An irrevocable trust (referred to as a “QPRT”) designed to hold title to an individual’s residence for a term of years subject to the retained right of the individual to reside in the home for the term, with title passing to children or other beneficiaries at the end of the term.
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Residence trusts in the United States are used to transfer a grantor's residence out of the grantor's estate at a low gift tax value. Once the trust is funded with the grantor's residence, the residence and any future appreciation of the residence are excluded from the grantor's estate, if the grantor survives the term of the trust, as explained below.
Personal residence trusts ("PRTs") are irrevocable split interest trusts. The transfer of the residence to the trust constitutes a completed gift. The split interest character of the trust is as follows: the grantor retains the right to live in the house for a number of years, rent free, and then the remainder beneficiaries of the trust become fully vested in their interest. PRTs are similar by nature to other types of retained interest trusts, like GRITs, GRATs and GRUTs.
Generally, if the grantor retains an interest in the trust, then for estate and gift tax valuation purposes, his retained interest is valued at zero. However, if the retained interest is "qualified" within the meaning of United States Internal Revenue Code ("Code") section 2702(b), its value is determined under Code Section 7520.
The value of the retained interest, as will be explained in more detail below, is important for gift tax purposes. Because the transfer of the residence to the PRT is a completed gift, it is desirable to minimize the value of the gift. The gift is valued at the fair market value of the residence, less the value of the retained interest. Consequently, if the retained interest is valued at zero, the taxable gift equals the fair market value of the residence. If the retained interest is valued under Code section 7520, its value will be greater than zero, and the gift value is minimized.
Code section 7520 values the remainder interest using the term of the trust, the life expectancy of the grantor and the 7520 rate in effect for the month of the transfer. The longer the term of the trust and the higher the 7520 rate, the lower the value of the gift. The age of the grantor also matters. If the grantor is older there is a greater likelihood that the grantor will die during the term of the retained interest (when a contingent reversion is retained by the grantor).
The regulations under Code section 2702 allow two types of qualified trusts: personal residence trusts and qualified personal residence trusts ("QPRTs"). Of the two, QPRTs are more widely used because they possess a greater degree of flexibility.
A personal residence is one of the following:
- the principal residence of the grantor;
- one other residence of the grantor; or
- an undivided fractional interest in either.
Up to two residences may be transferred into residence trusts, and one must be the primary residence. The other residence, usually a vacation home, may be rented by the grantor a portion of the time, but the grantor must live in the vacation home for more than the greater of 14 days or 10% of the number of days rented.
