.
A mortgage complicates the situation. Any mortgage payments are considered additional gifts to the QPRT. In addition, the grantor no longer owns the residence, so if it is not currently mortgaged, you cannot take out a mortgage on the property; and the property cannot be used as collateral.
If the property is sold it must be “replaced.” If the property is sold during the retained interest period and another property of equal or greater value replaces it, then the QPRT is still valid. Otherwise, the trust will most likely convert to a Grantor Retained Annuity Trust (GRAT).
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