California Partition Law Blog
The purpose of this article is to explain what a Qualified Personal Residence Trust (QPRT) is. A QPRT is an irrevocable trust which allows the creator, the grantor, to move a home out of their personal estate. This is done to give the home to a future beneficiary with gift tax savings. This is important because a QPRT lets the homeowner stay in the house with a “retained interest” until the specified date. After that date, the remaining interest and ownership of the house transfers to the beneficiary.
A QPRT trust must meet certain provisions: (1) all income generated by the trust must be given to the grantor at least annually (2) trust principal (money) will not be given to anyone besides the grantor before the term ends (3) the trust only holds one property with a reserved right of occupancy for the grantor (4) the trust cannot be terminated and its property cannot be distributed to beneficiaries before the end of the term (5) the residence must continually be the grantor’s primary residence (6) the house cannot become damaged or uninhabitable unless it is repaired or replaced before two years or the term ends (6) the trust cannot be sold or transferred to anyone else during the term. (26 C.F.R. § 25.2702-5; Sohn v. United States (2024) 2024 WL 1182879, at *1.)
A taxpayer who owns a residence can, as the grantor, transfer the property with a deed. This deed must be recorded with the local property registry. This means the home is retitled in the trust’s name. The grantor keeps the right to live in the property which means the taxable value of the home to the trust is discounted under federal tax law. This is important because the longer the grantor stays in the home, the more it can be discounted. When the term ends, the beneficiary gets the residence outright or in “further trust” as asset protection. If the grantor wants to stay in the home, they can rent it at fair market value which allows them transfers more cash to the trust without being taxed.
To create this type of trust, the house must be appraised to determine the present value of the remainder interest. This value is the projected value of the home when the term of the trust expires minus the value of the retained right for the grantor to live in the home. The grantor gets to report this transfer as a taxable gift which is calculated through the IRS federal rates. (Section 7520 rate.) During the duration of the trust, the value of the property can increase. The value is calculated through the Internal Revenue Service’s (IRS) federal rates which reflect minimum market rates. Since the grantor keeps a partial interest in the house, the gift value is calculated at a lower rate than the fair market value. This means the gift tax’s value is lowered. For this benefit to happen the grantor must survive the entire term of the trust. If not, the full value of home is brought back into the estate.
What are the Benefits and Drawbacks of a QPRT?
The benefits of a QPRT are largely tax based. Benefits include limiting estate taxes as well as passing property to heirs with a reduction in value for gift tax purposes. Transferring the property while the grantor is still alive can limit tax liability as opposed to transferring it following their death. This freezes the property value at its value at the time it is transferred to the trust. If the grantor lives past the trust’s expiration, then the full market value of the property (and any increase in value) is removed from the estate. The grantor can also possess and use the property through the term and can name themselves as trustee so they can control the property through the trust term.
There are some downsides to a QPRT trust. This type of trust is irrevocable and cannot be canceled or have its terms changed once it is put into effect. The term of the trust is arbitrary and assumes the grantor will not pass away before the term expires, which would defeat the tax benefits. The property can also no longer be refinanced or used as collateral by the grantor because they are no longer the owner of the home. This makes its use only appealing to those who own their home outright. There are also significant legal fees associated with creating the trust and its associated tax reporting requirements.
What is an Example of a QPRT?
For example, Julie owns her home and would like for her son Shawn to inherit it. Julie knows its value would be subject to gift taxes if it increases in value for any longer, but she does not want to move out yet. Julie sets up a QPRT so she can keep the house but not have it impact her taxable estate which on its own it valued at $2 million.
Julie’s home is currently worth $800,000. Julie sets up the trust with a term of fifteen years and transfers the home to it. She names Shawn as the beneficiary so he will get the house at the end of those fifteen years. Over the course of those fifteen years the house increases in value by $400,000. During this time Julie can claim deductions for any property taxes she pays on her annual income taxes. This increase is tax free because it is part of the QPRT. When the house passes to Shawn any gift and estate tax will be assessed at the original value of $800,000 even though the new value of the house is $1.2 million. If Julie had two sons, she could pass the home to her sons as joint owners. Under a QPRT trust Julie would be able to transfer a secondary home or even a vacation home to Shawn as long as she used the home for a minimum time period on a yearly basis.
Conclusion
The Underwood Law Firm has a team of experienced lawyers who can help resolve your property interest disputes at trial and help you pursue solutions like partition actions. We are here to help.