Florida homestead transfers: the advantages of short-term qualified personal residence trusts. .

• Author: Chamberlain, Steven M.

Estate planning involving Florida homesteads poses special challenges to estate planners because of the Florida legal requirement providing that if the owner is survived by a spouse or minor child, the homestead must pass as a life estate to the surviving spouse with the remainder to the owner's descendants. (1) Many clients simply do not want their homestead to pass in this fashion. The problem cannot be solved through a transfer of the homestead to a revocable trust. (2)

Accordingly, whenever the Florida restriction on devise of the homestead applies and there is a desire to control the passage of the homestead upon death; as a practical matter, Florida law compels the estate planner to recommend the gifting of a remainder interest in the homestead to an irrevocable trust. (3) Unless the gift is incomplete for gift tax purposes or the homestead is held in a trust which meets the technical requirements of the regulations under IRC [section] 2702 (i.e., a QPRT, discussed below); the value of the taxable gift of the homestead to the irrevocable trust will be deemed to equal the entire value of the homestead without reduction for the value of the interest retained by the donor. (4) This arguably unjust valuation brings us to the planning opportunities afforded by Qualified Personal Residence Trusts (QPRT).

QPRTs in General

The QPRT is a well-known and often used estate planning device. The purpose of the QPRT is to achieve a valuation "discount" for a gift of the owner's homestead or another personal residence or both. Usually the gift is made to a trust in which the donor retains a possessory right to the residence for a term of years, after which the residence either continues to be held in trust for the benefit of other family members or title shifts outright to such beneficiaries. (5)

From a gift tax perspective, the benefit of a QPRT is that the gift is measured by subtracting the value of what the grantor retained (i.e., the possessory interest) from the value of the gifted interests in the residence, all measured at the time of the transfer to the QPRT. (6) If the grantor survives the term, title shifts to the remainderman without additional gift tax consequences. If the grantor fails to survive the term, the net effect is essentially the same as if there had been no transfer in the first place. (7) Since there is no "downside" if the grantor fails to survive the term, the technique fits into the category of "heads I win, tails we're even." (8)

The Remainder Interest

The above discussion is well known and noncontroversial in the estate planning community. The difficulties arise on planning for the remainder interest. The primary question is how the grantor can continue to reside in the residence after the term expires. The usual answer is that the residence can be rented to the grantor. Since losing control is not particularly palatable to many clients, many estate planners recommend naming a trust for the benefit of the children (or other beneficiaries (9)) as the remaindermen. With careful drafting, there is no reason why the grantor(s) cannot be the trustee(s) of the remainder trust. (10)

The benefits of such an approach are impressive. Since the remainder trust can easily be drafted to be a grantor trust for federal income tax purposes, (11) the grantor can continue to be considered the owner of the residence for income tax purposes (but without being treated as the owner for estate and gift tax purposes). Consequently, for income tax purposes the lease of the residence by the grantor as tenant is considered a lease by the owner to himself, a nonevent. Thus, the grantor can lease the residence from the trust after the term expires without adverse income tax consequences and can also still have the same mortgage interest and ad valorem deductions as before, as well as qualify for the exclusion from gain on sale. (12)

The Short-Term QPRT

Suppose the QPRT is for only two years, instead of the typical 10- to 15-year period. Besides the real-world effects (discussed below), there are two obvious tax effects. The first is that the remainder interest, and thus the taxable gift on formation, is much larger. For example...