With the uncertainty surrounding the future of the lifetime gift and estate tax exemption, which is set to be cut in half if the applicable provisions of the 2017 Tax Cuts and Jobs Act expire, many people are exploring their options for reducing the size of their estates to avoid paying federal estate taxes. Rising home values are among the factors that, combined with a drastically lowered exemption, could push an estate over the threshold. In California, where real estate prices have been on a generally upward trajectory for decades with only relatively brief cooling off periods, the likelihood of this being the case are magnified for those who have owned a home for an extended period.
One possible strategy to reduce potential estate taxation is a Qualified Personal Residence Trust (QPRT), a type of irrevocable trust that allows the grantor to remove their personal residence from their estate to reduce the gift taxes they would pay when transferring assets to their beneficiaries. The grantor receives the right to live in the house for a specified number of years before the property is transferred. The terms of this type of trust can effectively remove the current value of the home and any future appreciation from the estate, but it has significant limitations that may not make it the ideal approach for every situation. Consulting an experienced estate planning attorney is the best way to determine if a QPRT is an effective means of accomplishing your estate planning goals.
How Does a QPRT Work?
When a QRPT is set up, the grantor’s personal residence is transferred into the trust for a length of time determined by the grantor—there is no maximum or minimum. However, the grantor must outlive the trust term for it to be legally binding, so it is vital to pick a reasonable trust term that takes into account the grantor’s life expectancy and health. The grantor’s retained interest in the home (their right to live in the property for the term of the QPRT) is calculated using the current Section 7520 rate and the term of the QPRT and then subtracted from the fair market value of the property. This yields the remainder interest, or the reportable gift tax value. In general, the longer the term, the lower the remainder interest will be.
This strategy doesn’t just freeze the fair market value at today’s levels, it reduces the taxable gift by the amount of the grantor’s retained interest, which can be a significant amount. However, depending on an individual’s circumstances, the limitations of a QPRT may make it an inadvisable means of reducing estate taxation.
Limits to Be Aware of with a QPRT
The most obvious caveat to consider with a QPRT is that it is irrevocable—once its terms are set, it can’t be changed. But other features of this type of trust should be fully understood before deciding if it makes sense for a particular situation. These include:
Aspect | Details |
Ownership After Trust Term | The home no longer belongs to the grantor. They lose legal access and may rent it from the beneficiary at fair market value, if allowed. |
Grantor’s Survival Requirement | The grantor must outlive the trust term. If they die before the term ends, the property returns to their taxable estate, making term length critical. |
Property Taxes (California) | Transferring property into a QPRT doesn’t trigger an immediate tax reassessment. Reassessment may occur when ownership transfers to beneficiaries. |
Cost Basis for Beneficiaries | Beneficiaries don’t get a step-up in cost basis. Gains are based on the property’s value when the QPRT was created, subjecting appreciation to capital gains tax |
The bottom line is that QPRTs are complex. Both the potential benefits and possible downsides should be considered before moving ahead.
Expert Estate Planning Guidance
Careful advance planning is your best opportunity to shield your wealth from avoidable estate taxes. The Trusts & Estates team at Bridge Law LLP is experienced in creating individualized estate plans that utilize the most effective strategies to accomplish your unique goals, no matter how complex your estate. If you have questions about QPRTs or other advanced estate planning strategies, we have answers. Schedule your consultation by contacting us here.