QUALIFIED PERSONAL RESIDENCE TRUSTS

A Qualified Personal Residence Trust (QPRT -- pronounced "kew-pert"), is an irrevocable trust that allows you to leverage your $600,000 estate tax exemption through the transfer of your personal residence. A QPRT can dramatically increase the amount passing to your beneficiaries and reduce estate taxes.

To create a QPRT, a homeowner transfers his or her residence to a trust that exists for a predetermined period of time, for example, 5, 10, 15 or some other specific term of years. The homeowner retains the right to use the residence during the trust term. At the end of the trust term, title to the residence is transferred to the beneficiaries of the trust, usually the homeowner's children. Alternatively, the residence might continue in trust for the benefit of the children. Typically, the homeowner will then lease the property back from the children so that he or she may continue to live in the residence. The rental amount must be fair market rent.

The tax benefits of the QPRT are a function of the IRS interest rate tables used to calculate the gift by the homeowner upon creating the QPRT. When the homeowner transfers the residence to the QPRT, the transfer is a taxable gift under the gift tax law. However, the amount of the gift is not the full value of the residence, but the value reduced by the value of the homeowner's retained right to use the residence for the period specified in the trust.

Because the homeowner has made a taxable gift, a gift tax return must be filed with the IRS on or before April 15 of the year following the transfer. A qualified real estate appraisal of the residence and a calculation of the gift amount will be attached to the return. However, there will be no gift tax payable because the homeowner will allocate a portion of his or her $600,000 exemption amount to the gift.

If the homeowner does not survive the specified term, the value of the residence at death will be pulled back into the homeowner's death tax estate. The estate will receive a credit for the exemption previously allocated. Usually, a provision in the QPRT will provide that, in the event of premature death, the property will be distributed back to the homeowner's probate estate to be distributed under his or her will, or to the homeowner's revocable living trust to be distributed with his or her other assets. In other words, if the homeowner dies before the end of the trust term, the only thing she stands to lose are the fees and costs incurred in setting up the trust. Other than that, the homeowner is no worse off for having tried the technique. If the homeowner survives the term, substantial estate taxes can be saved.

The following example illustrates the dramatic tax savings that can result from implementing a QPRT as part of your estate plan:

Hank Client, a widow aged 67, owns a home worth $500,000. Hank owns other assets which puts him in the 50 percent estate tax bracket. Hank has a life expectancy of 15.2 years. After consultation with his estate planning attorney and CPA, Hank decides to create a 15-year QPRT. At the end of the term, the property will pass to Hank's children outright. The applicable IRS table rate for the month in which the QPRT is established is 8.4 percent. Hank estimates that the property will appreciate in value a conservative 3% per year.

Without QPRT
Present value of residence: 500,000
Value of residence at Hank's death: 778,984
Death tax paid on residence: 389,492
Net to children at Hank's death: 389,492

With QPRT
Present value of residence: 500,000
Amount of taxable gift (exemption used): 75,060
Value of residence at Hank's death: 778,984
Death tax paid on residence: 0
Less adjustment for use of exemption: 37,530
Net to children: 741,454

Summary
Net to children without QPRT: 389,492
Net to children with QPRT: 741,454
Increase to children (estate tax savings): 351,962

Because the tax benefits of the QPRT are lost if the homeowner does not survive the term, considerable attention must be given to such factors as the homeowner's age, health, and history of family longevity in selecting the term of the trust. The longer the trust term, the greater the tax savings.

An important disadvantage of the QPRT is that the residence will pass to the children at the end of the trust term with a carry-over income tax basis. As a result, if the settlor survives the trust term, the property will not be entitled to a stepped-up basis at the homeowner's death. When the children eventually sell the property, there may be significant income tax consequences. However, the estate tax rates currently exceed the capital gains rates. Moreover, the children could defer or eliminate the income tax by structuring the sale as a like-kind exchange or establishing a charitable remainder trust. The basis step-up might also preserved if the homeowner buys back the residence at the end of the trust term.

A QPRT may be created using a primary residence or second home, such as a cabin, a vacation condominium, or even a yacht if it is used as a second residence. Business or investment property, such as an apartment complex, office building, or farm, cannot be used. For a married couple owning a home jointly, even greater estate tax savings are possible because their respective ownership interests are entitled to minority interest and marketability discounts.

Supplementing your estate plan with a Qualified Personal Residence Trust can be an effective tool to lower estate taxes and increase the amount of your estate passing to your children or other beneficiaries. QPRT's are very technical and should not be established without expert legal and tax advice