Many people with large estates have multiple homes. As such, it is common for many people inquiring about QPRTs to ask the question: can you put a vacation home or second home in QPRT?
In this guide, we answer that question and take a close look at the IRS language and also some sample language on the matter in a typical QPRT trust. The answer might not be as clear as you might think, so let’s dive in.
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Can you have a QPRT for a vacation home?
Let’s get to the good news first. A QPRT can be funded not only with a grantor’s principal residence but can also be funded with a secondary residence, such as a vacation property or cabin. However, a grantor can only create up to two QPRTs. Accordingly, you are not able to transfer an unlimited number of vacation homes into separate QPRTs.
The initial transfer of the home to the QPRT is considered a gift by the grantor to the remainder beneficiaries. The gift amount is calculated by taking the residence’s fair market value and subtracting the assumed value of the grantor’s retained interest.
The value of the retained interest is a function of the age of the grantor, the number of years during which the grantor will retain the right to use the residence, the value of the property at the time it is transferred, and the 7520 rate for the month the residence is transferred to the QPRT.
Like a GRAT, the grantor of a QPRT must outlive the retained interest term, or the entire value of the QPRT property will be included in the grantor’s estate. However, if this were to occur, the estate tax consequences are no worse than if the QPRT had not been created in the first place.
During the retained interest term, the QPRT will qualify as a grantor trust, and should the residence be sold during the period, the gain on the sale will be eligible for the same income tax benefits associated with owning the home directly, such as the exclusion from gain under Section 121 of the Code if the residence held by the QPRT is the grantor’s principal residence. But Section 121 is not available for vacation homes or second homes.
However, the residence held by the QPRT may not be sold to the grantor or the grantor’s spouse. In addition, it cannot be sold to an entity that is controlled by either of them. In addition, if the proceeds from the sale of the residence are not reinvested into a new residence, the QPRT must begin paying an annual annuity to the grantor calculated based on the Section 7520 rate.
Vacation or Second Home Language
The typical QPRT trust document will not speak directly to the use of a vacation home or second home. However, the IRS code is clear that the property many not be utilized as a rental property.
Here is some draft language that we recently saw in a trust that will give you an idea of how it is spelled out in a typical trust document. I know that it is a bit wordy, but you get the picture:
The specified term “personal residence” does not include any personal property, such as household furnishings. Section 25.2702-5(c)(2)(ii). A residence is deemed a personal residence only when its primary or main use is as a residence of the term holder and when occupied as such by the term holder. In addition, the principal residence of the term holder will not be deemed to fail the requirements of the preceding sentence simply as a result of a portion or section of the residence being used in such an activity that meets the requirements of § 280A(c)(1) or (4) (relating to the expense deductibility pertaining to certain uses), provided that the use is secondary to the use of the residence as a residence. A residence will not be considered as used primarily as a residence when used to provide transient lodging and substantial services are then provided in association with the provision of lodging, such as a bed and breakfast or hotel. A residence is not defined as a personal residence if, during any specified period not occupied by the term holder, its primary use is deemed other than as a residence. Section 25.2702-5(c)(2)(iii).
You can see that there is not much of a distinction made between a “primary” home and a “secondary” home. While it is clear that the property should not be used as a hotel or bed and breakfast, it may not be used as a rental and should only be used by the grantor and spouse (if applicable).
Below is more language that the IRS has annotated that spells out who is allowed to live in the property:
Cessation of Deemed Use As a Personal Residence (Article II, Paragraph E). The governing trust instrument must provide that the trust ceases to be a QPRT if the residence subsequently ceases to be held or used as a personal residence of the term holder. Under § 25.2702-5(c)(7)(i), a residence is deemed as held for use as a personal residence as long as the home is not occupied by any other person (other than a spouse or a dependent) and is made available at all times for the use by the term holder as a qualified personal residence.
In summary, a QPRT can be a valuable tool to reduce the size of a potentially taxable estate by creating a substantial reduction in the gift tax value of the transfer. But don’t forget that it is only available for two homes and any gain on the sale of a vacation home is not allowed a gain exclusion that is afforded to primary residences.
QPRTs can be great estate planning strategies. Make sure that you consider a QPRT for your vacation home or second home.