By now you are probably aware of the advantages of a Qualified Primary Residence Trust (QPRT). But one question always comes up: how are capital improvements treated?
In this post, we tackle this very topic and also offer up a few tips for you to consider. Let’s get started.
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What are the rules?
So let’s assume that you set up a QPRT several years back and it’s time to do some improvements. Maybe you are considering a new roof, cabinets, or maybe even adding a pool. Since the trust actually owns the home, how do you record these capital improvements from a trust standpoint as well as from a tax standpoint?
The treatment is rather straightforward. Any additional capital improvements are treated as gifts that are made to the trust. They would fall all the annual gift exemption rules and the requirement to file a gift tax return for any excess contributions. Let’s look at an example.
Let’s assume a single individual is looking to put a new roof on the house. I will assume the cost is $25,000. The individual should write the check for $25,000 from their personal bank account and contribute it into the trust account. From there he or she can distribute the funds to the contractor for the roof addition.
Because the capital improvement is over the $15,000 annual gift limit, the person has just made a taxable gift of $10,000 and must report this contribution on a gift tax return. Assuming they are not over the lifetime limit, no tax is due.
Let’s assume now that that same person is married and each spouse then makes a contribution of $12,500 into the trust. Because each person has a $15,000 exclusion, no gift tax return is required. If the contribution was made on one check, the couple can utilize gift splitting in order to fall under the annual gift requirements.
QPRT capital improvement strategies
Since QPRT‘s are typically done for individuals with sizable estates, you want to minimize the requirement of recording a taxable gift. So what options do you have?
The timing of the gift contribution is critical. Let’s assume the roof now is going to cost $60,000. Rather than having each spouse write a check for $30,000 to the trust and reporting a taxable gift, if the construction is towards the end of the year then it might make sense for each spouse to pay the contractor half upfront (let’s say November or December) with the final payment being made to the contractor in January of the following year. This way the gift is split between two years and the couple will not have any taxable gifts. You may not always have control over the timing, but if you can split it between taxable years that will be a huge benefit to you.
Capital Improvement Language
Below we will show language in a draft QPRT. You can get a general understanding of some of the requirements. Sorry that it is so technical, but you get the idea.
Additions to QPRT. From time to time, the Trustee is able to accept a cash addition to the QPRT in an amount which, when then added to cash already held, will not exceed the amount expected to be required for: (a) any payment of QPRT expenses (including any such payment of mortgage payments) that are already incurred or expected to be paid for by the trust within six months subsequent to the date the addition is made; (b) the cost or fees related to improvements to the Residence that are to be paid by the trust within six months subsequent to the date the addition is made or incurred; and (c) the purchase or acquisition by the trust of a deemed replacement Residence within three months subsequent to the date of the addition, provided that no addition shall be made, or held by the Trustee, for the acquisition or purchase of a replacement Residence unless the said Trustee has, before receipt of the addition, entered into a purchase contract of that Residence. The Trustee will hold the cash additions in accordance with this paragraph and maintained in a separate account.
As you can see, it is certainly possible to make QPRT capital improvements. You just have to remember that they will fall under the gift tax rules. Make sure you carefully time the payments to avoid making any taxable gifts.