The primary benefit of any QPRT is that it allows individuals to remove significant assets from their estate and reduce the taxes imposed on transferring assets between generations. This occurs by creating a large discount upfront based on a gift valuation that is significantly lower than the fair market value of the home.
But there is a way to significantly reduce the gift valuation as a result of creating a fractional interests. We’ll discuss in this post the mechanics of fractional interests and also explain the approach. Let’s get started.
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There are still other benefits to a QPRT. Since the home value for gift tax purposes is the value at the date of transfer to the QPRT, any appreciation in value between that time and the time of the homeowner’s death will never be subject to gift or estate tax. Instead, all of the appreciation will pass to the QPRT beneficiaries free of tax.
But it gets better. The grantor can divide the residence into fractional interests for each intended beneficiary and thereby realize even more savings in gift tax.
What is the benefit of a fractional interest discount?
The basic strategy is to create one trust, and a discount is applied to reduce the gift. But not many people understand that you can use multiple trusts to make the gift. These fractional interests further decrease the gift value.
The fractional interest creates a more significant discount because of the lack of marketability. Since the fractional interest essentially divides the home into parts, the parts themselves lose substantial value.
This is because owning 100% of a home is more than twice as valuable as owning a 50% interest in the same home because you lose the ability to freely live in the house and enjoy all the benefits of fee simple ownership.
Suppose a homeowner intends to give the property to two or more beneficiaries. In that case, the grantor can consider creating a separate QPRT for each of the beneficiaries. Each QPRT can hold a fractional interest in the property itself.
Since each QPRT will have just a fractional interest, there is a valuation discount created. The fractional interest creates a further discount that will reduce the total value of the gift transfer. The grantor could still live in the home and create a large discounted amount due to the QPRT’s fractional interest holding.
Another option is to have a husband and wife each deed a 50 percent ownership interest in the house to a separate QPRT. This is another great option.
In the case of a residence held jointly by husband and wife, the ownership can be restructured as a tenancy in common so that each can create a QPRT with his or her undivided interest in the home. Their QPRT’s can be for the same term or for different terms. Because each spouse is making a gift of a minority interest in the home, there is authority for valuing each 50% interest at less than one-half of the total appraised value of the home.
Fractional Interest Example
Let’s look at a simple example. Let’s assume a house is worth $100,000 and two 50% fractional interests are created in the home. The interest may be only worth $30,000 each as a result of the lack of marketability.
But the $30,000 value of each fractional interest represents the present value. But when you consider that the QPRT gift value is the current undiscounted home value less the retained interest at the end of the term, these interests may then be discounted to only $10,000. The grantor (homeowner) would then claim a gift of $20,000 to represent the discounted value of the two fractional shares.
QPRTs have many advantages. They allow the grantor to sell the home and invest the proceeds in a new home. An individual can transfer up to two houses to QPRTs, and a married couple can transfer up to three.