A qualified personal residence trust is a legal device that can be useful if you are exposed to the federal estate tax. Before we provide you with the details, we should look at the estate tax parameters.
Most families do not have to pay the federal estate tax because there is a credit or exclusion that is relatively high. The estate tax exclusion is the amount that can be transferred before the estate tax would be applicable. For the rest of 2015, the exclusion is $5.43 million, but it could be raised a bit next year if an inflation adjustment is applied.
You would naturally consider lifetime gift giving as a way to avoid the estate tax, but this window was closed when the gift tax was enacted a few years after the original enactment of the estate tax in 1916. It was briefly repealed, but it returned for good in 1926. In 1976, the estate tax and the gift tax were unified.
The $5.43 million exclusion that we touched upon previously is a unified exclusion. It applies to your estate, but it also applies to large lifetime gifts that you give. To explain by way of a simple example, if you gave $2.43 million in tax-free gifts using your exclusion, there would be just $3 million left to apply to your estate after you pass away.
Qualified Personal Residence Trusts
Now that we have set the stage appropriately, we can explain the value of qualified personal residence trusts. Your home is part of your estate for tax purposes. To implement this strategy, you convey your home into a qualified personal residence trust. When you do this, you are removing your home from your taxable estate.
You name a beneficiary to assume ownership of the home after the expiration of the trust term. During this term, which is often called the retained income period, you continue to live in the home as usual, so your life is not disrupted. You decide on the duration of the term.
Though you have removed the home from your estate for tax purposes, you are giving a taxable gift to the beneficiary. However, the value of the home for gift tax purposes will be considerably less than its true fair market value.
This is because of the retained income period. No objective buyer would pay full value for a home that he or she could not occupy for a number of years, and the IRS takes this into account. After the expiration of the retained income period, the beneficiary assumes ownership of the home at a tax discount.
Our Firm Can Help
The estate tax can have a very negative impact on your legacy because it carries a hefty 40 percent maximum rate. Fortunately, there are tax efficiency strategies that can be implemented, and a qualified personal residence trust can potentially be part of the plan.
If you would like to discuss your tax situation with a licensed professional, attend one of our free Estate Planning Seminars: Naples FL Estate Planning Seminars.