The family home, often steeped in memories, is more than just a piece of real estate. So when the time comes to pass it down to your children, it’s essential to do so wisely.
Irrevocable Trust to the Rescue
A special kind of irrevocable trust, called a Qualified Personal Residence Trust (QPRT), can be used to transfer your residence to your children at a significantly reduced gift tax cost and with no estate tax. Plus, it enables you to continue to live in the residence for as long as you wish.
How does a Qualified Personal Residence Trust (QPRT) work?
During your lifetime, you transfer your residence to the trustee, who (if state law permits) can be yourself. The trustee must allow you to continue to use the residence rent-free for a fixed number of years specified in the trust instrument (the “fixed term”), which should be a term you are likely to survive.
During the fixed term, you will continue to pay mortgage expenses, real estate taxes, insurance, and expenses for maintenance and repairs, and will continue to deduct mortgage interest and real estate taxes on your individual income tax return.
When the fixed term ends, the residence is distributed to your children, or remains in further trust for them.
What happens after the term of the QPRT ends?
Even after the fixed term ends, you can continue to use the residence in one of two ways.
- Rather than immediately distributing the residence to your children, your home can be retained in trust for your spouse’s lifetime, thus assuring that the residence is available to you.
- You can enter a lease with your children which will allow you to live in the residence for as long as you wish.
If you lease your home, you must pay fair market value rent to your children after the fixed term ends to keep the residence from being subject to estate tax on your death.
Tax Benefits of a QPRT
Although your transfer of the residence to the trust is a taxable gift, you are allowed to subtract the value of your right to live rent-free in the residence for the fixed term from the fair market value of the residence.
Thus, the amount of the taxable gift will usually be substantially less than the fair market value of the residence.
If the amount of the gift is less than your available exclusion from the gift tax ($11,700,000 in 2021 and $11,580,000 in 2020, reduced by amounts allowed for gifts in previous years), no gift tax will be due because of your gift to the trust.
What if you survive the fixed term of the QPRT?
If you survive the fixed term of the QPRT, the value of the residence will not be included in your estate for estate tax purposes.
If you don’t survive the fixed term, the estate tax consequences will be no worse than they would have been if you hadn’t created the trust in the first place
A QPRT is an effective way to remove a residence’s value from your estate at a greatly reduced gift tax cost.
However, you should also take into consideration whether holding your residence so that it is includible in your estate for a step basis is beneficial.
Handing Down Home: The QPRT in Family Planning
Transferring a home—especially one laden with memories—isn’t just about property rights; it’s about legacy, continuity, and the gift of stability to the next generation. With the QPRT, not only do you ensure a smooth transition, but you also navigate the intricate pathways of taxation. As you contemplate this significant step, remember that such a decision requires forethought, both for your personal comfort and the financial well-being of your heirs. A QPRT provides an avenue that satisfies both.
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