QPRT requirements: new proposed regs raise questions.

• Author: Brophy, Peter M.
• Position: Qualified personal residence trust

On Apr. 15, 1996, the IRS issued a notice of proposed rulemaking on the sale of a residence from a personal residence trust or a qualified personal residence trust (QPRT). The notice indicates that the sale of the residence to the grantor by the trustee of the personal residence trust or QPRT is not consistent with the intent of Congress in enacting Sec. 2702. As such, the proposed regulations would provide that the trust does not meet the requirements of Sec. 2702, unless the governing instrument prohibits the sale to the grantor or related parties.

Background

Valuation rules are provided by Sec. 2702(a) for determining the value of a gift on transfer in trust to or for the benefit of the donor's family when the donor retains an interest in the trust. Sec. 2702(a)(2)(A) values that retained interest at zero unless it is a"qualified interest." Hence, the value of a gift is equal to the property's full fair market value (FMV) at the time of transfer.

Sec. 2702(a)(3)(A)(ii) allows an exception to this rule for the transfer of an interest in trust of a residence to be used as a personal residence by persons with term interests in such trust. This enables a grantor to carve out the retained interest and the reversionary interest before valuing the gift based solely on the qualified remainder interest. The gift's FMV (less mortgage) is reduced by the present value of the right to reside tax free in the residence for the term of years (the retained interest). It may also be reduced by the present value of the right to retake the residence on death during the trust term (the reversionary interest). Regs. Sec. 25.2702-5(c) expands the viability of the personal residence trust through the creation of a QPRT. Should the grantor outlive the term of the QPRT, the personal residence passes to the remaindermen, who are the family members or designated members; the full FMV of the residence is no longer in the donor's estate at this time. The residence would otherwise be taxable at the incremental estate tax rate (which can reach 55% for the combined taxable estate and taxable gifts under Sec. 2001). Rather, only the remainder interest is subject to gift tax, and then only on the remainder's value as calculated when the residence originally was transferred into the trust. Any subsequent appreciation while in the trust avoids imposition of both gift and estate tax.

Assuming that the trust instrument meets the grantor trust rules such that the grantor is...