Personal Residence Trust Asset Protection: The #1 Strategy

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Paul Sundin, CPA

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Let’s be clear. Personal residence trust asset protection strategies are critical for anyone with substantial assets. That’s why people so often choose a Personal Residence Trust. It is often referred to as a “QPRT.”

Asset Protection Basics

Asset Protection Trusts are incredibly important asset protection tools. But these trusts can take different forms.

These are irrevocable trusts where you are allowed to be the settlor and the beneficiary. Your personal residence is transferred to the trust, which is then normally managed by a third-party trustee. As a result, they are no longer legally owned by you (the donor). However, you still will retain the associated benefits and usage of the home. This includes retained management and control through the trustee.

Asset protection trusts have consistently proven to be challenging for creditors to penetrate. There are many structures that can be used when it comes to these trusts. Many people will use a Qualified Personal Residence Trust (“QPRT”). But some attorney’s recommend an offshore trusts established in jurisdictions like Nevis, the Cook Islands, and Cayman Islands. This is usually because these offshore trusts are far out of the reach of local courts. These countries can provide many safeguards for the assets, offer confidentiality, and can have some tax benefits.

Many states offer domestic asset protection trusts. These are certainly less expensive and easier to manage, but they often don’t allow the same level of asset protection. Whichever trust you establish, make sure you review your situation with a qualified estate attorney. Everyone’s situation is unique and these trusts are complex instruments.

Personal Residence Trust Basics

A QPRT is a form of “grantor retained income trust” (GRIT). A GRIT could hold any type of asset. However, a QPRT is a GRIT that holds one particular type of asset, a personal residence.

All GRITs, including QPRTs, work the same way to allow the making of a gift at a reduced gift tax cost. The donor puts property into an irrevocable trust. But the donor reserves the income of the trust (or the use of the trust’s property) for a specific period. 

At the end of this term, the property passes to the donor’s chosen beneficiary if the donor is still living. When drafting GRITs, if the donor dies before the term ends, the property reverts to the donor’s estate.

There are several tests a property must pass to be considered the donor’s residence for QPRT purposes. The first two tests concern the primary use of the property.

A residence is only a personal residence when its primary use is as a residence of the donor when occupied by the donor. The home will not be considered a personal residence if, when not occupied by the donor, its main use is other than as a residence. Personal residence trust assets protection strategies can take many different forms.

For the average residence, the “primary use” of the property is not an issue. The place is the donor’s residence and has no other use at all. Primary use is an issue only if there is some nonresidential use of the property or if other people reside in the property as a matter of right (rather than as mere guests of the QPRT donor), such as rent-paying tenants or co-owners of the residence.

Defining Primary Use

There is minimal guidance on determining a property’s “primary use.” Presumably, in most cases, the amount of space devoted to the respective activities will provide the answer. In some cases, the relative values of the portions assigned to different activities might indicate.

If the property is vacant when the donor is absent, it still qualifies as a residence so long as its primary use is not “other than as a residence.” Even if the home ceases to be used as the donor’s residence, it still qualifies as the donor’s personal residence for QPRT purposes if it is “held for use as” the donor’s personal residence. A vacant property passes that test.

It is crucial that the donor transfers to the QPRT no property other than one “personal residence” of the donor. This could also include a partial interest in one personal residence. The statutory exception to the valuation rules is available only for a transfer to a trust “all the property in which consists of a residence to be used as a personal residence by persons holding term interests in such trust…” 

The regulation permits the QPRT to hold specific casualty insurance policies and limited amounts of cash for payment of expenses in addition to the residence. The requirement is that a QPRT must have “nothing but a personal residence,” meaning “nothing other than a personal residence, permitted casualty insurance policies, and limited amounts of cash for certain expenses as specified in the regulation.

Personal Residence Trust Asset Protection

If the property conveyed to the QPRT includes any property that is not a “personal residence,” the entire gift (not just the ineligible property) becomes subject to the gift tax. The entire property’s value conveyed to the QPRT would be treated as a taxable gift. As such, no discounts are allowed for the value of the donor’s retained term interest and reversion. This essential requirement is contained in the Internal Revenue Code. 

As you can see, personal residence trust asset protection strategies are imperative for many people. Make sure you get good legal advice regarding your situation.

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Estate CPA

Gilbert, AZ