An individual may transfer a residence to a trust while retaining the right to use the home for a specific term of years and directing the distribution of the house to their children on termination of the trust (§2702).
When the transfer to the trust is transferred, the owner is treated as having made a gift to the beneficiaries. The gift amount represents the residence’s fair market value on the date of the transfer reduced by the value of the right to use the home for the trust term and the right to receive ownership of the house if death occurs during the trust term. A gift tax return is required.
The owner continues to be treated as the owner of the residence for income tax purposes. If the owner outlives the trust (and if the owner may still reside in the home after trust termination), the value of the residence is not included in the value of the “owner’s” estate for federal estate tax purposes.
Only the value of the gift, as of the time of the transfer, is part of the estate tax calculation. If the owner passes away during the trust term, the residence is returned to the estate and included in the estate at its value on the date of death. The potential estate tax savings are lost, with the owner in the same position for estate tax purposes as they would have been if the trust had not been created.
If the owner no longer wants to live in the residence on termination of the trust, the children, as the new owners, may sell the home and use the proceeds as they wish.
If the owner desires to continue to live in the residence, they may lease the home from their children at a fair market value rent. The lease payments reduce the assets in the owner’s estate.
On termination of the trust, the children receive ownership of the house without any income, estate, or gift tax consequences. The children’s basis in the residence is the basis of the owner on the date of the transfer to the trust. An individual can contribute a primary home or vacation residence to a personal residence trust. Each individual may have two personal residence trusts.
QPRT Example
Dan and Deborah own a home in which they wish to live now but leave to their children. Dan was born in 1935, and Deborah was born in 1938.
They own the home as tenants in common, and the house is worth $300,000.
They each put their share of the home into a qualified personal residence trust in November 1997, retaining a term of 15 years.
The gift value for federal gift tax purposes was approximately $35,900 for Dan and $32,600 for Deborah, rather than $150,000 each.
The gift is valued under §7520, taking into account present value, term, and remainder or reversing interest.
Example #2
Looking at the table below and assuming an estate tax at a flat 50% rate, if a 60-year-old donor establishes a 20-year QPRT to hold a residence worth $1,000,000, the taxable gift is $251,220 (using an IRS 4% interest rate, which rate changes each month).
If the donor dies at age 85 and the property is then worth $2,000,000, the donor’s taxable estate will include the original taxable gift of $251,220 and, at a 50 percent tax rate, the estate tax attributable to that property will be $125,610. If the QPRT had not been created, the donor’s estate would have paid $2,000,000 at a 50 percent tax rate, or $1,000,000. The use of the QPRT results in $874,390 tax savings.
However, these tax savings may be reduced by the income tax cost of any additional capital gains taxes if the house is sold without the benefit of the step-up in basis to the estate tax value of the home at the time of the donor’s death.
Let’s look at a $1 million home transferred to a QPRT:
| Owner Age | 10 Year Length | 20 Year Length |
|---|---|---|
| 50 | $625,590 | $352,560 |
| 55 | $599,170 | $307,700 |
| 60 | $563,570 | $251,220 |
| 65 | $513,550 | $182,340 |
| 70 | $445,760 | $109,020 |
| 75 | $355,050 | $47,430 |
