Many people’s assumption that their estates will escape federal estate tax may be incorrect because they often underestimate the worth of the most valuable asset that they own, their personal residence. Federal estate tax law provides a means for reducing the tax consequences of transferring the family home. The device that is used to accomplish this goal is known as a “qualified personal residence trust” (QPRT).
The most obvious disadvantage of creating a QPRT is that the grantor of the trust has a predetermined limit on his right to occupy the residence, after which time he must give us ownership while he is still alive. The remaindermen (normally the grantor’s children) then will have ownership of the residence, and the grantor will have to pay rent to them. Since many people may find this to be an awkward situation, the QPRT requires a personal decision that should be given careful consideration.
A second disadvantage concerns the amount of income tax liability that will result if the grantor’s children (or other remaindermen) later sell the residence. If no trust is created and the residence passes at the grantor’s death, the heirs or beneficiaries get a “step-up” in basis, meaning that the gain on the sale will be measured against the value of the residence as of the grantor’s death. If a QPRT is created, however, there will be no such step-up and the gain will be measured against the price that the grantor originally paid for the property.
Cash may also be put into the trust, but the trust instrument must limit such additions to amounts needed to pay trust expenses, to make improvements to the residence, and to enable the trust to purchase a replacement residence.
The residence must be used by the grantor as his principal residence, although he may use the premises secondarily for business purposes. A vacation home can qualify for purposes of the QPRT provisions if certain requirements are satisfied.
The trust must prohibit the sale of the residence to the grantor, his spouse, or to an entity controlled by the grantor or his spouse during the period of the grantor’s retained interest and thereafter in certain situations.
A QPRT has many technical requirements and establishing one is very complicated. A poorly executed trust has many potential undesirable effects. Anyone considering the use of such a trust should seek qualified legal advice.