by Steve Goodman
CPA, MBA – President & Chief Executive Officer
Contact Steve today for more info.
A QPRT is an estate planning tool to gift a house from parents to children at a discounted value. This irrevocable grantor trust has temporarily fallen out of favor due to the substantial increase in the estate exemption due to the Tax Cuts and Jobs Act of 2017. If the estate tax exemption reverts to 2017 levels, adjusted for inflation, as scheduled in 2026, the QPRT could again become a popular estate planning tool.
The trust basics are simple and straightforward. A grantor gifts a residence to a trust for the children. The grantor continues to live in the home for an agreed upon length of time per the gift conditions. This length of time is “retained interest”. When the agreed upon time is over, the grantor can move out or stay in the house and pay fair market rent to the children. The post-agreement time is the “remainder interest”.
From the Children’s Perspective
The children receive a gift from the house. Assume the house is worth $800,000 and the retained interest time is 10 years. The value of the house is fixed as of the date of the gift. But the gift to the children is not $800,000 because the grantor has the right to live there for the next 10 years. Using IRS specified interest rate and other factors, the $800,000 is discounted by 10 years to reduce the value of the house for gift tax purposes.
If the grantor lives the ten years selected for our example, the trust owns the house. The trustee can either keep the house in the trust or dissolve giving fractional ownership to the children if there is more than one.
From the Grantor’s Perspective
The house and its appreciation might be removed from the estate. This could reduce any estate taxes that may be assessed upon death. If the grantor wishes to continue living in the house after the retained interest period, the grantor must pay market value rent. This additional transfer of wealth helps to enrich the beneficiaries while intentionally reducing the value of the estate.
The grantor continues to pay property taxes, insurance, and all other routine expenses during the retained interest period. The grantor takes all tax deductions during this period as if the home were titled in the grantor’s name.
If the Grantor Dies Early
The retained interest period can be anything the grantor wants it to be. The decision is a tradeoff between benefits and penalties. The longer the retained interest period, the greater the reduction in the value of the gift to the children. Prior to the Tax Cuts and Jobs Act of 2017, the federal gift exemption was $1 million. People with significant estates took great care to avoid paying a gift tax if at all possible. A longer retained interest period could reduce the gift tax valuation of the $800,000 house by many tens of thousands of dollars.
Offsetting the favorable gift tax reduction is the penalty if the grantor dies before the retained interest period ends. If the grantor dies during the retained interest period, the property returns to the grantor’s
estate where it is subject to estate taxes. In effect, the transaction is nullified as if it never happened. The grantor is out the costs of establishing and maintaining the trust, but otherwise no worse off than if the transaction had not occurred.
A grantor can have two QPRT’s, one for a primary residence and one for a second residence. Regulations permit one property per QPRT. The property may include a reasonable amount of adjacent land as would be expected given the property location and size. For example, one may not gift a house and 120 acres of surrounding forest through a QPRT.
Following the completion of a QPRT retained interest period, the grantor, the grantor’s spouse, or any trust or organization controlled by the grantor cannot buy the house back from either the children or the trust. Only trusts established prior to mid-1996 have this capability grandfathered.
The grantor may sell the house during the retained interest period. If sold, the grantor can reinvest the proceeds in another home owned by the trust subject to the same provisions.
QPRTs are not the appropriate vehicle for someone seeking a generation-skipping transfer (GST) tool. The GST cost basis is not determined until the retained interest period ends. Ten years of real estate appreciation will accumulate on the $800,000 house before the price is fixed for GST purposes.
When the QPRT ends
There are three popular options for the trust once the retained interest period completes. There are others, but they are uncommon.
- The trust distributes the property to the beneficiaries. If there are more than one, they will each own a fractional interest. From there, they must collectively decide what to do with the house, how to maintain it, and who will take care of the required record keeping.
- The trust pours into another trust for the benefit of the children. This trust can be structured as a grantor trust.
- The trust provides the grantor’s spouse to be the initial beneficiary. The spouse is granted lifetime residence with no rental payment due. This allows the grantor to also stay provided the grantor is married to the spouse.
The beneficiaries must establish their own rules as the retained interest period comes close to completion. They must decide how to own the residence, either fractionally or in trust with multiple owners. They need to decide what happens if and when an owner dies. Critical items such as a reserve fund for repairs, rental policies, and policy issues need to be determined and put on paper.
If the QPRT remains as a grantor trust after the initial trust term or distributes the residence to another grantor trust, the tax situation is greatly simplified. The grantor paying rent to continue living in the home is the grantor paying themselves according to the IRS. Following the logic, the rent payments are not taxable income. Any real estate taxes and other tax-deductible items flow through to the grantor.
If the new ownership is not a grantor trust, then the rent paid by the original donor to continue living in the home becomes income to the new ownership. The new ownership group can offset the income by depreciating the home.All other costs, including insurance, real estate taxes, repairs, utilities, etc. can be paid by either the tenant or the owners. The rent needs to reflect who pays these costs when fair market rent is determined.
CPA, MBA – President & Chief Executive Officer
About Steve Goodman
For more than 30 years, Steven has provided insightful solutions to the challenges of business succession, wealth preservation and charitable planning, focusing on the needs of owners of closely held businesses and high net worth individuals.
He's been featured in the New York Times and is an accomplished speaker and has presented over the years to many organizations and professional groups on efficient business succession, estate planning issues and tax strategies. Steven is a CPA who was vice president of the Trust and Investment Division of JP Morgan Chase and a supervisor for KPMG Peat Marwick, and holds an MBA from Fordham University.