Post initial trust term QPRT considerations.

• Author: Whitehair, Andrew L.
• Position: Qualified personal residence trusts

A qualified personal residence trust (QPRT) has long been a favored estate tax planning vehicle, given it is simple to establish, its existence is provided for in IRS regulations, and it requires little sacrifice on the donors part.

Essentially, a donor transfers a personal residence to a trust for remainder beneficiaries, generally children or a trust for children, and retains an interest in the trust (i.e., the right to live in the residence for a term of years). Upon funding the QPRT, the donor has made an irrevocable gift to the beneficiaries, but the value of the residence is discounted for gift tax purposes based on the actuarial value of the donor's retained interest. During the initial trust term (i.e., the period of the donor's retained interest), the donor continues to occupy the residence rent-free, pays normal operating expenses, and claims the relevant income tax deductions on his or her personal return. Not much changes following the gift, which is appealing for donors who are reluctant to part with assets during their lifetime. However, all good things must end, and the end of a QPRT's initial trust term brings with it many potential issues.

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What Happens After the Initial Trust Term?

Assuming the donor survives the initial trust term, one must understand what happens to the residence once the donor's interest ends. Typically, the trust agreement will call for the residence to be distributed outright or retained in trust for the beneficiaries. To ensure correct tiding of the client's assets, the tide should be transferred into the name of the remaindermen, whether that is a trust or individuals.

The form of ownership following the initial trust term will have significant income and estate tax implications, so it is critical to read and understand the trust agreement. If the residence is distributed outright, then each individual beneficiary will own a fractional piece of the property. However, if the property is retained in the trust or distributed to another trust, the income tax status of the trust after expiration of the initial term must be determined. During the initial trust term, a QPRT is a grantor trust under Sec. 677(a) as to the income portion and possibly also Sec. 673(a) for the remainder of the trust, but whether the QPRT remains a grantor trust after the initial trust term depends upon the language in the trust agreement. Generally, the power of substitution under Sec. 675(4) is not...