In a high interest environment, a QPRT ("Qualified Personal Residence Trust") is a great tax strategy with a statutory basis, supported by both the Internal Revenue Code and its Regulations, that can allow taxpayers to make a large gift while alive and simultaneously reduce their federal and any applicable state estate tax.
First, how does a QPRT work?
A QPRT allows someone to transfer ownership of a primary residence or vacation home out of their taxable estate to family members at a discounted value for gift tax purposes. Ownership is transferred into an irrevocable trust for an initial term during which time the owner may continue to live in the home and remain responsible for ordinary expenses of the residence. A QPRT may hold only an interest in one personal residence and some related assets.
The gift's discount is a function of the donor's continued residency in the home and the possibility that the gift will revert if the donor dies during the QPRT's term. The factors determining the discount are the federally set Section 7520 interest rate at the time of the gift, the length of the initial term, and the donor's age.
If the initial owner survives the initial term of the QPRT, the interest in the personal residence used to fund the QPRT will be removed from the donor's estate, thereby reducing federal and state estate taxes.
If the initial owner does not survive the initial term of the QPRT, the trust property reverts back to the donor's estate, is included in the donor's estate, and the lifetime gift tax exemption applied to the initial gift is returned to the donor's estate. Thus, if the donor does not survive the initial QPRT term, it is as if the QPRT were never created.
Why is now a good time for a QPRT?
QPRTs are more efficient when rates are higher because higher interest rates result in a larger discount of the initial gift and a smaller gift value is used for gift taxes purposes. The rate used to determine the discount is the Internal Revenue Code Section 7520 rate and the expected rate for January of 2024 is 5.2%. This rate was 4.6% in January 2023.
Benefits to Washington residents and residents of states with a state estate tax
Residents of Washington, and other states with a state estate tax, can benefit from a QPRT because a married couple's or individual's primary residence is often the largest asset in their estate. A QPRT can help remove that value from the taxable estate in a leveraged manner and allow the donor to continue residing in the home. Additionally, with the exception of Connecticut, states like Washington and others with a state estate tax do not have gift taxes. Therefore, individuals can use their larger federal exemption to remove the property from their gross estate for both federal and state estate taxes.
In the realm of estate planning and in this interest rate environment, QPRTs present a compelling opportunity and low-risk technique to reduce the value of your estate for federal and estate tax purposes.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.