Qualified Personal Residence Trusts
|A strong form of protection is available with the use of a
"Qualified Personal Residence Trust" (QPRT). This device is best suited
to situations when there is a substantial estate tax problem and when
the home (or a vacation home) has a substantial value. However, it seems
to me it could also be used as a pure asset protection device for
family real estate even when estate taxes are not a significant
In a nutshell, the QPRT involves making a future gift of your residence (or a vacation home) to your children at the end of a term of years selected by you. The house is put into a grantor trust to hold the property until the term of the trust has expired. Until the end of the term of years, you continue to use the home. At the end of the term of years (selected by you), the home belongs to the beneficiaries of the trust - usually your children.
By making a delayed gift, the value of the gift is discounted at an interest rate prescribed by the IRS, based on the term of years that you select. The longer the term of years, the lower the current value of the property for gift tax purposes. Gideon Rothschild wrote an article on this subject that gives an example of a 50 year old man who sets up a QPRT when the IRS prescribed interest rate is 7% - and the trust is to last for ten years. The value of the future gift would be about 46% of the current value of the property. Where the same trust is set up for 20 years, the value of the future gift would be 19% instead of 45%. Scott Blakesley computed the same amounts based on a December, 1994 prescribed interest rate of 9.4%, resulting in a value of 37% for a ten year term and 12% for a 20 year term.
If you die before the end of the term of years for the QPRT, the home is included in your estate and you've gained nothing in terms of estate taxes. But - your home has been protected from creditors while the trust was in existence. Thus, a QPRT could be worthwhile purely as an asset protection device.
If you live beyond the term of years of the QPRT, the home is
transferred to your children. Until recently, you could arrange to buy
it back from them if you made the purchase before the end of the term of
the trust. However, the IRS has recently ruled that type of repurchase
arrangement will result in the loss of the estate tax benefits.
If You Believe Interest Rates Will Fall, Check Out The QPRT Now
Scott Blakesley reminded me that if interest rates drop, the use of a Qualified Personal Residence Trust (QPRT) is less attractive as a way to reduce future estate taxes because the computed value of the future gift increases as interest rates decrease.
For example, with a 7% interest rate, the present value of $100,000 in twenty years is just $25,842. At a 6% interest rate, that value increases to $31,180 and at 5% the present value is $37,689. With a ten year period, the differences are not as great, but they are significant. For a ten year example, the present value of $100,000 in ten years at 7% is $50,835. At 6%, the value increases to $55,839 and at 5%, it is $61,391. Gideon Rothschild reminded me that you can elect to use the highest rates for the current month and the two previous months, so if rates start back up, you can catch a lower rate. (These rates do not include a life expectancy element.)
The basic concept with a qualified personal residence trust (QPRT) is that you are making a gift of your home in trust at a future date, which can be any number of years in the future. If you survive for the term of the trust, then the property goes to the trust beneficiary. If you die before the end of that term, the property is still included in your estate. By making a deferred gift, you get a substantial discount on the value of the gift. The value of the gift is computed by using IRS prescribed interest rates, which are based on the interest rate paid on federal obligations of a similar duration. As the market interest rates change, the rates that must be used for a QPRT also change. As shown above, if the prescribed interest rate for a QPRT falls, the present value of the gift increases. Thus, the prospect of falling interest rates provides an incentive to do it before the rates actually fall. Of course, if interest rates should rise, the opposite would be true.
Further details about protecting your assets from future lawsuits with the QPRT are available in our subscriber's web site.
NOTICE: This Information is intended only for educational purposes and may be regarded as controversial by some legal experts. Readers should consult with a qualified professional who is familiar with their specific financial and tax circumstances before adopting any ideas that are discussed in this article.
About the author:
Jacobs is a CPA who works as a tax author and
consultant. He can be reached by phone at (913) 362-9667.
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Sponsored by Offshore Press, Inc. Copyright, 2002, All rights reserved. Offshore Press, Inc., Box 8194, Prairie Village, KS 66208. (913) 362-9667. Email to Offshore Press Vernon K. Jacobs, Webauthor