Trusts and Estates

Qualified Personal Residence Trust

A "trust" is created when the person making it (the "settlor" or "grantor"), transfers ownership of certain property or assets to a "trustee." The trustee, in turn, uses or invests the assets for the benefit of a third party (the "beneficiary"), who was specified by the settlor when he or she made the trust.

There are numerous types of trusts, all with different goals. Some trusts are "revocable," that is, the settlor can change or even revoke ("cancel") such a trust at any time during his or life. Some trusts are "irrevocable:" the settlor gives up all control over the trust property or assets ("trust res" or "trust corpus") and the trust does not end until the purpose or goal of the trust has been met.

In most revocable trusts, the settlor retains some beneficiary interest in the trust property. In other words, the settlor gives up ownership in the property, but the settlor has the right to receive income that is generated by the trust.

A common type of revocable trust is the "qualified personal residence trust (QPRT)," which can be useful tool for avoiding estate taxes.

There are several requirements that must be met in order for a QPRT to be valid. If you're considering such a trust, be certain to read the federal tax laws carefully, or seek the advice of an experienced tax attorney or estate planning attorney.

How a QPRT Works

In a QPRT, the settlor transfers his or her residence to a trust but keeps the beneficial right to use such the residence during a certain period of time, or "term of years." The settlor chooses the term of years. At the end of the term, the home is given to the beneficiaries. The result of a properly drawn QPRT: the home is transferred to the beneficiaries at a discount, and usually a substantial discount, from the home's actual value.

This is so because over the term of years, the house's value decreases, and at the end of the term, it is "worth less" than it did when the trust was made, and in fact, is worth less than it's actual value, at least as far as the Internal Revenue Service (IRS) is concerned. The rules for valuing the home are complex, so be sure to read them carefully or seek the advice of an attorney experienced in tax or estate planning matters.

The trick to a successful QPRT is to select a term of years that will end before the settlor's death. Why? If the settlor dies before the term has lapsed or expired, the home will be included in his or her estate and estate taxes will have to paid on it. But, if the settlor does not die during the trust term, the home will transfer to the beneficiaries without any estate or gift taxes.

Some Things to Consider

In the typical case, parents own their home jointly. If they wish to establish a QPRT, it is generally advisable for one spouse to transfer his or her share of the home to the other, and that spouse will, a short time later, transfer the entire home to a QPRT. In addition, the parent making the trust should be the younger and healthier spouse, because in order for the trust to work properly, the settlor-spouse has to outlive the term of the trust.

The choice of QPRT's term is purely subjective, but one place to begin is the life expectancy tables used by the IRS. As the term gets closer to or exceeds the grantor's life expectancy, the chances of you outliving the term decrease, and so the less the chance the beneficiaries have of ever the home.

A QPRT may be funded with only one personal residence. A settlor can't have more than two QPRTs and one of them must be for his or her principal residence. Therefore, a vacation home can be transferred to a QPRT, provided that the settlor uses it at least 14 days each year.

The home must continue to be used as the settlor's personal residence throughout the term of the QPRT. If it is not, the QPRT fails. There is an exception to this rule if the home is destroyed or damaged, and if the home is sold, the sale proceeds should be used to purchase another residence within two years.

If the property you want to transfer to a QPRT is a house with other buildings, like a barn and several acres, the QPRT will likely be valid if you can show that the other buildings and land are used for residential purposes.

Putting a mortgaged residence in a QPRT is generally a bad idea because the IRS will likely consider part of each mortgage payment- the payment on "principal" - as a taxable gift to the trust and/or to the beneficiaries. To avoid this, it is best if you pay off your mortgage before you transfer the home to the QPRT.

Questions for Your Attorney

  • Can I transfer my farm to a QPRT?
  • Can I change the term of years of my QPRT if it looks the term will expire after I die?
  • Do my children have to agree to the QPRT?
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