QPRTs - determining the tax-optimal trust term.

• Author: Baumann, Dale R.
• Position: Qualified personal residence trust

A qualified personal residence trust (QPRT) is a valuable estate planning technique that can be used to significantly reduce a client's overall transfer tax burden. Generally, a QPRT is an arrangement that allows an individual to transfer a personal residence to a trust and retain the right to live in the property for a specific number of years. At the end of the trust's term, the remainder interest in the property will be transferred to the trust's remainder beneficiaries (e.g., the grantor's children). Because the grantor retains an interest in the residence (which has substantial value for transfer tax purposes), gift tax on the property transferred (i.e., the remainder interest) may be significantly reduced or eliminated.

In order to realize the transfer tax savings from a QPRT, the grantor must survive the term of the trust. If he does not survive the term, the value of the residence will be includible in his gross estate. Consequently, choosing the correct trust term becomes a critical factor when establishing a QPRT.

Determining the Tax-Optimal Trust Term

When a grantor transfers a personal residence to a QPRT, the transfer is treated as a gift to the trust remainder beneficiaries (e.g., his children). The amount of the gift is equal to the residence's fair market value (FMV) on the transfer date less the FMV of the grantor's retained term interest. The value of the retained term interest is calculated using the grantor's age, the applicable Sec. 7520 interest rate and the trust's term. If a longer trust term is selected, the value of the retained interest will increase, thereby decreasing the value of the gift to the QPRT remainder beneficiaries.

In an effort to minimize the gift tax consequences of establishing a QPRT, financial planners will often consider increasing the length of the trust term. However, increasing the trust term will also increase the probability that the grantor will die during the term, defeating the purpose of the QPRT (if the grantor dies during the trust term, the value of the residence will be included in his estate and the benefits of the QPRT will be lost). Therefore, it is important to optimize the trust term in order to minimize both the amount of the gift and the risk that the trust will be included in the grantor's estate.

Generally, a grantor will recover most of the benefit of his retained interest during the early years of the QPRT. Given the law of diminishing returns, a point will be reached at...