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Is a qualified personal residence trust a smart tax strategy?

Given the uncertain real estate market, individuals may wish to include their homes in their estate planning. Yet is there a way to transfer a home while minimizing the tax implications?

A qualified personal residence trust might be the option for such individuals. For example, parents might set up a QPRT for their children. Technically, the transfer is to the trust, with a retained right to continue living in the home for a set period of time. When that time has elapsed, the trust will distribute the home in accordance with the documentation to the children or other designated remainder parties. 

However, if the parent were to pass away before the expiration of the period, the effect of the transfer to a QPRT is essentially negated. In other words, the home will be included in the value of the decedent’s estate, as he or she was still living in the property during the trust term. For that reason, many individuals set the term at less than their remaining life expectancy.

A parent might also be living at the end of the trust term. In that event, he or she may have to pay rent to the remainder parties. In other words, a parent could end up paying rent to his or her children, and the kids would have to report that money as income. Notably, an individual cannot buy back the home from the QPRT after the end of the trust term.

So how does a QPRT accomplish tax savings? According to the IRS, a gift above the annual gift tax exclusion amount requires the giver to file a gift tax return, and potentially pay gift tax. With a QPRT, the value of the property is usually deemed to be lower with each passing year, depending on how the IRS values the original owner’s retained interest. That, in turn, reduces the potential gift tax. An attorney can explain this calculation in greater detail.

Source: FindLaw, “”Qualified Personal Residence Trusts FAQ,” copyright 2015, Thomson Reuters

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