Financial Advice for Retirement, Social Security, IRAs and Estate Planning

The Qualified Personal Residence Trust: How to Leave Your Home to Your Heirs

Published on: Feb 04 2020
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In last week’s retirement watch Weekly, we reviewed the Qualified Personal Residence Trust (QPRT), and how you can use this classic estate planning tool when deciding how to pass on your home.

Let’s pick back up with the second installment (here’s Part 1 of our Qualified Personal Residence Trust story)…

In our example in Part 1, we looked at a hypothetical $1 million vacation home belonging to “Max Profits.”

Now of course, Max has a principal residence. And the Qualified Personal Residence Trust can be used in this case as well.

If Max used the trust with his main home and survived 20 years, he would have several options.

He could move into a different home. He might have been planning to downsize at that point in his life anyway.

He also could remain in the home but pay his children or the trust fair market rent. That would be another way to benefit his children, by paying them rent on the home.

The rent would avoid any gift tax consequences. Most qualified personal residence trusts, however, are done with homes other than the principal residence.

The grantor of the trust (Max in the example) and his or her spouse are not permitted to purchase the home from the trust as any point.

During the trust term, Max is treated as owner of the property for federal income tax purposes. He pays and deducts the real estate taxes and any mortgage interest.

If the home is sold during the trust term, the qualifications for tax-free treatment are determined by looking at Max’s ownership and residence of the property.

After a sale of the property during the trust term, the proceeds must be reinvested in a new residence within two years.

If the proceeds aren’t reinvested, the trust must either terminate and distribute the proceeds to the grantor or convert to a grantor retained annuity trust (GRAT).

Remember, there are tax complications if the home has a mortgage. The mortgage balance is subtracted when computing gift taxes. Future mortgage payments by the grantor are considered to be additional gifts.

If the beneficiary or trust takes over the mortgage payments, then the trust grantor is treated as selling the property and receiving the amount of the outstanding mortgage balance in return.

Because of these complications, it is best to transfer a property that doesn’t have a mortgage.

Only a personal residence, either primary or secondary, is eligible for a qualified personal residence trust. Commercial properties and other types of real estate don’t qualify.

A single person can have no more than two qualified personal residence trusts, and a married couple can have up to three QPRTs. The trust is allowed to receive only a personal residence and a limited amount of cash.

The cash allowed is only enough to cover the cost of purchasing a home (if one isn’t transferred to the trust), improvements, and mortgage payments for the next six months.

Since you are making a gift, your children or other beneficiaries of the trust will take a tax basis in the home equal to your tax basis.

That means if you have a low basis in the property, your children eventually will pay taxes on any capital gains when they sell the property.

You have to consider the trade off between the capital gains taxes and the estate tax savings and other advantages when deciding whether or not to create a qualified personal residence trust.

Additional property related to the house, such as household furnishings, does not qualify for the tax breaks of the QPRT. If you transfer these items in trust along with the house, then you will owe gift taxes on 100% of the value of the furnishings and other personal property.

To get the maximum benefits at the lowest cost from a qualified personal residence trust, you should be young enough to reasonably expect to live more than 10 years. If you are older, then a QPRT still might work if you can justify a relatively low appraisal on the home.

But older clients who have high-priced homes probably won’t get much savings from using a qualified personal residence trust and should consider other options. When the QPRT doesn’t appeal to you, there’s another creative strategy to consider based on an IRS ruling.

The couple sold their home to their children and excluded all the gain from income using the $125,000 exclusion that then was available to homeowners who were age 55 or older.

The children had a choice of either getting a traditional mortgage from a lender or having the parents finance the sale through a private annuity.

Under a private annuity, the children promise to make regular payments to the parents based on the value of the home, prevailing interest rates, and age of the parents. Either choice would work.

After the sale, the couple continued to live in the home. Again, there was a choice.

One option was to pay rent to the children. The rent is another way to get money out of the parents’ estates and into the children’s hands without incurring gift taxes.

Renting also gives the children a tax shelter. Since they now own the home, they can deduct depreciation and other expenses from the rent.

The second option was for the parents to live in the home rent free. The rental value of the home would be a gift from the children to the parents.

If the value of the gift exceeds the annual gift tax exclusion, the children must pay gift taxes or use part of their lifetime estate and gift tax credits. (IRS Letter Ruling 8502027)

The results of this strategy are that the home is out of both parents’ estates, is in the children’s hands, and the parents continue to live in the home.

Editor’s Note: I always say, “everyone needs a retirement plan and an estate plan.” Especially now that Congress is changing the Rules of Retirement right before our very eyes (and NOT in our favor). So, if you’re saving and planning for your retirement, there’s a breaking story you need to read — and act on — right away. You won’t find it anywhere else but here at Retirement Watch. Click here for the full development.

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