A “QPRT” or “Qualified Personal Residence Trust” is a legal sanctioned method of transferring a primary or vacation home to family members at a reduced gift and estate tax cost. In other words, by transferring a home to a QPRT and retaining the right to live in the home for a stated period of years, a taxpayer could transfer his home to his children or heirs and save estate taxes at the same time. While there are many pitfalls to this type of transaction, for a wealthy taxpayer, i.e., a taxpayer who believes that his or her or their family will eventually be subject to estate taxes, it may make sense to transfer a home to a QPRT.
However, before someone does this, a complete tax analysis must be completed. Moreover, there are a number of potential disadvantages to using a QPRT, including the eventual need to “rent” your home back from the QPRT, which discourage the use of a QPRT.
Without getting into too much detail, one example will show how a QPRT can produce tax savings. If taxpayer A owns a house that is worth 5 million dollars, and the rest of his assets are worth 15 million, then, if there was a 5 million dollar exemption from estate taxes, with a 40% tax rate, the estate tax on the 15 million dollars that is subject to estate taxes would be 6 million dollars. If A, age 60, transfers his house to a QPRT, retaining the right to live in the house for 10 years, then A would be making a gift of approximately $3,700,000. In 10 years, if the house has appreciated to $7,400,000 (which is a 4% growth rate each year), and if A dies at that time, then the house will have been transferred to A’s children and the estate tax on the difference between the $3,700,000 gift and the $7,400,000 value would be saved; or, almost $1,500,000 in estate taxes would have been saved. However, the story is not over yet. If A had only paid 4 million dollars for the house, then his children would pay capital gains tax on the difference between $4,000,000 and $7,400,000 (when the house was sold). If the house was in a state which had no estate taxes, but a 5% income tax, then the total capital gains tax, surtaxes and state income taxes would be almost 29%, or a total of almost 1 million dollars. So, the true savings is only $500,000. Obviously, this is just an example, which is highly influenced by state estate taxes, state income taxes, the taxpayer’s basis in the house, the expected growth rate, and the taxpayer’s other assets. Consequently, as stated above, a complete economic and tax analysis must be done before a QPRT is created, to insure that the there is truly a tax savings before transferring a house to a QPRT.