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Wyoming Qualified Personal Residence Trust
A Qualified Personal Residence Trust (QPRT) is an irrevocable trust in which you as the grantor place your personal residence into a trust, while retaining the right to live in the residence for a specified term, typically twenty (20) years. If you survive the trust term, the trust terminates and the principal of the trust (the home) passes to the beneficiaries designated in the trust, removing the residence from your estate. Upon creation of the trust, you will have made a taxable gift of the remainder interest in the residence to the beneficiaries of the trust. Increasing the term of the trust reduces the amount of the initial taxable gift because the value of the remainder interest is less. Although a longer trust term reduces the initial taxable gift, it increases the chance that you as the grantor will fail to survive the term. If you fail to survive the term of the trust, the residence will revert to your estate at its then fair market value, subjecting the asset to estate taxation. This strategy works best when the interest rates are high. How is a Qualified Personal Residence Trust Operated? You, as Trustmaker, will have unlimited use of the residence during the term of the trust. You have the right to occupy the property, have guests on the property, and sell and purchase a substitute property. You will also be responsible for paying all expenses relating to the property. If you intend to continue residing in the residence after the trust expires, a fair market rent will have to be paid to the remainder beneficiaries of the trust. When does the Qualified Personal Residence Trust Terminate? If the trust term expires during your lifetime, the residence will pass from the trust to the remainder beneficiaries of the trust. If you fail to survive the term of the trust, the trust will end and the residence will be includable in your estate. What are the Tax Consequences of a Qualified Personal Residence Trust? The benefit of the QPRT is the potential estate tax savings by removing the residence from your estate. The transfer of the residence to the trust is subject to gift tax, which will utilize a portion of your lifetime gifting exemption. A gift tax return will need to be filed upon the transfer of the residence to the QPRT. However, the taxable gift will be significantly less than the value of the residence, since the gift is of a remainder interest in the residence, and is based on your age and the terms of the trust. The full value of the residence is excluded from estate tax if you survive the term of the trust. Income Taxation of Qualified Personal Residence Trust 1. Grantor Trust Rules in General A QPRT is conventionally treated as a grantor trust with regard to the income portion of the trust, but not with regard to the corpus portion of the trust where the remainder has been previously transferred by the grantor. IRC §§ 671 through 679. A grantor trust is created where the grantor holds certain rights, interests or powers over the trust. IRC § 671. A grantor trust causes the income, deductions and credits of the trust to be attributed directly to the grantor of the trust, as though the trust did not exist. However, a QPRT can be both a grantor and a non-grantor trust if the grantor retains rights or powers over only a portion of the trust. Example: A grantor retains the right to make use of the trust’s income but not its principal. In this case, the trust is a grantor trust with regards to the income portion of the trust, and all income, deductions and credits related to the income portion of the trust are passed to the grantor. However, the corpus portion of the trust, over which the grantor has retained no rights, are treated as a non-grantor trust and are taxed to the trust as set forth in subchapter J of the Code. The grantor trust rules allow all of the income, deductions, such as the mortgage interest deduction, and credits of the trust to be attributed to the grantor of the trust, and for the trust to be wholly ignored for income tax purposes. PLR 9249014. Furthermore, the grantor can lease the residence from the QPRT following the expiration of the term of the trust and not have the residence included in his or her estate so long as he or she pays a fair market value rental for the use of the property. PLRs 9249014 and 9448035. Even more beneficial is the fact that a grantor trust allows the grantor to pay the income taxes related to the trust, thereby preventing the trust from suffering further depletions, and in effect making another non-taxable gift to the remainder beneficiaries. During the term in which the grantor retains the right to use the personal residence placed into the QPRT, the grantor is treated as the owner of the income, but not the corpus, portion of the QPRT. IRC § 677(a)(1). This means that all of the income of the QPRT and any deductions and credits related to the income portion of the QPRT are passed on to the grantor. However, if the grantor retains any reversionary interests in the income or corpus of the trust which exceeds 5% of the value of that portion of the trust subject to the reversionary interest, the grantor will be treated as the owner of the entire trust for income tax purposes. IRC § 673 (a). Example: Grantor creates a QPRT reserving the right to receive all of the undistributed income at the expiration of the term of the trust. The grantor then places his or her personal residence into the QPRT. If the grantor dies during the term of the QPRT, and if the reversionary interest exceeds 5% of the value of the trust at its time of creation, based on the AFR in effect for the month in which the trust was created and the grantor’s age, the grantor will be deemed to own the entire trust and have it included in his or her estate. PLRs 9447036 and 9402011. Furthermore, the grantor may be treated as the corpus portion of the trust if the grantor, or another non-adverse party, retains certain other rights, interests or powers in the trust, and these powers, rights or interests do not require the consent of any adverse parties, such as the remainder beneficiaries. IRC § 674(a). Example: Grantor creates a QPRT which provides that at its termination a special trustee possesses the power to distribute the trust estate, exclusive of accrued and undistributed income, to the then living descendants of the grantor. There were no mechanisms for the remainder beneficiaries to consent or oppose these acts of the special trustee and the special trustee was related, subordinate or subservient to the grantor. The service held that the grantor was treated as the owner of the entire trust for purposes of income and estate taxation. PLR 9315010. Following the expiration of the trust term, the trust becomes a non-grantor trust unless specific steps are taken to structure the trust as a grantor trust. Again, the primary benefit of keeping the trust as a grantor trust is that the grantor is able to pay the income taxes on the trust, keeping the trust from being further depleted, and in essence making further non-taxable gifts to the remainder beneficiaries. There are several different ways to structure the trust as a grantor trust following the expiration of the trust term: a) The QPRT could provide that an unrelated or non-subservient disinterested trustee possesses a power of disposition over the grantor’s beneficial enjoyment of the income or corpus of the trust. IRC § 674(a). b) The QPRT could provide an independent third party with the right to add certain beneficiaries to the class of remaindermen entitled to receive distributions of income or principal following the expiration of the trust term. IRC §674(c). c) The QPRT could provide the beneficiaries or a third party, either of which acting in a nonfiduciary capacity, with the power to reacquire trust corpus by substituting other property of equivalent value, either by purchase or by an exchange of the residence for other appreciated assets. PLRs 9311021 and 9037011. However, this power can no longer be given to the grantor or the grantor’s spouse. IRC § 675(4)(C). 5. Cost Basis of Residence The cost basis of a residence placed into a QPRT is the grantor’s cost basis plus any federal gift tax attributable to the appreciation of the residence included in the gift tax base. IRC § 1015 (d)(6). If the grantor survives the term of the QPRT, the remainder beneficiaries will inherit the grantor’s cost basis in the residence. If, however, the grantor dies during the term of the QPRT, the residence will be included in the grantor’s estate and will receive a step-up in basis. It would appear that under EGTRRA the grantor’s estate could allocate some or all of the modified carry-over basis available in 2011 to the residence to increase its cost basis as well. In the context of community property states, the grantors should transfer a community property residence into the QPRT, without having previously partitioned the residence, in order to obtain a step up in basis for the entire property on the death of either spouse. 6. Sale of Residence Traditionally, the gains realized on the sale of a residence in a QPRT are allocated to the trust corpus and pass to the remainder beneficiaries, causing the remainder beneficiaries to be liable for the capital gains taxes. If the grantor pays these capital gains taxes, the grantor will be treated as having made an additional gift to the remainder beneficiaries. One area of confusion relates to the use of the grantor’s principal residence capital gain exclusion if the principal residence is sold from the QPRT. In the context of traditionally revocable trust, the owner of a grantor trust may use IRC § 121 to exclude gains on the sale of a principal residence held by a trust so long as the grantor holds some reversionary or remainder interests in the trust. Rev. Rul. 66-159, 1966-1 C.B. 162; PLRs 9026036 and 199912026. However, if the grantor does not retain any reversionary or remainder interests in the trust, as is such with virtually all QPRTs, the gain realized on a sale of the residence is attributable to the holders of the remainder interests and not the grantor, thereby defeating the application of IRC § 121. It is also possible for a QPRT to engage in an IRC § 1031 exchange, whereby the QPRT sells the residence to an accommodator, who then acquires the new residence for the QPRT. In this context the capital gains are deferred or postponed. |
GONNELLA & MAJORS, PC
Attorneys and Counselors at Law
Attorneys in Our Office Carol H. Gonnella, J.D. M. Jason Majors, J.D., LL.M. Stephen P. Adamson, Jr., J.D. David I. Beckett, J.D., LL.M. |
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