You can give away your house at a great discount, freeze the value for estate tax purposes, and still continue to live in it. You may not be able to eat your cake and have it, too, but, because of recent legislative changes at the federal as well as state levels, you can now give away your house yet continue to live in it, saving you a bundle in estate and gift taxes.
How It Works
The basic plan requires you to deed your house to a type of trust known as a Qualified Personal Residence Trust ("QPRT"), reserving the right to live in the house for a specified number of years. If you live to the end of the specified period, the house (including all post-gift appreciation) passes to your children or other named beneficiaries free of any additional federal or state estate or gift taxes. If you die before the end of the period, the house will be includible in your estate for estate tax purposes. But in most cases you are no worse off than you would have been had you done nothing.
Real Examples, Real Gains
John, age 55, is a successful businessman with total assets worth over $2 million, including his beautiful Georgian mansion, recently appraised at $300,000. If John continues to live in the house until his death 20 years from now, the house will be worth $657,337 (based on 4% annual appreciation). The house will be included in his estate at an estate tax cost of over $360,000.
Instead, John deeds his house into a QPRT, names himself as the sole Trustee, and reserves the right to live in the house for 20 years, at which time it passes to his children (or to a trust for their benefit). There will be an immediate gift of $31,980. So long as the total amount of taxable gifts made by John during his life (including the house transfer) does not exceed $1,000,000, no federal gift tax is currently payable. Depending on where the property is located, however, there may be some state gift tax due, e.g., $1,759 if it is located in Tennessee. (There is no state gift tax in Colorado, however.) In any event, at the end of the 20-year period, even though the property will then be worth $657,337, no additional taxes will be due when the house is transferred to John's children.
What are the Savings?
In other words, John has managed to give his children property worth $657,337 at a gift tax value of only $31,980. This results in a tax savings of almost $350,000 to his estate!
How Long Should the Term Be?
Depending on your age, you may decide to have a longer or shorter term, with the understanding that you must survive the QPRT term for this to accomplish anything. However, even a 10-year term can result in significant savings: in the above example, a ten-year QPRT would result in savings of over $300,000 in estate taxes (assuming John dies in twenty years). Of course, if appreciation is higher than the 4% assumption, the savings will be even greater.
To be fair, note that an outright transfer of the house today would also freeze the value and result in estate tax savings of over $196,000, but this method would not have permitted John to continue to live in the house for the next 10 or 20 years. In other words, the QPRT effects an estate tax freeze, a discounted gift tax value, and permits the donor to live in the house just as before. Now you know why I think this is such a great deal for so many people!
Risks and Complications
If John dies before the end of the 20-year period, the entire amount of property in the trust will be included in his taxable estate at its then value. Second, when he set up the QPRT, he may have had to pay some state gift tax, and he may or may not be given credit for that payment. Finally, if any federal gift tax had to be paid, he will have lost the use of that money for the 20 years. All in all, the benefits clearly outweigh the risks.
What If I Survive the Trust Term?
If you are still alive at the end of the term, you do not have to move out of the house, although your children (or a trust for their benefit) are now the owners. First of all, the QPRT could be written so that, if you are survived by your husband or wife, after the initial term of the trust he or she will be permitted to occupy the residence rent free, and therefore your occupancy continues unabated.
Can I Lease the House Back?
A second possibility is to enter into a lease or rental agreement of the house with the trust (or your children, if they become the outright owners at the end of the initial trust term). This can even be put into the trust agreement, to ensure that you will be able to stay in your own home, so long as the terms are at fair market value. An additional benefit is that each payment of rent to the trust will effectively transfer additional funds to your children free of income and gift tax consequences.
Can I Buy the House from the Trust?
One disadvantage of the QPRT is that if the house continues to be a part of the trust after the initial term ends, it will pass to your children with your old income tax basis. This could cause huge capital gains when your children eventually sell the house. Under IRS Regulations effective May 17, 1996, all QPRTs must specifically prohibit the sale of the personal residence to either the grantor or a trust taxed to the grantor. This was enacted to prevent you, as grantor, from buying the house from the trust, owning it until death, and passing it to your children at the date-of-death income tax basis (thereby eliminating all potential capital gains). Because of this rule, it is important to compare the potential estate tax savings with the increased capital gains tax, assuming the ultimate beneficiary of the residence will sell the house prior to his or her own death.
Who pays the real estate taxes, repairs, utilities, etc.?
You would pay for all repairs to the house, utilities, lawn care and other basic maintenance, homeowner's insurance premiums, and real estate taxes. Such payments, since they are for your benefit as the tenant during the trust term, should not constitute taxable gifts.
How Many QPRTs Can I Set Up?
Each person can set up no more than two QPRTs: one for the primary residence and one for a vacation home or condominium.
All in all, establishing a Qualified Personal Residence Trust is one of the best techniques currently available for transferring a significant amount of assets to your children or other beneficiaries at a deep discount. Be aware, however, that because the QPRT is a result of recent federal tax legislation, there is no guarantee of its continued availability; Congress may take this one away from us at any point, so it behooves you to take advantage of this opportunity while it is still here.
K. Gabriel Heiser is no longer with Frascona, Joiner, Goodman and Greenstein, P.C.
Disclaimer -- Content is general information only. Information is not provided as advice for a specific matter, nor does its publication create an attorney-client relationship. Laws vary from one state to another. For legal advice on a specific matter, consult an attorney.