A Qualified Personal Residence Trust (QPRT) is a legal estate planning tool used in the U.S. to minimize estate taxes while allowing an individual to retain the right to live in their primary residence or vacation home for a predetermined period of time. The primary goal of a QPRT is to transfer the ownership of a personal residence or vacation property to the next generation at a reduced tax cost.
What then happens if the residence is sold during the term?
The IRS regulations set specific requirements for a trust to qualify as a QPRT. Among the rules, the trust is typically prohibited from holding anything other than the principal home or one another residence to be used by the grantor. But what happens if the home is sold during the term of the QPRT?
Despite the rule that a QPRT must hold a residence (home), QPRT status does not normally terminate if the property is sold during the QPRT term. The IRS provides that a QPRT can still continue to be in effect and hold the proceeds from the sale of the home until the earliest of:
- Two years subsequent to the sale date.
- The QPRT term ultimately ends.
- The QPRT subsequently acquires a new home.
However, the trust agreement must allow the trust to hold the sales proceeds. If the trust agreement does not conform to this requirement, the trust will cease to be a qualified QPRT even when the sales proceeds are held within the trust.
Should a QPRT reinvest all of the sales proceeds by acquiring a new property of equal or greater fair value and does so prior to the earlier of (1) two years from the sale date; or (2) the date the QPRT term subsequently ends, the trust’s QPRT status will carry on.
The replacement property must meet the same rules and requirements as the original home. That is, the replacement property must be used as the primary or one other home of the grantor.
Because a QPRT typically qualifies as a grantor trust, the grantor can exclude up to $250,000 (or $500,000 when married) of capital gain from selling a primary residence in the QPRT. This assumes the grantor meets the other requirements, including that the home was used as the grantor’s primary residence for at least two of the prior five years.
How does a QPRT work?
Here’s how a QPRT generally works:
- Creation of the Trust: The individual (grantor) creates a QPRT and transfers the ownership of their primary residence or vacation home into the trust. The grantor names beneficiaries (typically family members) who will eventually inherit the property.
- Term of the Trust: The grantor specifies a fixed term during which they will continue to reside in the property. This term can be a certain number of years or until a specific date.
- Retained Right to Use: During the trust term, the grantor retains the right to live in the property and use it as before. This retained interest is a crucial aspect of the trust.
- Valuation of the Gift: When the trust is created, the property’s current value is assessed, and the future value of the retained interest is calculated based on factors like the grantor’s age, the length of the trust term, and prevailing interest rates. The IRS provides tables to calculate the value of the retained interest.
- Gift Tax Implications: The value of the property transferred into the trust minus the value of the retained interest is considered a gift to the beneficiaries. However, due to the retained interest and the trust term, the value of the gift is usually much lower than the property’s full fair market value.
- Gift Tax Exemption: The grantor can use their applicable gift tax exemption to reduce or eliminate the potential gift tax liability associated with the transfer. If the gift value falls below the exemption limit, no gift tax is owed.
- Estate Tax Implications: The primary benefit of a QPRT is that, at the end of the trust term, the property is no longer considered part of the grantor’s estate for estate tax purposes. This can lead to significant estate tax savings if the property appreciates in value over time.
- End of Trust Term: Once the trust term expires, the property ownership is transferred to the named beneficiaries. They gain full control and ownership of the property, free of any estate tax liability.
|QPRT Advantages||QPRT Disadvantages|
|Large Estate Freeze||No Stepped-Up Basis|
|Asset Protection||Higher Administrative Fees|
|Still Reside in Home||Complicated Exits Strategies|
|IRS Safe Harbor Approach||Requires 709 Gift Tax Return|
|Allowed for Vacation Home||Mortality Risk|
|Primary Home Gain Exclusion||IRS Complexity|
QPRT Sale of Residence
Note that while QPRTs offer potential estate tax benefits, they are complex legal tools that come with certain restrictions. Consulting with qualified legal and financial professionals is crucial when considering the creation of a QPRT to ensure that it aligns with your specific financial and estate planning goals.