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Dear Financial Advisors:

Here is a structure that can really benefit clients who want to transfer either

their personal residence, a second home, or both to their heirs without estate

or gift tax. Additionally, they can increase their estate through insurance or

financial investment without increasing their estate or gift tax liability. The

answer is that the real estate could be purchased by or placed into a Qualified

Personal Residence Trust (QPRT) with the beneficiary being an ILIT.

Why? I am glad you asked:

The QPRT is a trust that places the property in an irrevocable trust for the

benefit of the beneficiary (ILIT) but the owner retains a "retained interest"

i.e., the free use and enjoyment of the property for a period of time. At the

time the property is bought or transferred to the QPRT the value of the

property is a completed gift for gift tax purposes. However, the gift tax basis

is reduced by the retained interest. Depending on the length of the retained

interest, the owner can substantially, and I mean substantially, reduce the gift

tax that would be owed at the time of transfer. Why would anyone do this? I

am glad you asked that too: The property transfers to the ILIT without estate

tax, and the gift tax is substantially reduced.

Why an ILIT for a beneficiary? Good question, here is why:

First, if the owner dies during the term of the QPRT, then the property will be

included in the owner's estate, requiring an ILIT to be the back up. Secondly,

and most exciting, is that after the property is transferred to the ILIT, the owner

does not own it anymore, but can stay in the property if the owner pays

market rent.

Why would anyone rent their own house? Another good question:

They must move the property outside of their estate, and retain no interests in

it for the avoidance of estate tax, but the cool thing is that the property is in

their own ILIT, with a third-party trustee (kids?), and their "rental payments"

would pay for their current premiums, or even better, the trustee of the ILIT could purchase more

insurance. What is more, the "rental payments" would not be gifts, requiring gift tax exclusion, but be

income. Since the ILIT will be a "grantor trust" for income tax purposes only, the trust will not have

to pay income taxes on the "rental payment" because the IRS sees it as a payment to yourself.

Huh? Let me give you an example:

In April of 2006, a 60 year old man buys a second home as his property sole and separate. He is

married but they agree to purchase the house as his separate property. The house is worth

$800,00.00. He transfers the house to a QPRT with a 7 year term. The value of the gift is

$488,792.00 (61.099% of the $800,000.00). The value of the retained interest in the house is

$242,128.00 (30.266% of the $800,000.00). Upon the end of the 7 year term, the QPRT transfers the

house to the beneficiary (an ILIT that was created at the beginning of this process.) The ILIT

currently holds a $500,000.00 life insurance policy and a year's worth of premium. The 60 year old

man then rents the house from the ILIT for fair market value. The ILIT then takes the rental income

to boost the insurance policy to $1,000,00.00. Upon the 60 year old man's death, after the 7 year term

of the QPRT, both the $1,000,000.00 policy and the second home go to the heirs.

Result: Client gets to have a second home, enjoy the second home, and pass it to his heirs estate tax

free. On an $800,000.00 house, appreciated to $1,125,680.00 over the term of the QPRT, assuming

he already has over a million dollars in estate tax exemption used in personal life insurance, the estate

tax would be $619,124.00. Instead, the Client gets to use the QPRT and his lifetime gift tax

exemption to transfer the property tax free. Additionally, the Client has grown his overall

distributable wealth to $1,000,00.00 of liquid insurance proceeds, and an additional $325,680.00 in

capital gains appreciation.

That totals a $1,325,680.00 benefit to the client.

To sum up, this program allows clients to purchase second homes in a buyer's market, protect them

from all creditors, but the mortgage company, transfer it gift and estate tax free, and increase their

distributable wealth to their heirs exponentially.