Establishing a QPRT is a no-brainer for people in the right situation. But discussions often come up regarding the length of the QPRT term. Specifically, does a QPRT have a minimum term?
In this article, we will examine QPRT terms and address the proper length that you should consider. Obviously, any decision you make should be made in consultation with your CPA and estate attorney. We know the decision can be a tough one, so we will try to make it a little easier for you.
When a QPRT is established, you will need to consider the term upfront. The fair value of the remainder interest is a result of the QPRT term. As such, the longer the QPRT term, the lower the amount of the taxable gift that is recorded. Conversely, the shorter the QPRT term, the higher the gift value. The goal is to get the gift value as low as possible but making sure that you outlive the term.
QPRT Minimum Term
There is no required mandated maximum or minimum term. But the donor should make sure to select the correct term. Should the donor pass away during the period, the fair value of the entire property at the date of death will be included in their taxable estate.
If this occurs, it will nullify the estate tax savings. But the result to the donor would be the same as if the donor had never created the QPRT in the first place.
Most clients will select a term of 10 to 20 years. Unfortunately, many people do not consider estate tax planning until later in life and must select a term that is shorter than optimum, and they obtain a gift tax value that is higher than desired. If planning had started earlier, they could have established a longer time period and a lower gift value.
If you set up a qualified personal residence trust with a five-year term, the estate tax savings would be insignificant and you might have to vacate the home or pay rent upon expiration of the term.
Interest Rate Considerations
The trust is: the term length should be consider along with the interest rate environment. Higher interest rates do make the QPRT a more attractive tool.
However, the interest rate is not the only, or even the more important, factor in a QPRT’s success. The QPRT technique is highly sensitive to the value of the real estate being transferred. If a property is “undervalued” in the sense you think it will likely appreciate considerably during the QPRT term, you should consider a QPRT even if interest rates are relatively low.
Also, the longer the term of the QPRT, the greater the discount. Accordingly, the QRPT can make sense in a low interest rate environment if it is for a longer term with undervalued real estate. Often, a gift of a vacation home will fit this profile.
The following is typical language that you would find in the trust instrument as it relates to a QPRT:
Residence. The Transferor will hereby transfer and assign to the Trustee all of the said Transferor’s interests in and rights to certain real property, including all capital improvements thereon and appurtenances, known as [legal description and descriptive address], [city], [state]. This real property, or any specified property acquired as a replacement, will from now on be referred to as the “Residence.” The Trustee accordingly accepts the Residence and agrees to manage, hold, and distribute the Residence and any other trust property under the terms outlined in this trust instrument.
Determining the proper term should only be done with careful discussion with your CPA and attorney. There are pitfalls if you select a long term and a short term.