Why Should You Consider a Qualified Personal Residence Trust (QPRT) in Estate Planning?

What Is a Qualified Personal Residence Trust?

A qualified personal residence trust (QPRT) is a type of irrevocable living trust designed to minimize estate and gift taxes. It is a popular estate planning technique used to reduce the value of the grantor’s estate. A properly structured QPRT freezes the value of the grantor’s residence at the time they establish the trust, which can result in significant estate tax savings. Federal law on qualified personal residence trusts is found in the Code of Federal Regulations, Title 26, § 25.2702-5 Personal residence trusts.

How Does a Qualified Personal Residence Trust Work?

A QPRT can increase estate tax savings by reducing the value of a grantor’s residence upon their death. It enables a grantor to transfer ownership of a home to the trust while retaining the right to live in the home rent-free for a specified term. When the term of the trust expires, ownership of the residence is transferred to the trust beneficiaries. If the grantor wants to continue living in the residence, they can pay rent to the beneficiaries at fair market value, further reducing the value of the estate. 

What Are the Benefits of a Qualified Personal Residence Trust?

Qualified personal residence trusts may offer tax advantages to grantors in several different ways, including:

• Income tax deductions: A grantor may claim deductions on personal income tax for real estate taxes paid on the property, even if they are no longer the owner. 
• Estate tax benefits. Real estate can appreciate rapidly. Establishing a qualified personal residence trust essentially freezes the value of the property for estate tax purposes as of the date of the trust’s creation. Appreciation in property value during the term of the trust is not subject to estate taxes.
• Gift tax benefits: Factors the IRS uses to calculate the value of the remainder interest for gift tax purposes include the life expectancy of the grantor, the length of the trust term, and the current federal interest rate. Retained interest valued at greater than zero can lower gift tax liability, which can be particularly advantageous if a property appreciates significantly.

How Does the Federal Interest Rate Affect Estate Tax Savings With a QPRT?

In valuing the gift of a residence, a major factor associated with a favorable tax outcome is the federal interest rate under IRC section 7520. The Section 7520 interest rate reported by the IRS for January 2024 is 5.2, which is 120% of the applicable federal midterm rate. The higher the federal interest rate, the lower the gift value and the potential gift tax. A lower federal interest rate usually means lower estate tax savings. 

What Role Does a QPRT Play in a Comprehensive Estate Plan?

A qualified personal residence trust can provide several important estate planning benefits:

• It essentially freezes the value of the property at its value when the trust is created. Value is discounted by the IRS because the property can only be owned by the trust beneficiaries at a future date.
• The full market value of the property is removed from the estate if the grantor lives beyond the term of the trust. 
• The grantor can maintain control of the property throughout the trust term by naming himself or herself as trustee. 
• The grantor retains a partial interest in the property placed in trust. He or she can continue to use and enjoy the property throughout the trust term. 
• When the term of the trust expires, the beneficiaries can rent the property back to the grantor and keep it out of the estate. 

Can You Sell a Home After It Has Been Transferred to a QPRT?

Regulations permit the sale of a home that has been transferred to a QPRT under certain conditions. For QPRT status to continue, the grantor must reinvest the proceeds in the purchase of another home that meets trust requirements within two years. In addition, the trust terms must allow the trust to hold the proceeds from the sale of the property, or the QPRT terminates automatically. 

If the home is sold and only a portion of the proceeds are used to purchase another home, as the grantor is downsizing, for example, the QPRT will continue with the new residence, but the remaining proceeds are not qualified as a QPRT asset. The grantor must, within 30 days, distribute the remaining proceeds to himself or convert that portion to a grantor-retained annuity trust (GRAT). 

Are There Any Drawbacks With a Qualified Personal Residence Trust?

There may be some disadvantages to consider before establishing a QPRT:

• This type of trust is irrevocable, meaning you cannot dissolve it or change any of its terms once it goes into effect. A QPRT can only be terminated before the term of the trust expires upon the death of the grantor.
• You cannot refinance the property or use it as collateral once it is transferred to the trust.
• If an outstanding balance remains on your mortgage, the payments you make after the trust is created are treated as gifts that reduce your gift tax exemption. 
• The term of a QPRT trust is an arbitrary decision made by the grantor. If you die before the trust term expires, the property goes back into your estate and becomes subject to estate taxes. 

Consult with an Experienced Pennsylvania Estate Planning Lawyer

Creating a trust is not a do-it-yourself project, as there are many federal, state, and tax regulations to consider. Peak Legal Group can offer sound legal counsel in all your estate planning matters. Contact us for skilled legal assistance with a QPRT trust.