A Qualified Personal Residence Trust (QPRT) is an irrevocable trust created by an individual (donor). At the time of its creation, a QPRT is funded with the donor’s ownership interest in a personal residence. By using a QPRT, the donor can exclude the full value of the residence from the donor’s estate, and the residence will not be subject to estate tax.
The donor transfers title to the donor’s primary residence or vacation home to a QPRT, retaining the right to continue to use the residence for a term of years. Provided the donor survives the term of years, the donor’s reserved right to use the residence terminates when the QPRT term terminates, and the residence will not be included in the donor’s estate for estate tax purposes.
At the termination of the QPRT term, the residence will be distributed to the donor’s children or to other beneficiaries chosen by the donor, or may remain in further trust for the benefit of those beneficiaries. The donor may agree with the beneficiaries or with the trustee to continue to use the residence, so long as the donor pays fair market rent for this use.
The initial transfer of the residence to the QPRT will be considered a gift by the donor for tax purposes. However, the tax consequences of this gift will be considerably more modest than the estate tax consequences to the donor’s estate had no QPRT been created. Provided the donor has not already fully utilized the applicable credit against estate and gift tax, no tax may be payable at the time the QPRT is created.
Since the donor retains the right to occupy the residence until the end of the QPRT term, at the time the QPRT is created the only gift made by the donor is a gift to the remainder beneficiaries of the future right to the residence at the end of the QPRT term. This deferral of the beneficiaries’ full ownership rights in the residence reduces the value of the donor’s gift of the residence, typically by 25 – 50 percent of the residence’s value depending on the duration of the QPRT term selected and prevailing interest rates. In addition, all appreciation in the residence’s value after the transfer to the QPRT will escape estate and gift tax.
For example, if the donor were to transfer a $1 million residence to a QPRT, retaining the right to use the residence for a seven-year term, the value of the present gift to the remainder beneficiaries might be only 50 percent, or $500,000. Provided the donor survives the seven-year term, the residence will not be included in the donor’s estate for tax purposes, nor will any of the appreciation in value of the residence occurring after the initial transfer. If, after seven years, the residence has appreciated in value to $1.4 million, the donor has succeeded in transferring this amount to the beneficiaries at the same tax cost as a transfer of only $500,000.
Note that if the donor dies during the QPRT term, the residence will be brought back into the donor’s estate for estate tax purposes. However, since the donor’s estate will also receive full credit for any tax consequences of the initial gift to the QPRT, the donor is no worse off than if no QPRT had been created.
Since a QPRT is a “grantor” trust, during the term the donor remains entitled to any income tax attributes of the residence, such as real estate tax deductions and other income tax advantages associated with home ownership.
As noted above, if the donor wishes to continue to use the property after the QPRT term, the donor may lease the residence from the beneficiaries at fair market rent. The payment of fair market rent avoids a challenge by the Internal Revenue Service (IRS) that the donor’s continued enjoyment of the residence draws the residence back into the donor’s estate for tax purposes.