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A Real Estate Residence Trust - How Great Is This

Posted by attorney Steven Tarta

A Qualified Personal Residence Trust (QPRT) is a trust in which the person establishing the trust, call the Grantor, reserves the use of a residence (either the Grantor's primary residence or a seasonal residence) for a specified term of years. In the trust agreement, the Grantor designates the individuals who will be entitled to the property at the conclusion of the trust term. These individuals are called "remaindermen", and they are typically the Grantor's children, but they do not have to be.

Because a QPRT is irrevocable, the Grantor makes a gift to the remaindermen at the time the QPRT is established. The value of the gift, however, is not the fair market value of the residence being transferred to the QPRT. Instead, the value is the remaindermen's right to the property at the end of the Grantor's retained use. In other words, it is only the value of the remainder interest which represents the gift and not the full value of the residence.

A QPRT is an especially effective estate planning device because, under IRS valuation tables, the Grantor's retained interest is overvalued while the interest of the remaindermen is undervalued. Additionally, the IRS valuation tables assume that the property in a QPRT does not appreciate once it is transferred to the QPRT. While this assumption may be accurate for short periods of time, over longer time periods most residential real property will appreciate.

For example: An individual, age 65, has a residence worth $600,000. He sets up a QPRT retaining the right to use the property for 15 years with a reversionary interest (a right to receive the property back) if he dies during the 15 year term. Under IRS tables, the Grantor's right to use the property for 15 years plus the reversionary right are equal to 77.93 percent of the fair market value of the property ($467,568). The gift tax value of the remainder interest in the residence is worth only 22.07 percent of the value of the residence ($132,432). Frequently, the Grantor's gift can be paid by a debit against his exclusion amount (currently $345,800).

If the Grantor survives the 15 year period, the property passes to the remaindermen with no further estate or gift tax consequences. Also, if the property appreciates over the retained use term, the appreciation totally escapes estate taxation.

Returning to the example discussed above: assume that the property appreciates at 4 percent a year for the 15 years of the Grantor's retained use. At the end of the 15 years, the property would be worth $1,080,566. There would be no additional gift or estate tax. Thus $480,566 worth of appreciation ($1,080,566 - $600,000) plus the $467,568 original value (total $948,134) would completely escape estate and gift taxation.

If the Grantor were in a 50 percent federal estate tax bracket, the overall estate tax savings would be $540,283.00. Of course, greater tax savings can be achieved if the property appreciates faster than 4 percent.

In our example, if the Grantor survives the term, he achieves the following:

  • Passes property to his family actually worth $1,080,566 at a gift tax value of only $132,432;
  • Retains all tax advantages of ownership during the use period (i.e. homestead exemption, income tax deduction of real estate taxes); and
  • Retains the use and enjoyment of the property during the QPRT term (and even for extended periods thereafter if other steps are taken).

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