What Is a Personal Residence Trust and Is It Right for You?

Estate planning is essential for high net-worth families to organize their finances for the future. Taxes can take a huge chunk of value from any estate, but with proper estate planning through a personal residence trust, Americans can keep more of their value and pass it on to their descendants.

But what is a qualified personal residence trust, and is it the best option for planning for the future? With the help of a professional estate planning team, families can create a structure that minimizes taxes and maximizes value.

What is a Qualified Personal Residence Trust?

A qualified personal residence trust (QPRT) allows the owner of a residence to transfer ownership of that property into a qualified residence trust for estate planning. The owner then receives qualified term interest, also known as the retained income period, in exchange for transferring ownership. Owners can use this interest to continue living in their homes while paying the fair market rent to their designated heirs.

Crucially, the residence is discounted from the portion of the owner’s estate that’s eligible for tax if they die while receiving qualified term interest. QPRT trusts are an excellent way of reducing tax liability and can potentially save high net-worth families hundreds of thousands of dollars.

What are the Pros and Cons of a QPRT?

Estate planning is complex and should always involve the help of a qualified professional. Everyone’s situation is different and requires a tailored approach to personal residence trusts. Evaluate the advantages and drawbacks of a qualified personal residence trust and contact the experts at Porte Brown to determine if this is the right option for you.

Pros

Let’s examine the main advantages of starting a personal residence trust for families in the U.S.

• Appreciation Hedge – The entire value of the primary or secondary residence, and any appreciation, are removed from the taxable estate. It costs mere cents on the dollar to do this and can defend against real estate appreciation before the homeowner’s death.
• Exemption Decreases – Unified credit consists of the estate tax exemption and the shared lifetime gift tax exemption. Currently, it stands at $11.7 million, but starting a QPRT now provides protection if the Federal government alters the unified credit limit.
• Reduce Your Taxable Estate – QPRT trusts reduce the taxable estate of the trust’s owner. Paying fair market rent to the trust’s beneficiaries allows homeowners to give their families more of their net worth without worrying about the lifetime gift tax exemption.

These qualified personal residence trusts are potent tools to wield for some homeowners and could save significant amounts in tax upon the homeowner’s death.

Cons

Remember that if the homeowner passes before the retained income period expires, many benefits become worthless. But what other disadvantages must homeowners take into account?

• Rental Payments – Homeowners who are asset rich and cash poor may struggle to pay fair market rates to continue living in their property. This does not apply if the homeowner intends on moving out.
• Loss of Property Tax Benefits – When the retained income period expires, the home will be reassessed for real estate taxes. Homeowners may lose out on property tax benefits, as well as homestead status.
• Selling Difficulties – After being owned by a qualified personal residence trust, selling the home could become problematic. Either homeowners need to invest the proceeds into a new home or take an annuity.

As you can see, the difficulty is not with the idea of a personal trust itself but with what happens when the retained income period ends. Any expert will tell you that avoiding premature qualified personal residence trust termination depends on timing.

What are the Tax Implications of a QPRT?

The tax implications of a personal residence trust are simple enough to understand. Primarily, a QPRT removes the trust’s personal or secondary residence from their estate’s value. It also eliminates any future appreciation.

Overall, it reduces the value and gift tax rate of their estate because the value of the interest granted to the trust’s owner is non-taxable and can be retained by the grantor. The taxable portion of the residence is classified as a future interest gift, but it does not contribute toward the annual exclusion.

Plus, the homeowner may continue to take income tax deductions, including the real estate tax deduction.

What Happens to a Trust When the Grantor Dies?

If the trust’s grantor passes away before the end of the term, the residence is removed from the trust and the value added to the owner’s estate. When it comes to avoiding estate tax rates, QPRT termination could be disastrous. Furthermore, the assets within the trust may find their way to probate court, which is costly and lengthy.

An estate planning team can mitigate this risk by creating staggered trusts, which hold a portion of the residence’s total value. This is where it gets complex, and hiring a professional is crucial.

Conclusion

There’s no denying it: estate planning is complicated. Getting it wrong could prove disastrous when trying to avoid high estate taxes. Pass on as much of your estate as possible and reduce your tax liability by working with the experts at Porte Brown.

Learn more about estate planning through a personal residence trust or a personal financial advisor by getting in touch with Porte Brown today.