This was a great Thanksgiving, but who will host Thanksgiving next year? Based on calls we receive from clients in the weeks following Thanksgiving, we know that home and cabin ownership planning is a common discussion topic during Thanksgiving. In this month’s update, I provide a brief overview of a Qualified Personal Residence Trust (“QPRT), which is one of several legal strategies a family might consider to transfer ownership of a home or cabin to a child or children during lifetime.
The QPRT Planning Strategy
A Qualified Personal Residence Trust is a planning strategy designed to allow a senior generation (“Mom and Dad”) to irrevocably transfer a residence to children, but only after a predetermined period during which time Mom and Dad retain residency. Most QPRT plans typically proceed as follows:
- Mom and Dad transfer the residence to the irrevocable trust, retaining the right to use the property for a certain period, called the “residence term.” The residence term is usually 7-20 years. During the residence term, Mom and Dad have the continued right to use and occupy the residence as they did previously.1
- At the termination of the residence term, the ownership of the residence is transferred to the children, or to trusts for the benefit of the children. If Mom and Dad want to continue to use the residence, they would be legally required to pay rent to the new owners, either the children or trusts established for their benefit.
The main tax benefit of the QPRT is the reduction in the reported value of the gift of the residence. While the legal transfer is complete as of the date the residence is gifted to the QPRT, the value reported on a gift tax return is the expected future value of the residence at the end of the residence term. The internal revenue code calculates this future value using the following variables: (1) the current appraised value of the residence, (2) the age of the current owner(s), (3) the length of the residence term, and (4) an assumed rate of return set by the IRS. The main tax “cost” of a QPRT is the loss of the opportunity to obtain a step-up in cost basis in the residence if the residence were owned by Mom or Dad at death. For that reason, a QPRT is only appropriate for those families likely to owe estate taxes.
QPRT Planning Under Current Conditions
For the reasons specified below, now might be a good time for you or your clients to consider QPRT planning:
- The Future of the Federal Estate Tax. With the impending reduction of the federal estate tax exemption, more families are likely to face federal estate taxes following death. Therefore, more families are likely to benefit from a QPRT plan.
- Longer Residence Period. Based on current real estate market conditions, my observation has been that Mom and Dad are more likely now to stay in their residence for a longer residence period.
- Lower Home Values. A lower appraised value of the residence results in a smaller reported gift.
- Higher Interest Rates. Finally, higher interest rates result in a lower reported value to children at the end of the residence term. A residence transferred through a QPRT in 2020 when interest rates were 2% would have a reported gift value of $513,208; that same residence gifted this month with interest rates at 5.65% would have a reported gift value of only $362,790.2
A QPRT could be considered by families who are likely to face a federal estate tax liability and whose children desire to retain ownership in a residence. For those families, I can think of no better Thanksgiving dinner conversation starter than, “when you own this place in 10 years, are you ready to host Thanksgiving dinner?
1 If Mom and Dad both die before the end of the residence term, the QPRT structure is effectively ignored, and the value of the residence is included as owned by Mom and Dad for estate tax purposes.
2 If a 70-year old gifted a $1.0 million residence through a 10-year QPRT in January of 2020 when the assumed rate of return was at 2%, the transfer value reported on a 2020 gift tax return was $513,208. If a 70-year old gifted a $1.0 million residence through a 10-year QPRT in November of 2023 when the assumed rate of return is at 5.65%, the transfer value reported on a 2023 gift tax return will be only $362,790. In November of 2024, the 7520 rate is set at 5.65%. For a free online calculator, see here: https://rogerhealy.com/QPRTCalculator.aspx