- Wealthy Americans can give their children a home before they die and save taxes with an irrevocable trust.
- You can stay home for the duration of the trust, and the letter of appreciation is exempt from gift and estate taxes.
- The interest rate hike has a large tax-saving effect, but heirs who wish to sell their properties should be careful.
Rising interest rates offer a silver lining for wealthy taxpayers. They want to give their children a home to see them having fun while they are at home.
In a Qualified Personal Residence Trust (QPRT), an individual puts a primary residence or vacation home in trust and retains ownership of that property for a chosen number of years. The giver (the person who funds the trust) can live in the home until the trust expires and the property is transferred to a designated beneficiary (usually an adult child).
The original homeowner’s estate will have two big tax savings once the transfer takes place. First, even if the trust lasts for years and the home’s value increases by millions, you’ll only have to pay gift tax on the value of the property when the trust was established. Second, because the property is no longer part of the taxable property of the transferor and the transferor spouse, inheritance tax is not payable on the value of the home as if the property was bequeathed.
QPRT has gained popularity over the past year because high interest rates offer another benefit, according to Jennifer Galvaña, head of trusts, real estate and tax solutions at Bank of America Private Bank.
The amount subject to gift tax is the original fair market value of the home minus The value of the grantor’s right to reside on the land during the term of the QPRT. As interest rates rise, the discount increases as the IRS uses the higher interest rate to calculate the value of the grantor’s retention interest.This rate called 7520 rate, is currently at 4.40%, up from 1.2% in the same period last year.
“We’re hearing more and more that people are thinking about QPRT even though they haven’t thought about it in years because the environment is starting to change,” Galvagna told Insider.
The QPRT is most relevant to high net worth individuals as it provides a federal lifetime estate and gift tax exemption of $12.92 million ($25.84 million for married couples). However, the federal estate tax exemption will be cut in half by the end of 2025 and no further legislation will be enacted.
These trusts come with some conditions, but the QPRT is a fairly easy way for the rich to save tax and keep their family home.
This is how QPRT works
There is no limit to the life of a QPRT, but life expectancy should be considered, as the tax benefits are only realized if the giver outlives the trust. The ideal client is in her 40s or 50s, likely to last for a period of 10 to 20 years, and the longer the trust period, the higher the property value that will be excluded from the property.
The value of the discount is calculated by the IRS using the 7520 rate and several other factors such as age of the grantor and length of term.
Another advantage is that after the trust expires, the transferor can continue to live in the house if he/she pays the new owner a fair market rent. This rent allows parents to pass more property to their heirs without gift tax. Payments can help beneficiaries with expenses such as property taxes and housing improvements.
Here is a working example of QPRT provided by Galvagna:
Consider a giver who wants to give an adult child a fortune worth $1 million. The giver chooses a 15-year term because she is 50 and in good health. Her interest rate on her 7520 when she funded her trust is her 5%, so her retained interest is valued at her $577,400.
She will outlive the trust for 15 years, and assuming a 4% after-tax growth rate, the assets are now worth $1,800,944. However, this growth is not taxed. The taxable gift (residual interest) was only $422,600, which is the difference between the original value of the property and the retained interest.
In other words, the giver was able to give away $1.8 million worth of property, but only paid $422,600 in gift taxes.
She can live in the property for 15 years and pay her children fair market rent to live in the property after that period ends. Rent payments are not subject to gift tax.
Although there are some restrictions,
The IRS has some requirements for QPRTs, including:
- Taxpayers are limited to transferring two properties: the primary residence and a secondary residence or villa.
- The QPRT is irrevocable and grantors cannot withdraw assets from the QPRT.
- If the grantor ceases to use the property as a personal residence, the trust ceases to qualify as a QPRT and must distribute all assets to the grantor or convert the trust to a grantor retained pension trust or GRAT. I have.
- Minor repairs and improvements don’t add value to your gift, but capital improvements like building a new deck or installing central air do.
- Grantors can use mortgaged property for QPRT, but mortgage payments are considered gifts to the trust, adding complications such as additional gift tax returns. perfect for home.
The most important caveat, Galvagna said, is that QPRT taxes can be high if the beneficiary plans to sell the home. If a beneficiary receives a property through her QPRT and sells it, they will be required to pay capital gains tax on the property’s increase in value since purchase. If you inherited after your parents died before you sold it, thanks to the IRS, you’ll only have to pay capital gains tax on the increase in value since it was bequeathed. A step up of the basic rules.
Garvaña talks with clients about family housing plans and usually advises against QPRT if the beneficiary plans to sell the home.
“This is a great strategy for families trying to keep their wealth within the family,” she said. “Maybe it has sentimental value.”