October 29, 2012
Authored by: Larry Brody and Stephanie Moll
As discussed in our prior post, “2012 Gift Tax Opportunities: Wait to Gift, but Do Not Wait to Plan“, we discussed how the 2010 Tax Relief Act has provided a great opportunity for lifetime gifts to family members with a temporary increased estate and gift tax exemption of $5.12 million making these gifts potentially free of ever incurring gift or estate tax. The exemption will return to $1 million on January 1, 2013 unless Congress acts, and although most commentators think a return to $1 million is unlikely, there is a good possibility the exemption will be reduced. However, many people are reluctant to make gifts of their liquid assets, in case they might have need of them as the get older. Many people, therefore, are looking for ways of making a gift on a non-liquid asset, such as their home or another piece of real estate, such as a vacation home. Two methods of making such gifts are the Qualified Personal Residence Trust (a “QPRT”) and the Intentional Grantor Residential Trust.
A QPRT is an irrevocable trust, to which the Grantor transfers a residence (either his primary residence or a vacation home) while retaining the right to live in the transferred residence rent-free for a term of years (not for life). If the Grantor outlives the term, his retained interest ends and the residence is either distributed to the trust beneficiaries (always living children, not grandchildren or lower generation beneficiaries) or continues in trust for them. If the Grantor wishes to continue to live in the residence after the retained term, the Grantor must then pay arm’s length rent to the remainder beneficiary(ies). If the Grantor dies during the retained term, the then fair market value of the residence is includable in to the Grantor’s estate for estate tax purposes. The gift the Grantor makes when the trust is created is equal to the fair market value of the residence minus the actuarial value of the retained term, based on the Grantor’s age and the then current IRS interest rate; the longer the term, the higher the interest rate, the smaller the gift. If the residence is sold during the retained term, and if no replacement residence is purchased by the QPRT, the QPRT must turn into a Grantor Retained Annuity Trust, paying the Grantor an annuity for the remainder of the term. If the residence is subject to a mortgage, each monthly payment of principal on the mortgage is partially a gift to the remainder beneficiaries.
An Intentional Grantor Residential Trust is an irrevocable trust created by the Grantor, to which the Grantor transfers a residence (either his primary residence or a vacation home), subject to a lease, under which the Grantor pays arm’s length rent for as long as he wishes (including his lifetime). The value of the gift is the fair market value of the residence; there is no risk of estate tax inclusion if the Grantor dies during the term of the lease (assuming that the rent is actually arm’s length rent). Since the trust would be created as an intentional grantor trust for income tax purposes, the rental income received by the trust would not be subject to income tax, either to the trust or the Grantor. Under a retained power to do so, the Grantor could reacquire the residence owned by the trust by substituting assets of equivalent value. The trust could be for the benefit of children, could continue in trust for children for life, remainder to grandchildren, or could be a dynasty trust lasting for generations.
See our Comparison of the QPRT to the Intentional Grantor Residential Trust.