Real estate prices have been falling all over the country. While no one likes to think that their home is worth less than it used to be, the downturn has created an opportunity to give your home to your eventual heirs while saving a large amount of estate and gift taxes.
This can be done with a “Qualified Personal Residence Trust”, or QPRT. The idea is that you put your home into a trust for a certain period of time – five years, 10 years, 15 years or whatever period you choose. At the end of that time, the trust expires and ownership of the home goes to the beneficiaries you name.
There are two big advantages to this idea:
1) The value of your home for estate and gift tax purposes will be its value now- not its value at the end of the trust term or when you eventually die, when presumably it will be worth a lot more.
2) The value of the gift is further reduced by the value of your right to live in the home for the duration of the trust.
Its possible using this technique to reduce the taxable value of a home by 50% or more. So if you have a $500,000 house, you might be able to give it to your children while reducing its value to $250,000 for tax purposes. If the home increases in value to $750,000 by the time you pass away, you will have reduced your taxable estate by half a million dollars.
QPRTs can be especially valuable at times like these when real estate values are depressed, because you can “lock in” lower prices for tax purposes. A QPRT can be an excellent way to pass along a vacation home, too, as well as a primary residence. If you want, you can have two QPRTs one for each home. When you create a QPRT, you incur gift tax on the current value of the home minus the value of your being able to live there for the term of the trust. However, you might not have to pay anything to the IRS at the time. Generally, you can make up to $1 million in lifetime gifts and defer any gift tax until you die, at which point the amount of the gifts simply reduces the portion of your estate that can pass to your heirs without incurring the estate tax. So if the value of the home minus the value of your right to live there is less than $1 million, you’ll likely have to pay nothing at all right away. During the term of the trust, you’ll still have to pay real estate taxes on the property, but you can also continue to take a deduction for these on your income tax.
When the term of the trust is up, your children will own the house. One issue is that if you want to continue living in it, you’ll have to pay fair-market rent to your children (or risk problems with the IRS). However, this can also be an advantage. You can think of your rent payments as a gift to your children that gets additional money out of your estate without being subject to the gift tax. The rent payments will not reduce your ability to also give your children up to $13,000 a year tax free.
There’s one big drawback to QPRTs, which is that if you die before the term of the trust is up, the tax benefits are lost. So you need to think carefully about the length of the trust – a longer terms means more tax benefits, but it also increases the risk that you’ll die before the trust ends.
On the other hand, if you die before the term is up, your heirs haven’t lost anything. They will be no worse off than if you have done nothing so a QPRT is generally a no-lose bet. Of course for a QPRT to work, you have to be willing to relinquish ownership of your house. So a QPRT is ideal if you’re planning to move somewhere else when you retire, if you want a smaller home when you get older, or if you don’t mind having your children as your landlords.