James R. Balmforth: Qualified Personal Residence Trust

A home is oftentimes a person’s most valuable and long term asset. That said, in today’s very litigious society it is very important that people protect any exposed assets of value; especially their homes. The Qualified Personal Residence Trust is an excellent strategy to protect your home is to talk to an asset protection lawyer. A QPRT can even extend to secondary residences and vacation homes (depending on certain tax code conditions). In addition to the asset protection properties of the Qualified Personal Residence Trust or QPRT it also has several tax benefits.

What is a QPRT?

A Qualified Personal Residence Trust is a type of irrevocable living trust. It is designed to reduce the amount of gift and estate tax. Oftentimes, one incurs these taxes when transferring an asset to a beneficiary. The asset protection in a Qualified Personal Residence Trust comes into effect partially because it is an irrevocable trust. As a trust of this nature, it can protect the assets therein that it passes down to your beneficiaries. The law sees it as a valid legal method to protect an individual’s assets for their beneficiaries.

How it Protects Assets

It protects those assets, accordingly, from creditors and judgments. The trust’s irrevocable status means that you cannot readily change the conditions of the trust while the trust is in effect. That means once you put an irrevocable trust into effect no one can readily change it. Plus, the parties are not, by and large, legally obligated to comply with order an individual to change it. This helps to ensure that a judge cannot simply order a person to hand those protected assets to creditors. Plus, legal provisions typically forbid the judiciary from ordering a change of the conditions of the trust; for example, making one’s enemies at law the beneficiaries of the trust.

Lifetime Use of Home

With the Qualified Personal Residence Trust (QPRT) homeowners place their homes into the trust. The transferee(s) retain(s) the right to live in that home for a set number of years. During this time when the owner is living in the house he would not be paying rent. He would be responsible for all housing expenses like repairs, real estate taxes, and maintenance fees which is covered by Revenue Procedure 2003-42 [2003-23 IRB 993 section 4 Art. II (B) (2)]. Suppose the owner is alive after that predetermined number of years. In that case, the trust automatically transfers ownership of the home to the owners’ beneficiaries. The trust does this without triggering the estate tax.

Now I know what you may be thinking. “I outlived the trust and now I do not have a house to live in because it belongs to my beneficiaries.” You can easily solve this by placing certain provisions in the trust. One such provision is that the beneficiaries must rent the home out to the original owner of the house.

The attractive part is this. By paying rent after the QPRT has ended, a person is transferring additional assets to their beneficiaries; without having to pay any gift or estate tax. There is nothing stopping the kids from paying the rent money back to Mom and Dad. Plus they can use this money to cover their parent’s expenses. Plus if you decide to sell the house, the trust can use the proceeds to purchase another residence. In addition, it can cover other items for the parents, as the beneficiaries see fit.

5 Qualified Personal Residence Trust Benefits

Asset Protection from Lawsuits

The Qualified Personal Residence Trust offers the benefits of a trust to protect a residence. At the same time, the owner can still live in the house while the trust is in effect. This means while the residence is held within the QPRT it is protected from judgments and creditors. The structure provides this shield for the lifetime of the trust. The owner can also live in the residence during the duration of the QPRT. They are able to maintain control of the residence. This means that the owner can still remodel or update the home. They can proceed without any restrictions from the trust.

Gift Tax Benefits

The protection of the home is not the only benefit of the Qualified Personal Residence Trust. The Qualified Personal Residence Trust’s main advantage is its tax benefits. It provides these to both the property owner and the beneficiaries of the trust. When you transfer a home to the Qualified Personal Residence Trust it counts as a gift but a typical IRS gift tax. Instead, the IRS calculates a modified gift tax. The IRS determines this through their published tables and the amount of time the home stays in the Qualified Personal Residence Trust. They apply this to the value of the home. The predetermined amount of time is agreed upon when creating the QPRT. When this time has passed and the owner is still alive then the trust passes the home on to the beneficiaries. Again, this is free of any gift or estate tax.

So, how does the gift tax apply when the trust passes the house on to the beneficiaries? If the home has appreciated in value since its initial appraisal, the gift tax would be based on the initial value of the home. Incidentally, the IRS determines this using their own calculations – and not on the final value of the home. This would save the beneficiaries a great deal of money. That is because they would have to pay a gift tax on the initial value of the home and not on the appreciated value. What if the home’s value did not increase or stayed the same? In that case, the beneficiaries would not have to pay any gift tax on the home.

Lifetime Use of Home

So now you may be thinking, “After passing my home to my heirs I may still want to live in it.” As mentioned above, the Qualified Personal Residence Trust allows for the original owner to pay rent, at a fair market rate, on the property. This seems like a strange notion but there is a tax benefit. By paying rent, the original homeowner is transferring assets to his beneficiaries without having to pay any sort of gift or estate tax on those assets.

In a QPRT the homeowner is essentially betting that they will live longer than the lifespan of the trust. But what happens if the owner dies before the trust ends? In that case the grantor (the homeowner) of the Qualified Personal Residence Trust, thereby, protects the home from seizure in lawsuits during his/her lifetime. Taxwise, the modified gift tax percentage on the property is placed back into the calculation. In that case, the normal tax laws apply. IRC section 2036(a)(1) governs the return of the property to the deceased homeowner’s estate.

Estate Tax Benefits

Another benefit of the Qualified Personal Residence Trust is that it can enhance the tax benefits if a husband and wife own the home jointly. According to Treasury Regulations section 25.2702-5(c)(2)(iv) a husband and wife can both transfer half their ownership in the home into two separate Qualified Personal Residence Trusts. Each separate QPRT allows the husband and wife owners to live in the residence for a set number of years based on the conditions of each trust. Suppose one of the homeowners die before the QPRT ends. The half that was in the trust is now put into the estate and estate and gift taxes apply.

Ability to Change Residences

So what happens if you want to sell the house that is in the trust and buy a new home? The trustee would simply sell the old home and buy a new one in the name of the existing Qualified Personal Residence Trust. If the new home is worth more than the old one then the trustee would have to pay out of pocket for the difference and would retain ownership of that percentage of the home.

If the new home’s value is less than the old one then Treasury Regulation section 25.2702-5(c)(7) and (8) would go into effect. In this case the excess funds would go back to the Qualified Personal Residence Trust grantor. But this would defeat the purpose of much of the tax benefits. The other option is to place the excess funds into the trust and convert those specific assets into a Grantor Retained Annuity Trust or GRAT, which would provide the trust’s grantor an annuity payment until the Qualified Personal Residence Trust ends.

7 Steps to Use a QPRT

Draft the Trust
The first step in a Qualified Personal Residence Trust is to have a professional write up the irrevocable trust agreement. You and your professional would decide who the trustees and the beneficiaries are. Then you decide how long you would retain the right to live in the residence before it is transferred to the beneficiaries. This initial planning stage is very important because as an irrevocable living trust it is very difficult if not near impossible to change its conditions once it goes into effect.
Place Home in Trust

The second step is to fund the Qualified Personal Residence Trust with your residence. You accomplish this by creating a new deed that transfers the home from the owner’s name to the Qualified Personal Residence Trust’s name. You record this deed in the local county recorder’s office of the property.

Appraise Home

The third step is to have an appraiser performs an appraisal on or near the date you transfer into the Qualified Personal Residence Trust. You do this to get the fair market value of the property to determine the gift tax.

Report to IRS

The fourth step is to report the gift to the IRS. This is done by filling out a Form 709, United States Gift and Generation-Skipping Transfer Tax Return. You complete and file this form with the IRS on April 15th of year you transfer the property into the Qualified Personal Residence Trust.

Reside in the Home

The fifth step is by far the easiest and that is to reside in the home and live your life as usual.

Transfer to Beneficiaries

The sixth step occurs once the predetermined number of years for the Qualified Personal Residence Trust ends. The property is transferred to beneficiaries as detailed in the Qualified Personal Residence Trust. You accomplish by recording a new deed that transfers the residence from the trust’s name to the beneficiary’s names and documenting it in the land records for the property.

Fair Market Rent

The seventh and final step is to pay a fair market rent for the property. That is, if the former owner wants to continue living there. The rent will transfer more assets to the beneficiaries free of gift taxes. Thus, it will reduce the size of the taxable estate.