Planning for tax liabilities of an estate ahead of time is a good idea because it can save your heirs thousands of dollars in estate taxes. This will not only provide your children and loved ones with a larger inheritance, but it can also help to reduce the chances that the bulk of your estate will be eaten up by federal estate taxes. One of the tax planning strategies that you can implement while you are planning your estate is to establish a Qualified Personal Residence Trust (QPRT).
Qualified Personal Residence Trust
A Qualified Personal Residence Trust is a great option to use if your estate will include a valuable piece of property. This program allows homeowners to transfer their property to their children through the use of a Grantor Retained Income Trust, which is also referred to as a GRIT account. The premise of this account is that you are basically promising to give your children a valuable gift at a predetermined time in the future, however, in the meantime the grantor reserves the right to use the gift.
Advantages of the Qualified Personal Residence Trust
One of the largest advantages of using a Qualified Personal Residence Trust is that it will dramatically reduce the tax base used to determine the estate’s tax liability during probate. Currently the federal government can assess an estate tax of up to 55% on estates that are valued over $675,000. This whittles away over half of the value of the estate. However, by using the Qualified Personal Residence Trust the value of the home is prorated based on what the home was worth when it was gifted, and how long the beneficiaries had to wait until they took possession of the property.
To illustrate how this program can save your heirs money take a look at an example of a home that is valued at $1 million at the time it was placed into a Qualified Personal Residence Trust for a ten year period. The IRS determines that the present value of this $1 million future gift based on a ten year term is $341,200. This reduces the amount of money that counts towards the $675,000 estate tax threshold by $658,800. If the time span of this example is reduced to five years the value of the future gift assessed by the IRS will increase to $585,932, which uses up a larger portion of the estate tax threshold of $675,000. This illustrates the importance of establishing a trust life span that is as long as possible without surpassing the life span of the grantor.
Another advantage that the Qualified Personal Residence Trust possesses is that the grantor retains control of their home and they also retain the tax advantages of owning a home during the life of the trust. For example the grantor is allowed to sell, modify, and replace the home as they see fit, they can use it as a tax deduction, and they can still used it as an asset to borrow against. However, while placing a home in a Qualified Personal Residence Trust has many advantages, it also has a few drawbacks that should be taken into consideration before making the decision to use this estate planning strategy or not.
Drawbacks to the Qualified Personal Residence Trust
One the largest drawbacks to using a Qualified Personal Residence Trust is that it involves estimating how long the grantor will live. In order for the Qualified Personal Residence Trust to produce the tax benefits that it was designed to do many events need to take place. First the trust must mature before the death of the grantor. Second the term of the trust must be as long as possible without surpassing the life span of the grantor to receive the greatest benefits. Finally the home, or a home equal in value, must remain in the trust for the term of the trust’s life. If any of these events don’t live up to the requirements of the Qualified Personal Residence Trust, then the home will revert back to the estate at its current value and all estate tax savings will be forfeited.