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The Qualified Personal Residence Trust (QPRT)

Nov. 1, 2022

In a previous blog post, we talked about the grantor retained annuity
trust, or GRAT, and gave a brief description of that planning strategy
which is based on section 2702 of the tax Code. In short, the GRAT is a device for discounting the present value of a deferred gift, but it requires that the trust be funded with assets from which a fixed annuity can be paid. What if the asset you are trying to give to your children and grandchildren is your residence?

The personal residence trust, or PRT, is also a creature of section 2702, and it works on roughly the same principle, that is, you place the residence in a trust for a term of years, with the remainder at the end of the term to your children or grandchildren, or to a further trust for their benefit. The present value of the gift is discounted by the present value of your retained term interest in the trust.

The "qualified" personal residence trust, or QPRT, is an improvement on this basic model, made possible by Treasury regulations issued a couple of years after section 2702 was enacted.

While the statutory PRT can hold only the residence itself, the QPRT can hold a modest cash endowment to cover ongoing maintenance and repairs, and even improvements. If the residence is sold, you have two years to reinvest the proceeds in another residence. If residential use ends, the trust instrument may provide either that the assets are redistributed to the settlor -- which of course would undo your gift tax planning -- or to a GRAT over the remaining term of the trust.

Another advantage of the QPRT over the PRT is that it may hold a fractional interest in the residence. This allows for planning analogous to the "rolling GRAT" we discussed in the earlier blog post, that is, several QPRTs with staggered terms to mitigate the risk you might die during the term of years and have the entire property come back into your taxable estate.

This feature of the QPRT also enables each spouse to convey her interests in the residence to separate trusts, so that if one spouse does predecease the term of one or more of the QPRTs, the basic exclusion amounts she has consumed through these gifts are not "wasted."

But what happens when all the QPRT terms expire, you are still alive, and the residence is owned, not by you, but by a trust for the benefit of your children or grandchildren? The answer, which feels counterintuitive to come clients, is that you begin paying fair market rent.

On closer examination, this turns out to actually be a further benefit of the QPRT as a tax planning device. Because the trust is a disregarded entity for income tax purposes, the trust will not be paying tax on the rental income, and because the rental obligation is at arms' length, your payments into the trust are not treated as further taxable gifts.

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