There are quite a few different acronyms used in the field of estate planning to shorten certain wordy terms. We are unraveling them one by one for our readers, and we explained the QDOT the last time around.
In this post, we will dissect the QPRT, which is an acronym that stands for a qualified personal residence trust. To understand why you may want to consider the utilization of this estate planning device, you have to absorb some information about taxation.
Federal Estate Tax and Gift Tax
You pay innumerable taxes all of your life, including income taxes, property tax, sales tax, capital gains tax, etc. After giving out all of these slices of your pie to government entities for many years, you would like to think that dying would not be yet another taxable event.
Whether it is fair or not, there is a federal estate tax in place. It can have a very heavy impact, because it carries a robust 40 percent maximum rate. The existence of the tax is the bad news, but there is also some good news to pass along.
Most American families will not be forced to pay this tax, because there is a credit or exclusion that allows you to transfer a certain amount before it would become applicable. There are annual adjustments to account for inflation, but right now in 2020, the exact amount of the federal estate tax exclusion is $11.58 million.
This is the amount that you can transfer tax free, but it does not apply to your spouse, because there is an unlimited marital deduction. Any amount of property can be transferred between spouses tax-free, as long as both people involved are American citizens.
The estate tax exclusion is portable, so a surviving spouse would be able to use the credit that was allotted to their deceased spouse. This was not the case prior to 2011.
Anyone would logically consider lifetime gift giving as a way to sidestep the estate tax, but the tax code closes this window of opportunity. There is a federal gift tax that is unified with the estate tax, so the exclusion is a unified exclusion.
As a result, if you give $11.58 million in taxable gifts during your lifetime and you die this year, the entirety of your estate would be subject to taxation.
Qualified Personal Residence Trust
Now that we have set the stage appropriately, we can get to the point of this blog post. If you are exposed to the estate tax, you could potentially transfer your home to an heir or heirs at a tax discount if you convey it into a qualified personal residence trust or QPRT.
The best way to explain is through the use of a simple example. We will assume that you are a homeowner, and you want to leave your house to your son eventually.
You fund the trust with the house, and at that point, you are removing it from your estate for tax purposes. Your son is named as the beneficiary of the trust, so he will assume ownership of the property after the term expires.
When you are establishing the trust declaration, you set a term during which you will live in the house as usual rent-free. This is called the retained income period, and we will use a 10 year period for our example, though it would be your choice.
Though the home has been removed from your estate, the eventual transfer to your son would be looked upon as an act of taxable gift giving by the IRS. However, for gift tax purposes, they would place a value on the home that is far less than the actual fair market value.
Why is this so? No one would pay full price for a house if they could not assume ownership for 10 years, and this is taken into account by the Internal Revenue Service. As a result of this discount, when the transfer takes place, the taxable value of the home would be far below its true value.
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