QUALIFIED PERSONAL RESIDENCE TRUSTS
A special kind of irrevocable trust can be used to transfer
your residence to your children at a significantly reduced
gift tax cost and with no estate tax, yet allow you to continue
to live in the residence for as long as you wish. This special
type of trust is known as a qualified personal residence
trust (QPRT). (QPRTs are sometimes also referred to as “residence
GRITs” or “house GRITs”.) Here's how it
works.
During your lifetime, you transfer your residence to
the trustee, who (if state law permits) can be yourself.
The trustee must allow you to continue to use the residence
rent-free for a fixed number of years specified in the
trust instrument (the “fixed term”), which
should be a term you are likely to survive. During the
fixed term, you will continue to pay mortgage expenses,
real estate taxes, insurance, and expenses for maintenance
and repairs, and will continue to deduct mortgage interest
and real estate taxes on your individual income tax return.
When the fixed term ends, the residence is distributed
to your children, or remains in further trust for them.
Even after the fixed term ends, you can continue to
use the residence in one of two ways. First, rather than
immediately distributing the residence to your children,
the residence can be retained in trust for your spouse's
lifetime, thus assuring that the residence is available
to you. Second, you can enter into a lease with your children
which will allow you to live in the residence for as long
as you wish. (If you do so, however, you must pay fair
market value rent to your children after the fixed term
ends in order to keep the residence from being subject
to estate tax on your death.)
Although your transfer of the residence to the trust
is a taxable gift, you are allowed to subtract, from the
fair market value of the residence, the value of your
right to live rent-free in the residence for the fixed
term. Thus, the amount of the taxable gift will usually
be substantially less than the fair market value of the
residence. If the amount of the gift is less than your
available exclusion from the gift tax ($1,000,000, reduced
by amounts allowed for gifts in previous years), no gift
tax will be due as a result of your gift to the trust.
If you survive the fixed term of the QPRT, the value
of the residence will not be included in your estate for
estate tax purposes. Even if you don't survive the fixed
term, the estate tax consequences will be no worse than
they would have been if you hadn't created the trust in
the first place. In other words, from a tax point of view,
there's no potential downside to a QPRT.
A QPRT is an effective way to remove a residence's value
from your estate at a greatly reduced gift tax cost
IRREVOCABLE LIFE INSURANCE TRUSTS ("ILIT")
How to make sure the life insurance benefits your family
will receive after your death avoid the federal estate tax.
This is an important issue because, once the federal estate
tax applies, the rates are high (beginning at 37% and going
up to 55%; though the top rate drops to 50% in 2002, 49%
in 2003, 48% in 2004, 47% in 2005, 46% in 2006, and 45%
in 2007, 2008, and 2009).
Insurance on your life will be included in your taxable
estate if either:
Avoiding the first situation is easy: just make sure
your estate is not designated as beneficiary of the policy.
The second rule is more complex. Clearly, if you are
the owner of the policy, the proceeds are included in
your estate regardless of who the beneficiary is. However,
simply having someone else possess legal title to the
policy will not prevent this result if you keep so-called
“incidents of ownership” in the policy. Rights
that, if held by you, will cause the proceeds to be taxed
in your estate include: