QPRTs – Qualified Personal Residence Trusts – Introduction

QUALIFIED PERSONAL RESIDENCE TRUST (“QPRT”)
GIFTS OF THE HOUSE

A QPRT can be used to transfer a house at a
significantly reduced gift tax cost. For smaller estates, the
concept may be useful for controlling the bequest of a house, even if tax
benefits are not of primary importance.

What is a QPRT?

By creating a QPRT, the client would
transfer the entire ownership of the family house to a trust while retaining
the right to live in the house for a term of years (e.g. 10
years). At the end of the specified number of years, the ownership
of the house would be transferred to the beneficiaries of the trust, generally
the client’s children. The term of years is, in effect, a gamble
on the likely duration of the client’s life. The longer the term,
the lower the value of the gift of the future interest in the house to the
children (or other heirs) for gift tax purposes. However, the
longer the term of years the greater the likelihood that the client may not
survive the term of the trust, thus causing the entire value of the house to be
included in the client’s estate.

The QPRT technique can be especially useful
for a senior client whose estate is taxable and a major asset is the client’s
house. Many senior clients are reluctant to gift marketable
securities and cash, since they view these liquid assets as their source of
meeting living expenses and security. In such situations, a QPRT
may be the ideal estate planning technique. The clients can retain
control over their liquid assets, while the ownership of their major asset,
their house, is transferred by gift at favorable rates.

The key benefits of the QPRT technique include the ability
to leverage the use of the client’s applicable exclusion amount (as a result of
the time value of money discount feature of the QPRT calculation) and remove
future appreciation (after the date of the gift of the house to the QPRT) from
the client’s estate.

Drafting the QPRT

The IRS has issued a Revenue Procedure
2003-42, 2003-23 I.R.B. 993 (6/9/03), with sample language to include in a QPRT
trust. Practitioners should incorporate this model language into their QPRT
forms.

Requirements for a QPRT

A host of requirements must be met for a
QPRT to obtain the anticipated tax benefits. These include the
following:

a. The only assets that the QPRT can hold
are a residence (defined below) and house insurance policies (and payments
under such policies) and a modest amount of cash for upkeep. The
cash that a QPRT can hold includes only the funds to pay the QPRT’s expenses.
This can include any trust expenses, including but not limited to
mortgage payments. Expenses that qualify are those already
incurred, or which are reasonably expected to be incurred in the six months
following. Also, funds to pay for improvements to the residence
held by the QPRT over the next six months may be held by the QPRT.
Condemnation proceeds or proceeds from insurance paid for the damage or
destruction of the residence (and any earnings on those proceeds) may be held
for two years from the date of the event (condemnation or destruction) if the
trustee intends to reinvest the proceeds.

b. Upon formation, the QPRT can also hold
funds to purchase a new residence in the next three months.
However, the QPRT agreement must prohibit the gift of additional funds to the
trust until a contract to purchase a residence exists.

c. In addition, the QPRT may hold cash for
the purchase of a residence to replace another residence, within three months
of the addition of cash, so long as a contract to purchase the new residence
exists. Cash funds in excess of those permitted by the regulations
must be distributed quarterly to the grantor, and upon the termination of the
QPRT.

d. The property contributed to the QPRT must
be a qualified residence. A principal residence, vacation house, or even a
fractional interest in a principal residence can be transferred to a
QPRT. A key concept is that the residence must be available for
the grantor’s use as a residence. Land that is adjacent to the
residence can also be included within the definition of a qualifying residence
for transfer to a QPRT where the land is reasonably appropriate for residential
purposes. The IRS even permitted lots on opposite sides of a
street to be treated as a single residence for purposes of a QPRT where there
was evidence that the lots were historically used as a single vacation
property. Where a residence was situated on 10 acres of land used
for many years as a residence, the IRS held that the property constituted a
residence for QPRT purposes. The IRS noted that the
property was listed as one parcel on the tax map, although a map prepared for a
proposed development of the property showed it divided into three
lots. Where separate structures were joined by a deck and walkway,
the IRS held that if the clients separated them into separate parcels for
contribution to different QPRTs they would be treated as separate parcels and
not a single residence. Where a QPRT was to include a primary
house and a guest house (which was not rented) and 1.65 acres of land, the IRS
held that the property qualified as a residence for a QPRT. The
IRS has permitted a transfer to a QPRT of residential property that consisted
of two connecting lots, one of which was unimproved property. The
other lot had a house and two separate rental units attached to the house, with
their own entrances, bathroom, and kitchen area, consisting one of 21 percent
of the total area. The IRS has permitted interests in a
cooperative apartment to qualify even where the cooperative board of directors
refused to give permission to the grantor to make the transfer.
,

e. The definition of vacation house is based
on the usage tests under Code Section 280A. This test provides
that if the property was used for the greater of either: (i) 14 days; or (ii)
the number of days that equals 10 percent of the number of days the residence
was rented at a fair rental, it will qualify. , The IRS has
permitted the qualification of a guest house adjacent to a vacation house in a
QPRT.

f. Any particular QPRT can only hold a
single residence, used by the grantor, for the entire term of the
QPRT. A grantor may not have interests in more than two
QPRTs. A QPRT must be irrevocable, and the trust document should
so state. The regulations prohibit the interest of the
beneficiaries in the remainder interest in the QPRT from being commuted (bought
out based on actuarial values prior to the termination of the
trust). During the term of the QPRT, the trust agreement must
prohibit the trustees from making income or principal distributions to any
person other than the grantor. The only exception is that on trust
termination distributions can be made to the remainder beneficiaries instead of
to the grantor.

QPRT Considerations in Light of Current Market
Conditions.

QPRTs are an interest sensitive planning
technique. The higher the interest rates, the more leverage the technique
provides. This makes QPRTs less than an ideal tool in the current environment
with historically low interest rates. However, the more appreciation that
occurs after the house is transferred to the QPRT, the more tax benefit the
technique will provide. If your client believes that home prices are near their
lows, now may still be an ideal time to shift the value of a house to a QPRT.

What Happens on QPRT Termination

Following the termination of the
QPRT term, the house would be retitled from the QPRT to the children, other
heirs, or a further trust designated in the QPRT document. Should
the client still wish to continue to reside in the house, as is likely, the
client must sign a written, arm’s length lease with the children (or other
title holder), renting the house.