Home is Where the Trust is:

Take a Look at the Personal Residence Trust  
BY STEPHEN M. WALTAR

Very often, one of the most valuable assets in a person’s estate is their home. There has been a great deal of interest recently in a type of trust known to many simply as a “House” Trust, but known better to the IRS as a Qualified Personal Residence Trust, or QPRT. The reason for the interest in the House Trust is that it will allow to pass your home or vacation home to your children while potentially saving a huge amount of estate taxes.

How It Works
In a House Trust you place your primary home or your vacation home in a trust for a term of years, during which you retain the right to use the property. After the term of years the home is transferred to the beneficiaries you designated in the Trust. Thus, the beneficiaries (usually your children) become the new owners of the property and you can rent the property from them, or make some other arrangement with them. Many times, the vacation home is ideally suited for such a trust, because it has high sentimental value and the children very often desire to keep the home in the family.

Saves Estate Taxes
The advantage of a Personal Residence Trust is that it can save you estate taxes. For example, if your home is worth $500,000 and you transfer it into a Personal Residence Trust you will be deemed to have made a gift to the beneficiaries of only a certain percentage of the property's fair market value. With a 10 year term of years the value of the gift would be approximately $170,245 or 34% of the value of the home. Therefore, you will file a gift tax return at that time reporting that you have used up $170,245 of your lifetime exemption from estate taxes. [Note: As your personal exemption increases under recent tax reforms, you will get unused increases in your applicable exclusion amount.]  If you had held the property until your death the home may have been worth $740,122. Thus, you would have saved estate taxes on $569,877 of value, or about $284,939! [Please note numbers cited within this article were calculated years ago when this article was first published ~1997.  If this strategy is deemed appropriate for you, current IRS tables and numbers would be used for all calculations.]

Why isn’t everyone doing this?
One drawback of a Personal Residence Trust is that you lose the advantage of the stepped-up tax basis on the property at your death. If you had bought the house for $300,000 and it was valued at $700,000 at your death, and your heirs simply inherited the property through your will or Living Trust, then their new tax basis in the property would be stepped-up to $700,000. If they then immediately sold the property there would be no capital gains tax. With a Personal Residence Trust your heirs receive the same tax basis that you had in the property. If they don’t make it their residence before selling the property, they’ll be subject to capital gains taxes. Therefore, you should weigh the estate tax savings against the capital gains disadvantage. Capital gains may be 20% or less whereas estate taxes range from 43% or higher (plus separate State Estate Taxes often) so a capital gain tax is far less expensive.

How Flexible Is This?
A Personal Residence Trust may hold cash to pay for expenses over the next six months. You may sell the property. If you sell the property you must either purchase another residence within two years, or convert the cash to an annuity. Because this is a “grantor trust” it is income tax neutral-if you could avoid capital gains taxes selling it as an individual you get the same treatment selling it as a trustee. Likewise, if you qualify for a mortgage tax deduction as an individual, you’ll still qualify in this trust but the IRS might consider your payment of the principal as an additional gift so it is best not to use mortgaged property for a Personal Residence Trust. You may be the trustee of your own Personal Residence Trust.