Understanding estate planning with Qualified Personal Residence Trusts.

• Author: Baskies, Jeffrey A.

QPRTs provide one of the few remaining potent estate planning techniques for your client.

Some estate planners and commentators describe Qualified Personal Residence Trusts (QPRTs) as a "can't miss" estate planning opportunity, while others consider them "having your cake and eating it too."(1) This article attempts to explain the issues involved in this complex estate planning technique in a manner intended to make estate planning with QPRTs comprehensible to all.(2)

Essentially, a QPRT is an irrevocable trust funded by the transfer of a personal residence to the trustee while retaining in the transferor a right to reside on the property for a term of years. Due to the complex valuation tables used to value the gift, a QPRT provides a means for clients to leverage their $650,000 applicable exclusion amounts.(3) As so many estate planning techniques designed to leverage the applicable exclusion amount are now less attractive due to the enactment of Chapter 14, QPRTs provide one of the few remaining potent estate planning techniques for your client. Please note, however, that the time to create QPRTs is now, as the President's budget proposals for 1998 and 1999 (also known as the Treasury Department's "wish list") have included a provision to repeal the section of the Code which permits the creation of QPRTs.

Transfer of Residence with Retained Interest

As indicated above, a QPRT is funded by the transfer of a personal residence to the trustee. A personal residence includes an individual's "principal residence," one other residence (which may be a vacation home, for example), or an undivided fractional interest in either.(4) Although this transfer is an irrevocable transfer of the client's ownership interest in the residence, the trust provides that the client, as beneficiary of the trust, has the right to live in the residence for a term of years. The term selected is typically between five and 20 years, although the IRS imposes no minimum or maximum term. The longer the term, the greater the tax benefits that are available.

At the end of the term stated in the trust, the client no longer has the right to live in the residence; however, the client may then lease the property from the trust or its beneficiaries, if the client desires to continue to live there. If the QPRT is coupled with a continuing trust at the expiration of the QPRT term, and if the continuing trust is structured as a "grantor trust" for income tax purposes, then arguably the transferor may pay rent to the continuing trust without creating income tax. Revenue Ruling 85-13, 1985-1 C.B. 514 indicates that the continuing trust (the grantor trust) is ignored for income tax purposes regarding transactions with the individual being treated as grantor of such trust under [sections] 671 of the Code. Thus, if that revenue ruling is followed, the payment of rent to the ongoing trust after the QPRT term should not constitute taxable income.

Unfortunately, due to regulations passed by the IRS, the grantor may not purchase the home from the QPRT before the trust expires or from the continuing trust after the QPRT term. Therefore, clients who create QPRTs must be aware that if they outlive the term (which we expect), they will either need to vacate the residence or rent it. Of course, even if the rent cannot be paid income tax free, paying rent to one's beneficiaries may be a good tax "trade-off"--it reduces the client's taxable estate (at rates up to 55 percent) while generating income for the beneficiaries (who may be in much lower brackets--the highest federal income tax rate is 39.6 percent).

Trustees

The client has a variety of choices as to who shall serve as trustee of the trust. First, the client may select a corporate trustee who may bring professional management experience to the fiduciary role. However, where the sole asset of the trust is a personal residence, professional management may not be needed. Instead, the client may choose to serve as the trustee himself or herself; however, in that case the trust must either curtail the trustee's discretion upon cessation of use of the property as a personal residence (regarding whether or not to convert the trust assets to a Qualified Grantor Retained Annuity Trust (GRAT) or to distribute them outright to the grantor), or it must require the grantor/trustee to either resign or to appoint an independent trustee to make that decision. Unless the discretion is so limited, the transfer to the QPRT may not be deemed as a completed gift. Finally, the grantor could choose an individual other than himself or herself who would serve as trustee--a spouse, child, or friend, for example. By doing so, the trust could retain its flexibility while avoiding the costs of employing a professional fiduciary.

Typically, in a QPRT, clients prefer to be the trustee. The trust can provide that in the event of a discretionary decision to distribute principal to the grantor or to convert the QPRT to a GRAT (i.e., on the sale of the residence), if the grantor is serving as the sole trustee then there shall be no discretion. The trustee must convert to a GRAT. If the grantor is not serving as the...