The passing of the Tax Cuts and Jobs Act (TCJA) brought about significant changes to the estate planning arena, doubling the lifetime exemption through December 31, 2025. While fewer taxpayers will find themselves with taxable estates over the next eight years, asset protection via a trust — particularly a Qualified Personal Residence Trust (QPRT) — continues to be invaluable to a taxpayer’s overall estate strategy.
Generally speaking, a properly structured trust can protect assets — such as real estate, bank accounts and personal property — from creditors, lawsuits and judgements. When assets are transferred to a trust prior to any creditor claims, they are considered separate from the grantor. If a subsequent claim arises in which the grantor is sued, the assets in the trust cannot be touched; only assets personally owned by the grantor can be pursued.
How Does a QPRT Work?
Specifically, a QPRT is an irrevocable grantor trust, which allows an individual to take advantage of the gift tax exemption by putting a personal residence, either primary or secondary, into a trust. The grantor determines how long he will retain possession and use of the residence. Once the term is up, ownership is passed onto the beneficiaries. Ultimately, a QPRT reduces estate tax to the grantor and benefits the grantor’s heirs/beneficiaries.
Primarily, a QPRT:
- Removes the grantor’s personal residence from his estate, including any future appreciated value, at a reduced value and reduced gift tax rate. This is possible because the value of the grantor remainder interest is nontaxable and retained by the grantor; the taxable portion of the residence is considered a future interest gift that does not qualify for the annual exclusion. The taxable portion can, however, be minimized by using the estate and gift tax exemption, which is $11.2 million for 2018. Essentially, the longer the QPRT’s term, the larger the grantor retained interest and the smaller the amount of gift tax exemption used.
- Allows the grantor to retain possession and use of the residence. During the term of the QPRT, the grantor, including a spouse and any dependents, can continue to live in the residence without any changes. This means that the grantor can live rent-free and will continue to pay any normal operating expenses applicable to the personal residence. As a result, the grantor can also claim all the appropriate income tax deductions on his tax return, such as the real estate tax deduction.
- The grantor must outlive the term of the trust. If he does not, the entire value of the personal residence held in the QPRT will revert back to the grantor’s estate. When setting up the QPRT, it is important to consider the grantor’s current and potential future health. This will help determine expected life expectancy and the appropriate term of the trust.
- Since the grantor only has a right to the residence for the trust-stated term, the home is not as marketable as when the grantor owns the residence outright. This also increases the inconvenience to the creditor because they cannot force the grantor to sell the residence, since the rights have been contributed into an irrevocable trust. This point was confirmed in a recent court case In re: Yerushalmi by the Eastern District of New York.
- Once the term of the QPRT expires, the grantor may still occupy the residence, but he must give up ownership of the property to the specified beneficiaries. The grantor is then required to pay a fair market value rent to reside in the home. In addition, paying rent will also pass wealth to the next generation without any gift tax implications.
- The beneficiaries will receive carryover basis in the residence. There is no step-up in basis; instead, their basis will be equal to the grantor’s basis in the property. Note that if the beneficiaries do not intend to hold onto the residence for an extended period of time, this estate planning method has the potential to create a high-income tax liability when the residence is sold.
When set-up properly, a QPRT can provide a valuable means of asset protection to your estate. Talk directly with your advisors to weigh the pros and cons relative to your own situation.
Please contact a member of your service team, or contact Laura Sefcik at email@example.com or Alane Boffa at firstname.lastname@example.org for further discussion.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.