Should I create a QPRT before 2026?
The current, historically-high lifetime gift and estate tax exemption of $12,060,000 is scheduled to expire in 2026. Absent any legislative intervention, this tax exemption will revert to $5 million, the amount it previously was in 2016. Are there any planning strategies to benefit from the historically-high exemption before any future changes? Fortunately, yes. One popular strategy is a Qualified Personal Residence Trust (QPRT). Depending on your situation, creating a QPRT could be one effective way to make current use of a portion of the $12 million estate and gift tax exemption.
So, what is a QPRT and what are the tax benefits of creating one?
A QPRT is a type of “split-interest trust.” It is an irrevocable trust that an individual creates to hold the title of his or her home for the future benefit of the individual’s heirs and to reduce gift taxes imposed upon the transfer. The individual/donor retains the right to live in the house for a period of time specified in the trust, which is referred to as the “retained interest.” Upon the expiry of the retained interest, the house is transferred to the beneficiaries, whose interest is the “remainder interest.” The existence of these separate interests or rights to the home is why the QPRT is a type of split-interest trust.
One question frequently asked is what happens to the donor who formed the QPRT when the retained interest expires. Following the expiry of the retained interest, the donor may still live in the house but must pay fair market value rent to the beneficiaries who then legally own the home.
But why would I give up ownership of my house?
By transferring the title of your home to the QPRT, the house is no longer part of your estate. Hence, the full fair market value of the house at the time of your death will not be included in your gross estate for estate tax purposes unless you pass away during the retained interest term. If you survive the trust term, only the “remainder interest” value would have been subject to gift tax and all appreciation in the home would avoid estate tax. By using a QPRT, you are leveraging the estate and gift tax exemptions for other highly valued assets. Should the lifetime exemption revert back to $5 million in 2026, a QPRT would be highly beneficial in taking any appreciation of this highly valued asset out of the estate. This could result in significant savings, especially in an area like Southern California, where real estate values appreciate at historically constant rates.
In addition to removing the value of the house from your estate, transferring your house to the QPRT for the benefit of your children, for example, would reduce your potential gift tax in two ways. First, when you transfer your house to the QPRT, that transfer is treated as a present gift for tax purposes. Based upon such characterization, the value of the gift will freeze as of the time of the creation of the QPRT. Accordingly, as a donor, you will incur a gift tax liability (credited against the lifetime gift and estate tax exemption) based upon the value of the house at the time of the transfer minus the value of the retained interests and any contingent reversion. This will significantly reduce the amount subjected to gift tax. As noted earlier, there will be no estate or gift taxes on the appreciation of the value of the house. Accordingly, the QPRT provides two significant tax benefits both at the time of the gift and at the time of death.
Let’s look at an example. Jen, 50 years old, owns a beautiful home she wants to transfer to her daughter Ana. The house is appraised at $1 million at the time of the creation of the QPRT. According to the QPRT’s terms, Jen has the right to live in the house for 20 years. After 20 years, let’s assume the house has modestly increased in value to $1.8 million. Because the house is owned by the QPRT, the $800,000 increase in value of the house will be transferred to Ana estate and gift tax-free.
Sounds interesting enough! There is more! Upon the expiry of the term of the QPRT, the gift tax is imposed only on the value of the remainder interest that is actually transferred to beneficiaries. Meaning that the longer the donor stays in the house, the better gift tax benefits gained. In other words, you are transferring the house to the beneficiaries at a reduced gift tax rate.
With the current rising interest rates, QPRTs are even more appealing. Why? Because the value of the remainder interest, which is what beneficiaries eventually receive, is calculated using Section 7520. The section 7520 rate is a rate published by the federal government that is used in valuations of a future property interest, such as, you guessed it, remainder interests! The higher the rate is, the lower the value of the gift is, the better it is for you when you are paying the gift tax!
The table below illustrates how the increase in Section’s 7520 rate affects the value of the gift:
|
Property Value |
§7520 Rate |
Initial Term |
Age of Donor |
Value of Taxable Gift |
Retained Interest |
Appreciation at End of Term |
Total Exclusion from Gift/Estate Tax |
|
$1,000,000 |
1.6 |
20 |
50 |
$581,779 |
$418,221 |
$800,000 |
$1,218,221 |
|
$1,000,000 |
2.0 |
20 |
50 |
$537,810 |
$462,190 |
$800,000 |
$1,262,190 |
|
$1,000,000 |
2.4 |
20 |
50 |
$497,317 |
$502,683 |
$800,000 |
$1,302,683 |
|
$1,000,000 |
2.8 |
20 |
50 |
$460,012 |
$539,988 |
$800,000 |
$1,399,988 |
Tell me more about QPRTs!
It is worth mentioning that QPRTs can also be used as an asset protection vehicle. Since the house is not owned by the donor and the QPRT is irrevocable, the house will be beyond the reach of creditors in most cases. Hence, protecting this valuable asset from being potentially at risk.
QPRTs sound perfect, so why doesn’t everybody just create one?
Even though QPRTs have all the benefits listed above and more, there are, however, some downsides to the strategy.
First, for all tax benefits to be achieved, the donor must outlive the period of the QPRT. If the donor dies before the expiry of the QPRT term, the full fair market value of the house at the date of death will be included in the gross estate and none of the above-mentioned goals would be achieved. Therefore, the task of choosing the right term for the QPRT is very important and should take into consideration the age of the donor and the probability of his or her death during the selected term. There are some advanced planning techniques that can be used to help mitigate these risks but a discussion of them is beyond the scope of this article.
Second, QPRTs are irrevocable, which means that once the trust is created, you cannot go back in time and undo it. Therefore, careful consideration of your current situation should be taken before creating the QPRT.
Third, although a QPRT can be established with a property that is currently encumbered by a mortgage, securing a mortgage after creating the QPRT or refinancing an existing mortgage may be difficult.
Finally, the creation and maintenance of the QPRT involve hiring an attorney to create the trust and regular tax filings with the IRS. These additional expenses should be balanced against the overall economic benefits a QPRT can provide such as the significant gift and estate tax savings and other benefits such as the reduction in probate administration fees. As with any complex planning strategy, you should discuss your personal situation with qualified counsel before making a final decision.
In summary, a Qualified Personal Residence Trust is a creative estate planning strategy that can generate significant estate and gift tax savings and other long-term benefits. With the potential reversion of the lifetime gift and estate tax exemption in 2026 and rising interest rates, now is a good time to sit down with your advisor to determine if a QPRT may be right for your situation.
Muzna Zeitouni
Author