Consider a qualified personal residential trust to cut estate taxes
October 19, 2010 | 07:58 AM
As property values on the North Shore of Long Island are beginning to rise again, estate planners and tax professionals are again focusing on strategies to minimize the estate taxes which will be due upon death for homeowners. One strategy which has proven effective is the use of a qualified personal residence trust. This is a clear-cut strategy for removing the entire value of a home from an individual's taxable estate. This strategy is appealing to many because of the significant potential savings in estate and gift tax.
Practically speaking, an individual who executes a QPRT would transfer title of their home into the name of the trust. The individual then retains the right to live in the home for a certain number of years during which time the grantor is not responsible to pay rent but is responsible for all other expenses associated with the property such as the real estate taxes, cost of repairs and any maintenance fees associated with the property.
At the end of the term of years chosen by the grantor, assuming that he or she is still alive, the home passes tax-free to the chosen beneficiaries; in most case the beneficiaries are the children of the grantor. Another option is to hold the home in trust for the beneficiaries. The grantor may then enter into a lease agreement and pay rent to the trust. This is an additional tax-free gift to the trust further reducing the grantor's estate.
The tax advantages in using a QPRT are two-fold. For illustrative purposes, assume that the grantor owns a home worth 1.5 million dollars and places that home into the QPRT. According to the IRS, this is a taxable gift, however the value of the gift will not be the full 1.5 million (as it would be if the home were transferred outright) rather, the value of the gift will be reduced by the value of the grantor's retained term of years.
Taking this into consideration, the longer the term retained by the grantor, the greater the tax savings. However, one caveat to be mindful of is that in order to realize benefits of this type of planning, the grantor must outlive the term so that the property can pass to the beneficiaries under the terms of the trust. Should the grantor die before the term ends, the entire value of the property will be included in his estate. The good news here is that even though nothing will be gained should the grantor pass away before the term of years expires, nothing will be lost either. It is, however, crucial to be mindful of this and choose a term of years that the grantor is most likely to outlive.
Where the grantor outlives the term of years, he may remain in the home so long as he agrees to pay a fair market value rent for the home.
Using our example above, assuming that the grantor outlived the term of years and during that time the property rose in value from 1.5 million to 2 million. The transfer to the beneficiaries will have been accomplished for a gift tax value of a fraction of the home's value at the date of transfer. Although the beneficiaries will not receive a stepped-up basis as they would have had the home passed outright to them at the grantor's death, any capital gains tax that would be due, should the beneficiary decide to sell the home, would be far less than the estate tax that would have been due had the home remained in the grantor's estate. Currently, the maximum federal capital gains tax rate is 15 percent, where the rate for federal estate taxes is approximately 45 percent, and is slated to go to 55 percent in 2011.
In sum, the QPRT is an excellent tool for transferring substantial assets with minimal tax implications. However, because of the many nuances and intricacies associated with the QPRT, it is important that the attorney handling these transfers be fully familiar with the drafting and implementation of these documents.
Nancy Burner, Esq. has practiced elder law and estate planning for 15 years. The opinions of columnists are their own. They do not speak for the paper.