Healthy: This by no means requires a person to be able to run a marathon, but merely requires that the grantor of a QPRT be healthy enough to have at least an average life expectancy for a person of his or her age. If a client wants to use a QPRT, but is in less-than-perfect health, there is always the option of using a shorter QPRT term, but the gift tax savings will be considerably less.
Healthy: To benefit from a QPRT, a client must have a taxable estate of more than $2 million. The residence should be a valuable, appreciating asset. Additionally, the ideal client will be financially secure. Parting with his or her home and potentially paying fair market value rent to continue to live in the residence in the future should not cause financial hardship. Because the grantor's right to occupy the residence ends with the QPRT term, vacation homes make attractive vehicles. Many clients in their 60s or 70s are ready to relinquish a slope-side or beachfront property in 10 or 15 years. A QPRT will be most valuable to a married couple with assets in excess of $4 million, or a single person with assets in excess of $2 million. The home should be worth $500,000 or more.
Wise: We will use "wise" to mean someone who has attained 50. The older the grantor of a QPRT, the larger the gift-tax valuation discount for mortality. The younger the grantor, the longer the QPRT term must run to get a significant valuation discount. Thus, grantors over the age of 50 are in the best position to realize significant transfer tax savings from the use of a QPRT.
The Sale of a Remainder Interest in a Personal Residence
The QPRT is a sound statutory vehicle that can yield significant transfer-tax savings. However, given the values of many residences today, it is possible to "outgrow" the QPRT technique in two ways. First, if one's home is worth more than about $4 million, then the QPRT term would have to be unreasonably and unrealistically long, resulting in greater mortality risk, for the gift value to be less than the $1 million gift-tax exemption. Second, an individual who has already used part or all of his or her lifetime gift-tax exemption may not be able to reap the benefits of a QPRT without paying a significant gift tax. In both cases, while a QPRT may help to reduce the estate and gift taxes, it might also require the payment of a significant out-of-pocket gift tax, thereby eliminating one of its main benefits, which is the leveraged use of the lifetime gift-tax exemption.
For those clients who have outgrown the practicality of the QPRT, a somewhat similar transaction, which the IRS has approved in recent rulings, may offer an attractive alternative. This technique involves a sale by the owner of a remainder interest in a personal residence. In contrast to a QPRT, where the future interest in the grantor's home is gifted to the children, in this transaction, the future interest in the home is where the future interest in the grantor's home is gifted to the children, in this transaction, the future interest in the home is sold to the owner's children (or to a trust for their benefit). In a nutshell, this technique involves a parent, who is the current owner of a substantial residential property, selling a remainder interest in the residence to or for the benefit of the next generation, typically in a trust. With a sale of a remainder interest, the parent would retain the right to occupy the residence for a term of years or the rest of his or her lifetime.
If the transaction is properly structured, such a sale should not result in a deemed gift under the Internal Revenue Code, and the retained use of the residence by the parent should not result in estate taxation.
The transaction is somewhat risky, however. While there is an argument that the continued use of the residence by the parent should not cause the home to be included in his or her taxable estate at death, the IRS has declined to rule on this issue. A relatively recent line of cases support the position that the transaction would not put the home in the taxable estate because the owner was paid "adequate and full consideration" for the sale of the remainder interest. There is nonetheless some uncertainty about this aspect of the transaction.
An Example: The Sale Of A Remainder Interest In A Personal Residence Transaction
Take, as an example Jim, who is 60 years old, has two adult children and a unique beachfront home on Cape Cod. He has also done some previous planning for his children, having created an older trust that we will refer to as the "purchasing trust." Jim creates a new trust that is tailored to meet the requirements of a qualified personal residence trust. Jim transfers the home into the new trust and retains the right to occupy the home rent-free for the rest of his life. At Jim's death, the property in the new trust (i.e., the home or any replacement home or other assets) passes into the purchasing trust that is held for the benefit of Jim's children and perhaps grandchildren. In exchange for Jim transferring the home into the new trust, in which the purchasing trust will receive the remainder interest at Jim's death, the purchasing trust pays to Jim assets equal to the actuarially determined value of the remainder interest at Jim's death. Ideally, the purchasing trust would purchase the remainder interests with its own "old and cold" assets. Since the purchasing trust was structured as a grantor trust, which is the same taxpayer as Jim for income tax purposes, the sale will not trigger income taxes.