1. What is a Qualified Personal Residence Trust?
A Qualified Personal Residence Trust (QPRT) is a trust that holds a personal residence for a term of years, allowing the creator of the trust (grantor) to remain in the residence. When the term of the trust ends, ownership of the personal residence transfers to the beneficiaries of the grantor. The grantor can retain the right to rent the residence after the term of the trust ends.
2. Why Use a Qualified Personal Residence Trust?
Qualified Personal Residence Trusts offer several advantages. An individual can accomplish the following using a QPRT:
- An individual may give his or her residence (or vacation home) away and still use the residence rent-free for a period of time
- The value of the individual’s residence will be discounted for gift tax purposes.
- If the individual survives the trust term, he or she will not be taxed upon his or her death on the full value of the residence or its future appreciation.
- An individual may still occupy the residence after the trust’s term provided he or she pays rent.
3. What are the Risks of Using a Qualified Personal Residence Trust?
In order to realize the tax advantages of a QPRT, the grantor must survive the trust’s term. If for some reason the grantor does not survive the term of the trust, the entire value of the residence is included in the grantor’s estate. However, this would be the result had the grantor never created the QPRT. To minimize the risk of the grantor dying before the trust’s term ends, life insurance can be taken on the grantor for the term of the trust. If this strategy is utilized, it is important to structure the policy ownership of the life insurance so that the proceeds are not included in the grantor’s estate.
4. What are the Requirements of a Qualified Personal Residence Trust?
There are several requirements that must be met to qualify the trust as a Qualified Personal Residence Trust.
1. Personal Residence. Only a personal residence can be held in a QPRT. A personal residence is one of the following: (i) the principal residence of the grantor; (ii) one other residence of the grantor; or (iii) an undivided fractional interest in either (i) or (ii). Only two residences of the grantor may be placed in QPRTs, but one residence must be the grantor’s personal residence. Therefore, if a grantor has one personal residence and two vacation homes, only the personal residence and one vacation home may be used.
If the grantor only owns a portion of his or her personal residence, he or she may transfer his or her interest in the personal residence into a QPRT. As a result, if spouses hold interest in a personal residence as tenants in common, they may each transfer their respective interests to a QPRT.
A QPRT may also contain “appurtenant structures” (such as a pool, greenhouse or barn) and adjacent land. The appurtenant structures, however, must be used for residential purposes and the adjacent land must be reasonably appropriate for residential purposes.
Mortgaged property may be held in a QPRT but this can create tax issues that should be discussed with an attorney. Personal property (such as household furnishings) may not be held in a QPRT
2. Cash. A QPRT may hold cash for payment of certain expenses. However, cash must be held in a separate account and cannot exceed the amount required for the following expenses:
Trust expenses (including mortgage payments) already incurred or reasonably expected to be paid by the trust within the next six months;
The purchase of the initial personal residence or a replacement residence, within three months, and then only if the trust prohibits any additions to the trust for this purpose unless the trustee has previously entered into a contract to buy the residence.
- Trust expenses (including mortgage payments) already incurred or reasonably expected to be paid by the trust within the next six months;
- Improvements to the residence to be paid by the trust within six months; and
- The purchase of the initial personal residence or a replacement resident, within three months, and then only if the trust prohibits any additions to the trust for this purpose unless the trustee has previously entered into a contract to buy the residence.
– If the QPRT permits cash to be held, it must also require the trustee to determine every quarter if the trust is holding excess cash. If excess cash is being held, it must be distributed immediately to the grantor.
– A QPRT may hold improvements made to the residence but only if the residence is able to meet the requirements of a personal residence after the improvements. Large capital improvements to the residence may trigger gift tax consequences and the grantor should consult his or her attorney before making any such improvements or paying out of the ordinary expenses.
– A QPRT may hold one or more insurance policies insuring the residence. In addition, a QPRT can hold proceeds of insurance payable to the trust as a result of damage to or destruction of the residence. However, the QPRT will cease to be a QPRT only with respect to all insurance proceeds held by the trust not later than the earlier of: (i) the date that is two years after the date of such damage or destruction; (ii) the termination of the term holder’s interest in the trust; or (iii) the date on which a replacement residence is purchased by the trust.
5. Trust Income Distribution. All trust income is to be distributed at least annually to the grantor.
6. No Distributions of Principal to Others. There may be no distribution of trust principal from a QPRT to anyone during the term of the trust other than the grantor.
7. Sale of the Residence. A QPRT may allow for the sale of the residence. In addition, the trustee of the QPRT may hold the sales proceeds as long as the proceeds are held in a separate account. However, the residence may not be sold to the grantor, the grantor’s spouse, or any entity controlled by the grantor or the grantor’s spouse. In addition, the QPRT will cease to be a QPRT with respect to all proceeds of sale held by the trust not later than the earlier of: (i) the date that is two years after the date of sale of the residence; (ii) the termination of the term holder’s interest in the trust; or (iii) the date on which a new residence is acquired by the trust.
8. Commutation. A QPRT must prohibit any payment to the grantor or the beneficiaries of the trust for their interests prior to the end of the trust’s term.
9. Failure to Use the Residence as a Personal Residence. A QPRT will terminate if the residence fails to be held for use as the personal residence of the grantor.
10. Summary. A QPRT is an excellent planning strategy to avoid estate tax, especially if an individual has a principal residence and/or vacation home that is appreciating in value and will probably not be sold before the individual’s death.
Disclaimer Notice: It is my intention that the comments, articles, and other information provided on this website are intended to provide you with general information which may be interesting and of value to you. You should not construe any of this information as legal advice or my opinion as it may relate to your specific circumstances. Please feel free to contact me directly if you would like to discuss your own situation and your estate, real property, or business planning needs.