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Sunday, September 5, 2010

The suitability of Qualified Personal Residence Trusts

A qualified personal residence trust (QPRT) is an irrevocable grantor trust where the Trustor (or Grantor) gifts a personal residence to the trust, reserving the right to use the personal residence for a term of years. While the transfer of the residence to the trust incurs gift tax (which can be offset by the Trustor's gift tax exemption), the gift is discounted from fair market value of the residence by the Trustor maintaining an interest in occupying the property for a specified term of years.

At the end of this specified term of years the property passes to the beneficiaries of the trust (typically the Trustor's children or grandchildren), who may rent back the property to the Trustor, allowing the Trustor to further lower the value of his taxable estate.

The benefits of the QPRT are that it "freezes" the value of the gifted property for estate tax purposes. Therefore if a Trustor expects to survive 20 years and expects the value of his personal residence to double during that period, a QPRT will allow him to count only the current value of the personal residence (at the time of QPRT formation) in his taxable estate, even if his property appreciates sharply over time.

However, this can be a double edged sword as the beneficiaries inherit the carry-over income tax basis of the Trustor when they sell the residence, rather than the "stepped-up" tax basis to which they would be entitled had they just inherited the property.

Risk Tolerance

A client electing to use the QPRT estate planning tool is essentially making a bet that he will live beyond the term of the QPRT. If he does not survive the trust, the personal residence in the QPRT will be considered a part of his taxable estate, negating the reasons for creating the QPRT.  Similarly, given that the QPRT is an irrevocable trust, the proceeds of the sale of the personal residence after the remainder interest has transferred to the beneficiaries, will not be available to the Trustor to fulfill his financial needs.

The net of the above is that the suitability of a QPRT will depend of the age for the Trustor(s), their life expectancy and health, their risk tolerance, as well as the liquidity and size of their estate. A client considering the use of a QPRT in their estate plan should seek the assistance of qualified counsel.

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| Phone: (949) 274-7107
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