A Qualified Personal Residence Trusts (QPRT) is an estate planning tool that can provide property owners with substantial estate and gift tax savings. However, they can be complicated to set up, and have numerous rules that must be followed.
In this article, you’ll be exposed to what QPRTs are, how they work, and whether or not one may be right for you. You’ll also be provided with instructions on how to take action if you’re interested to learn more about QPRTs, or you’re ready to begin using one yourself.
What is a Qualified Personal Residence Trust (QPRT)?
A Qualified Personal Residence Trust (QPRT) is a type of irrevocable trust used in estate planning to transfer the ownership of a personal residence to beneficiaries while removing the value of the property from the grantor’s (i.e. the trust creator’s) taxable estate.
This helps reduce the value of an estate and potentially lower the amount of estate tax owed upon their death. Additionally, by transferring their residence to a QPRT, they can take advantage of certain tax benefits while still retaining the right to live in and enjoy their property during the trust term.
How Does a QPRT Work?
With a QPRT, you transfer the ownership of your property to a trust. You also retain interest in your property along with the right to continue living in it for a specified period of time (ex: 10 years), which is called the “retained income period.” During this time, your property is still considered part of your estate, and is subject to estate taxes. You’ll still be responsible for bearing the ongoing expenses related to the property, such as property taxes, maintenance expenses, and other associated costs.
However, because the transfer of your property to the QPRT is considered a gift, you’re able to use your lifetime gift tax exemption to offset some or all of your gift tax liability. This means that after the retained income period ends, and the property is transferred to your beneficiaries, only part of your property is potentially subject to estate taxes.
The value of your property is determined at the time the QPRT is established, and it is based on the present value of the property at that time, taking into account your retained income period. You’re essentially able to freeze the value of your property by placing it into the trust, and then reduce it through the use of your retained income period.
Please Note: The taxable and nontaxable values of the QPRT are derived from the value of the property, the duration of the trust term, and the applicable federal rates (AFR) provided by the IRS each month. The longer your QPRT’s term, the greater your retained income period and the lesser your amount of gift tax exemption needed to cover any estate taxes. Additionally, you can continue living in your property after the end of the retained income period as long as you pay fair market value rent to your beneficiaries.
QPRT Pros and Cons
A QPRT can be a powerful tool for reducing estate taxes and preserving the value of your property for future generations. Nevertheless, similar to any estate planning instrument, there are advantages and disadvantages to take into account, and it’s essential to evaluate them thoughtfully before reaching a conclusion.
Pros
Encourages a Lasting Legacy: The structure of a QPRT incentivizes generational ownership of property. You can continue to live in it during, and even after your retained income period. As a result, it can be a great option if you’re looking to preserve a piece of property within your family line.
Protect Against Appreciation: By using a QPRT, you can exclude the value of your property, along with any potential appreciation, from your taxable estate. This approach can be especially advantageous in the event that the value of your property experiences a significant surge by the time of your passing.
Protect Against Lower Exemptions: A QPRT allows you to lock in your property’s value in relation to your lifetime gift and estate tax exemption. As a result, you don’t need to be concerned about decreases in estate exemption amounts at the time of your death.
Continue to Transfer Wealth and Lower Your Taxable Estate: By paying fair market rent to your beneficiaries after the end of the retained income period, you’re able to transfer more wealth without tapping into your annual exclusion gifts or lifetime gift tax exemption. This process can also work to lower your taxable estate.
Cons
Loss of Ownership: Upon the conclusion of the retained income period, the ownership of the residence will transfer to your beneficiaries, and your right to live in it without paying rent will be lost. If you wish to continue residing in the property, you will need to pay fair market rent to your beneficiaries.
Lost Property Tax Perks: After the retained income period ends, you might lose property tax benefits. The property will be reassessed based on its present market value for tax purposes, which could cause you to forfeit any property tax advantages associated with owning and living in the property as your primary residence.
Challenges in Selling the Property: If you need to sell the property after it’s owned by a QPRT, you may face challenges. You’ll have to either reinvest the sale proceeds into another property, or receive payments from the sale proceeds through an annuity.
Mortality Risk: If you pass away during your retained income period, your property will return to your taxable estate.
Your Tax Basis Passes On: Beneficiaries inherit your property along with your income tax basis at the time the QPRT is funded. As a result, if a beneficiary decides to sell the property after the retained income period ends, they will need to pay capital gains taxes equivalent to the difference between the grantor’s original tax basis (plus adjustments) and the current sale price of the property. For this reason, QPRTs are ideal for families looking to keep a piece of property within their family for generations.
Can a QPRT Be Revoked?
Since a Qualified Personal Residence Trust (QPRT) is an irrevocable trust, implying that it cannot be revoked or terminated by the grantor after its creation. In essence, the grantor must relinquish control of the property and adhere to the trust’s conditions.
The purpose of this is to ensure that the grantor cannot change their mind and interfere with the transfer of the residence to the beneficiaries, as well as to meet the requirements for a QPRT to qualify for estate tax benefits.
QPRT Vacation Home Rules
Vacation homes can be included in a Qualified Personal Residence Trust (QPRT), but there are some important factors to consider. A vacation home can be a valuable asset, but it may not be occupied as frequently as a primary residence and may have a different purpose in your overall estate plan.
Including a vacation home in a QPRT can have similar benefits to including a primary residence, such as reducing the taxable value of your estate and potentially eliminating gift and estate taxes. However, the value of the vacation home may fluctuate more than a primary residence, and it may be subject to different property tax rules.
The choice of whether to include a vacation home in a QPRT is a personal one that depends on your individual circumstances, financial situation, and estate planning goals.
QPRT Calculation Example
Let’s say a homeowner has a primary residence worth $1 million and has an estate valued at $10 million. If the homeowner were to pass away today, their taxable estate would be valued at $10 million, and the estate tax owed would be approximately $3.5 million (assuming a 35% tax rate).
However, if the homeowner were to create a QPRT and transfer ownership of their primary residence into the trust, they would be able to remove the full value of the residence ($1 million) from their taxable estate.
Let’s also assume the homeowner chooses a retained income period of 10 years, and their retained interest in the property would be 50% of the home’s value. This means that for estate tax purposes, only 50% of the home’s value, or $500,000, would be included in their taxable estate.
Using the same assumptions as before, if the homeowner were to pass away with the QPRT in place, their taxable estate would be valued at $9.5 million ($10 million – $500,000), and the estate tax owed would be approximately $3.325 million (assuming a 35% tax rate). By creating a QPRT, the homeowner was able to reduce their taxable estate by $500,000 and save approximately $175,000 in estate taxes.
Please Note: The above is a simplistic example to help you grasp how QPRTs function. The exact numbers will vary based on your unique situation, and will incorporate the lifetime gift and estate tax exemption that specifically applies to you. Please speak with an experienced estate planning attorney or financial advisor to understand how a QPRT will impact your estate.
How to Set Up a QPRT
The following is a step-by-step guide on how to set up a QPRT and utilize it for effective estate planning:
Step 1) Establish Your Trust Agreement: The document that defines the conditions and guidelines for the management and administration of the QPRT is referred to as the legal trust agreement. This agreement should contain information such as the duration of the trust, its purpose, the trustee’s authorities, the allocation of assets to beneficiaries, and other pertinent terms.
Step 2) Place Your Property Inside the QPRT: To transfer the ownership of your property to the QPRT, you must record a new deed in the land records where your residence is located, transferring the property’s title from your name to the trust’s name.
Step 3) Get Your Property Appraised: To determine the value of the residence for gift tax purposes, an appraisal is essential. This valuation will be utilized to figure the potential gift tax amount due when your property is placed inside the QPRT.
Step 4) Notify the IRS: Once you’ve transferred ownership of your residence to the QPRT, you must report your gift to the IRS by filing a Form 709. The return will compute the gift tax amount due based on the residence’s value and the lifetime gift tax exemption amount you’ve used. Please note, if you reside in a state with a state gift tax, you’ll also have to file the necessary state-level gift tax return.
Step 5) Give Your Property to Your Beneficiaries: At the end of the term of the QPRT, ownership of the residence will automatically transfer to your ultimate beneficiaries, such as your children or other heirs. The transfer will occur without the need for probate, which can save time and reduce the cost of transferring the property.
Please Note: You’re still able to live in your property even after it’s placed inside a QPRT. During the retained income period you’re still able to live in your property rent free and claim all eligible income tax deductions. However, once your property is given to your beneficiaries, you’ll have to pay fair market value rent to continue living in your former residence.
How CW O’Conner Can Help You Further
At CW O’Conner it’s a privilege to help our clients keep their legacies in tact. And the primary way we’re able to help is ensuring you have the right estate plan in place.
Depending on your unique situation, it may be worth looking into a Qualified Personal Residence Trusts (QPRT). They’re a powerful tool that’s able to reduce the value of your estate substantially, and assure you and your beneficiaries have a place to stay.
As a team, we’ll help figure out the terms of QPRT that make the most sense. We’ll also be able to work with your attorney and tax professional, or recommend ones of our own. Our vetted network of industry professionals can point you in the right direction for all your estate planning needs.
If you’re ready to establish a QPRT, or have further questions on whether or not one may be right for you, please don’t hesitate to reach out. You can call us directly at 770-368-9919, or fill out a contact card, and we’ll reach out to you.
The opinions and analysis expressed herein are based on C.W. O’Conner Wealth Advisors, Inc. research and professional experience and are expressed as of the date of this report. Please consult with your advisor, attorney and accountant, as appropriate, regarding specific advice.
Download our 2023 Financial Planning Guide
Cliff is the founder and president of C.W. O'Conner Wealth Advisors, Inc. Cliff earned a Bachelor of Business Administration degree in Accounting from Georgia State University.
Kevin O'Conner is a financial planner with C.W. O'Conner Wealth Advisors, Inc. He earned a Bachelor of Business Administration degree in Business Management from Georgia College, and is a Certified Investment Management Analyst (CIMA).
