Winter 2008Newsletter

Qualified Personal Residence Trust

Wealth Planning Update

If you own your own residence and your estate would be subject to estate tax, you should consider the tax savings attendant on a special kind of trust called a Qualified Personal Residence Trust.

The owner of the home would set up an irrevocable trust to which you transfer your interest in the residence. In general, the trust provides that you keep the right to live in the residence for a set period of time. It has other provisions discussed below. These provisions reduce the value of the gift for gift tax purposes to a value less than the current market value of the home. The reduction in value (and, therefore, the value of the gift) depends primarily on how long you keep an interest in the home, your age and market interest rates at the time you create the trust.

If you are married and you own your home in joint tenancy, in order to accomplish the simplest method of creating such a trust, you would divide ownership of your residence and each spouse would create a trust to own his or her undivided one-half interest in the home.

Trust Terms

The trust is irrevocable; that is, you cannot change it after it is established.

The trust provides that, for a stated number of years, you have the right to live in the residence and continue to pay all expenses related to the home. At the end of the term of years, ownership of the home either stays in trust for the benefit of other beneficiaries you have named, presumably your children, or the trust terminates and ownership of the home is transferred to your beneficiaries, presumably again, your children.

If your beneficiaries receive ownership of the home outright, each of their interests will be controlled by the beneficiaries’ estate plan. If that is a concern, you should provide for continuation of the trust for the benefit of those beneficiaries for some period of time after the term ends in order to ensure that you have some control over who owns your home.

At the end of the term if you wish to continue to live in the home, you pay your beneficiaries a fair market rent. This is another good way of transferring funds to the beneficiaries without paying a transfer tax. That rent would be taxable income to the beneficiaries but would be offset, at least in part, by allowable depreciation.

The trust takes your income tax basis in the home. If the home is sold during the term of the trust, the benefit of the shelter of $250,000 (or $500,000 for married people) worth of capital gain is available.

If the home is sold during the term of the trust and the proceeds are not reinvested in another home, the trust would be required to pay you a specific percentage of the value of the trust each year. The percentage required depends on when you make the gift, but it is almost always more than you can make in the stock or bond markets in income. If income from the trust is not sufficient to pay the required amount to you, trust principal would be invaded every year to pay you that amount. It is not the best tax planning and, accordingly, a sale of a home without a purchase of a replacement during the trust term is not recommended.

If you die before the term of the trust expires, the trust property would return to your estate and would be disposed of under your will. If this occurs you have not gained any advantage from setting up the trust, but the only loss you have is the cost of setting up the trust.

Tax Savings

As mentioned above, the value of the gift that you make depends on your age, the term of the trust and interest rates at the time you make the gifts. For example, if your home is worth $800,000 and you are 65 years old and you set up the trust on December 1, 2007 for five years, the value of your gift at the time that you set up the trust is about $562,000. If the trust is set up for ten years, the value is about $373,400. A term of 15 years results in a taxable gift of $227,800. Therefore, under those assumptions, assuming that you survive a set term of 5, 10, or 15 years, you are able to remove an asset worth $800,000 from your estate for estate tax purposes at a cost of 70%, 46%, or 28% of the value. With the highest estate tax rate being 45%, the discounted value alone results in substantial tax savings. But if it is assumed that the home appreciates, getting the appreciated value out of your estate generates even greater savings.

Those savings must be compared with the fact that your beneficiaries will take your income tax basis in your home. Sometimes you have an extremely low basis and the capital gain that the beneficiaries face must be assessed as a part of the overall tax saving in this plan.

As you may know, if you retain the home in your estate until your death, the income tax basis after your death is the value at the time you die. Therefore, a sale shortly after your death usually results in no capital gain.

Since the capital gain tax rate has been significantly lowered, estate tax savings almost always outweigh the income tax cost of this type of gift.

You should note that there are a few restrictions on this type of trust. You are not allowed to purchase the residence back from your trust. The rent that you must pay after the term expires must be at fair market value rent.

In general, you may act as trustee both during the time at which you are the beneficiary, that is during the term of years you have established, and after that term expires.

If you own a condominium or property which includes rights to a golf course or other common facilities, there may be restrictions on entities to which you can transfer ownership. You may be precluded from using this type of trust by the bylaws of your condominium or other association.

If you have a mortgage on your home or you intend to make significant capital improvements to the home, you should not set up this type of trust until the improvements are completed or the mortgage is paid off. Otherwise, each payment for an improvement and each payment of principal on the mortgage is an additional gift which complicates the planning significantly.

This type of trust has been very popular recently. It can only be set up with a residence and represents an exception to certain other estate tax rules. There has been a suggestion that there should be legislation eliminating this exception, but no legislation is currently pending. Nevertheless, if you are interested in this tax saving device, you should make your decisions regarding it sooner rather than later.

For more information, please contact Gordon K. Miller at 414.225.4930, or

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