Janice owns a large home on Whidbey Island and, like most people, she prefers to maintain control of her home during her lifetime.
After she is gone, she wants the house to remain in the family. It has been in her family for generations and is filled with happy memories of vacations shared with children and grandchildren.
But she is concerned that her estate taxes might force her children to sell.
Homes have dramatically increased in value during the last decade. As a result, in spite of increased estate tax exemptions at both federal and state levels, a growing number of estates may be subject to tax.
So how can homeowners like Janice maintain control of their homes during their lifetimes, yet help to ensure that children or grandchildren are not forced to sell in order to pay the estate tax?
The QPRT Option
One possible solution is to contribute your home to a Qualified Personal Residence Trust, or QPRT. A QPRT can provide a significant financial benefit yet still allow you to maintain significant control over your home — including the right to live there for a predetermined number of years.
After that time, the home passes from the QPRT to your children or other beneficiaries. Because you are transferring ownership to the trust and reporting the gift during your lifetime, the home’s value will not be included in your estate for tax purposes. The financial benefit of the QPRT stems from the timing.
Because your beneficiaries must wait before taking ownership of the home, the value of your gift to them for gift tax purposes is far less than the home’s current value. The exact value depends on several factors, including your age, the term of the trust, and the current applicable federal interest rate. Depending on the length of the trust term, the value of the gift can be reduced so that there is little or no gift tax due.
During the term of the QPRT, you can continue to pay your home’s expenses by depositing funds with the trustee. The trust is generally ignored for income tax purposes, so you continue to deduct real estate taxes and interest, if any, on your personal income tax return. A separate income tax return for the trust is generally not required.
The art of setting up a QPRT is in the selection of an appropriate term of years. Ideally the term will be long enough to minimize the gift tax and allow you to maintain control of the home for life, but not so long that you die before the term expires. Assuming that you outlive the term of the trust, your home passes to your beneficiaries without additional gift or estate taxes. Any additional appreciation is effectively removed from your estate.
If you die before the home passes from the trust to your beneficiaries, however, your home is considered part of your taxable estate. This is a risk with any QPRT, but it leaves you in much the same financial situation as you would have been in had you not created the QPRT in the first place.
If you’d like to learn more about the impact of a Qualified Personal Residence Trust on to your estate plan, give us a call.