If you own your principal residence, you may be able to benefit from its build-up in equity, realize current tax breaks and pocket a sizeable tax-exempt gain when you sell it. What’s more, from an estate planning perspective, it may be more beneficial to transfer ownership of your home to a qualified personal residence trust (QPRT).
Using a QPRT, you can avoid potential estate tax pitfalls without making drastic changes during your lifetime. Notably, you can continue to live in the home for the duration of the trust’s term. When the term ends, the remainder interest passes to designated beneficiaries.
When you transfer a home to a QPRT, it’s removed from your taxable estate. The transfer of the remainder interest is subject to gift tax, but tax resulting from this future gift is generally reasonable. The IRS uses the Section 7520 rate, which is updated monthly, to calculate the tax. For July 2023, the rate was 4.6%, down from the year’s high of 5% in April.
You must appoint a trustee to manage the QPRT. Frequently, the grantor will act as the trustee. Alternatively, it can be another family member, friend or professional advisor.
Typically, the home being transferred to the QPRT is your principal residence. However, a QPRT may also be used for a second home, such as a vacation house. Also, the IRS will generally treat the land adjacent to a house as being part of the home as long as it’s reasonable under the circumstances. The location, size and use of the home are determining factors.
What happens if you die before the end of the trust term? Then the home is included in your taxable estate. Although this defeats the intentions of the trust, your family is no worse off than it was before you created the QPRT.
There’s no definitive period of time for the trust term, but the longer the term the smaller the value of the remainder interest for tax purposes. Avoid choosing a term longer than your life expectancy. Doing so will reduce the chance that the home will be included in your estate should you die before the end of the term. If you sell the home during the term, you must reinvest the proceeds in another home that will be owned by the QPRT and subject to the same trust provisions.
So long as you live in the residence, you must continue to pay the monthly bills, including property taxes, maintenance and repair costs, and insurance. Because the QPRT is a grantor trust, you’re entitled to deduct qualified expenses on your tax return within the usual limits.
Be aware of several potential disadvantages to using a QPRT. When the trust’s term ends, the trust’s beneficiaries become owners of the home, at which point you’ll need to pay them a fair market rental if you want to continue to live there. Despite the fact that it may feel strange to have to pay rent to live in “your” home, at that point it’s no longer your home. Further, paying rent actually coincides with the objective of shifting more assets to younger loved ones.
Note, also, that a QPRT is an irrevocable trust. In other words, you can’t revise the trust or back out of the deal. The worst that can happen is you pay rent to your beneficiaries if you outlive the trust’s term or the home reverts to your estate if you don’t. Also, the beneficiaries will owe income tax on any rental income.
There are certain costs associated with a QPRT, including attorneys’ fees, appraisal fees and title expenses. And you can’t take out a mortgage on a home that’s been transferred to a QPRT. (An existing mortgage is permitted, but it can complicate matters.)
Not right for everyone
A QPRT isn’t for everyone, but it may be a beneficial estate planning strategy for certain individuals. Contact your estate planning advisor to determine if a QPRT is right for your estate plan.
SIDEBAR: Home sale exclusion put in jeopardy with a QPRT
If you transfer your principal residence to a qualified personal residence trust (QPRT), you may forfeit the home sale exclusion. With the exclusion, if you’ve owned and used a home as your principal residence for at least two of the five years prior to a sale, you can exclude from tax the first $250,000 of gain ($500,000 of gain if you’re married and file jointly).
Can you claim the exclusion for a home in a QPRT? The short answer is, no. A QPRT is an entity and not an individual, thus it generally doesn’t qualify for the exclusion.