The Potential Keys to Paying Uncle Sam Less

If your estate is substantial and you're concerned about the federal estate tax bill your heirs will pay, there's a way you might be able to use your house to help the situation.

It may be as simple as giving away your home and as complex as knowing the mechanics of an estate planning tool called a Qualified Personal Residence Trust (QPRT).


Interest Rate Implications

    Interest rate fluctuations can affect Qualified Personal Residence Trusts. For example, if interest rates are falling, a QPRT loses some of its allure as a tax shelter because the value of the gift increases as rates decline, which could trigger a gift tax liability.
    With a QPRT, you make a deferred gift, meaning your heirs get the property sometime in the future. So you get a substantial discount on the value of the asset. The exact valuation is calculated using IRS tables, which change along with interest rates.
    Take, for example, a home valued at $1 million. At a 7 percent interest rate, the present value of a gift of your home in 20 years would be $258,420. At 6 percent, the value rises to $311,804. At five percent, it increases to $376,889.
    The prospect of declining rates can be an incentive to set up a trust before they drop further. Of course, if rates rise before you set up a QPRT, that would have favorable gift tax implications for you.

With a QPRT, you basically transfer ownership of your home (or vacation home) to a trust while you retain the right to continue to use the property during the trust term. After that, your kids or other designated beneficiaries become the owners of the property. If you still want to use the property, you can work out a rental arrangement with them.

Transferring property to a QPRT is considered a taxable gift, but you get a substantial break. The value of the house is discounted for gift tax purposes because you're allowed to continue using it for the term of the trust.

The Advantages of a QPRT

The QPRT allows you to get your home out of your taxable estate at a reduced tax cost. And because setting up the trust is a private transaction, there is no public record at your death that can be contested.

The QPRT may also provide advantages as an asset protection technique. The trust is irrevocable and the remainder interest may be insulated from creditor claims.

Sound too good to be true? A QPRT can save your heirs a bundle in taxes. However, the trust is irrevocable and the tax rules are complex. So you need a firm grip on the pros and cons of QPRTs before you give away such a valuable asset -- and one that many people are emotionally attached to as well.

Here are three key considerations when establishing a QPRT:

  1. Get an expert. Consult with an attorney who specializes in estate planning -- one mistake and the trust could be worthless. We have the experience and knowledge to guide you through the tax requirements and other alternatives.
  2. Pick a short term. Your goal is to continue using the home while getting it out of your taxable estate. So choose a term for the trust that you expect to outlive. If you die before the end of the term, the home goes back into your taxable estate with no tax savings. So the whole exercise was futile for a husband and wife. We may use separate trusts with different terms to provide a greater change of saving estate tax if one spouse dies first.
  3. Get a handle on your future. If you're planning to rent the house from your children or other beneficiaries after the trust ends, don't make the future rental a provision of the QPRT. The IRS could invalidate the trust. Don't set up a QPRT unless you have a good relationship with the beneficiaries, including in-laws. You don't want to worry about being thrown out someday after the trust ends.

The QPRT may even accommodate a sale or transfer of the residence if certain requirements are satisfied. If the personal residence held in a QPRT ceases to be used as a personal/ residence such as for a sale, then three alternatives are generally available:

  1. The original residence may be replaced within two (2) years
  2. The QPRT may convert to a grantor retained annuity trust
  3. The sale or insurance proceeds on the home itself may be distributed back to the donor.

The QPRT is an effective technique to reduce estate tax. At the present time, current law provides that the estate tax returns in 2015 with a 40% tax rate on estates in excess of $5,430,000. The QPRT is an effective technique for many families to reduce estate tax. We can help you determine if the QPRT is appropriate for you or your family.

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