A Qualified Personal Residence Trust (QPRT) Can Be an Effective Estate Planning Tool for Affluent Clients

A QPRT is a type of Grantor Retained Income Trust (GRIT) which is established to hold personal residences, including vacation homes, for the benefit of family members. Generally, this form of GRIT is created by transferring a residence or other property to an irrevocable trust with the grantor retaining the right to the income from the trust for a specified number of years, or allowing possession by the grantor of the trust property for the term of the trust. At the end of the trust term the property is distributed to the beneficiaries of the trust. The personal residence may include appurtenant structures used for residential purposes and adjacent land which is not in excess of that which is reasonably appropriate for residential purposes (taking into account the size and location of the residence). Treas. Reg. 25.2702-5(c)(2). A QPRT can hold limited amounts of cash for expenses or improvements to the residence and can also allow the residence to be sold or exchanged for another personal residence. The personal residence must be occupied by the grantor (with or without the spouse and/or dependents) and need not be a primary residence. Thus, it can include a vacation home or an undivided fractional interest in either. See Treas. Reg. 25.2702-5(b)(2)(i).

By transferring assets into a QPRT the grantor transfers the remainder interest in the property to the trust beneficiaries, typically children, which by definition is a future interest gift and does not qualify for the annual exclusion under IRC 2503. The value of the remainder interest at the time of the transfer is applied towards the grantor’s unified credit. This effectively allows the grantor to shift the appreciated asset from his or her estate to his/her trust beneficiaries.

The challenging aspect to the establishment of a QPRT is the selection of the appropriate term of the trust. A typical term for a QPRT is 10 years although the term may be varied to suit the grantor’s particular circumstances. The longer the term of the trust, the greater the value of the retained interest and, hence, the lower the value of the gift. If a term of sufficient length is chosen such that the value of the retained interest approaches 100%, significant estate tax liability due to appreciation in value of the residence is eliminated.

Because all income, deductions and credits are treated as if no trust exists and are attributable to the grantor, the grantor achieves additional tax leveraging by effectively achieving a tax-free gift of any tax due on the earnings on the trust assets, thereby removing the income tax liability from the grantor’s taxable estate. However, should the grantor fail to survive the trust term, the entire trust principal valued at the date of the grantor’s death is included in the grantor’s estate, thereby effectively wiping out the intended tax advantage. This is because the grantor has retained an interest for a period which did not, in fact, expire before the grantor’s death.

At the end of the term, the QPRT distributes the residence (or cash from a sale within two years of the conclusion of the trust term) to the trust beneficiaries, typically the grantor’s children or another trust. The grantor thereafter customarily becomes a tenant in the property. Upon transfer of the trust property to the named beneficiaries the grantor will typically lease the property from the beneficiaries, for fair market value as such leasing does not cause the property to be included in the grantor’s gross estate. Private Letter Ruling (PLR) 199916030.

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