TCJA Impact on Post Term QPRT Planning
Jean McDevitt, Tax Principal
Qualified Personal Residence Trusts (QPRT) have been a staple of sophisticated estate planning for some time. They are relatively simple to establish, they are well defined in IRS regulations, and can be structured with minimal initial tax consequences. Particularly for taxpayers living in areas with high property values, the QPRT was a popular choice to help minimize estate tax consequences.
A QPRT is established by a grantor who transfers his personal residence to the trust. The grantor reserves the right to live in the house for a term of years, which reduces the current value of the gift for gift tax purposes. The value of the property is effectively frozen in time for transfer tax purposes as all future appreciation in the property inures to the benefit of the trust beneficiaries.
At the end of the term of the years, the property is transferred pursuant to the trust instrument to trust beneficiaries or a continuing trust. The grantor no longer has a right to live in the property although he can rent it back from the new owner(s) at a fair market value rental price.
QPRTs were especially popular when the estate tax exemption was significantly lower than it is today. Between 1997 and 2009 the exemption amount went from $600,000 to $3,500,000. In 2011, the exemption increased to $5 million. The Tax Cuts and Jobs Act further increased the exemption to $10 million, which when indexed for inflation amounts to roughly $11.18 million in 2018.
QPRTs created in the late 90s and early 2000s made good sense from an estate and gift tax perspective. Because of the low exemption amounts available, it was essential to leverage the available exemption. For a grantor with a home valued at $1 million in 2002, an available estate exemption amount of $1 million, and an estate tax rate of 50%, the QPRT was a very good planning idea. Assuming even a moderate rate of return, the technique would have saved significant tax dollars under that tax regime.
Fast forward to 2018, there is no estate tax savings for this client because the available exemption amount has increased so significantly. Worse yet, when the heirs sell the property, it will not receive a step up in basis at the death of the grantor, so the beneficiaries will likely incur significant capital gains tax.
Clients and advisors both may be asking whether there is any way to undo prior planning, to take advantage of changes in the law. But I’d suggest that you first consider whether it is advisable to change course knowing how in flux our tax laws tend to be. The answer to that is, of course, a situation by situation analysis is required. No two situations are the same.
In evaluating these options, some of the factors to contemplate are:
- When will the grantor pass away?
- What will be the status of federal (and state) estate tax law at that time?
- What will be the value of the grantor’s estate then?
- Will the residence be sold imminently or will it remain in the family’s ownership?
Furthermore, there are challenges with how to undo the QPRT. The QPRT trustee may not simply convey the deed back to the grantor. A QPRT is irrevocable; the trustee has a fiduciary obligation to adhere to the terms of the trust instrument. (The trustee’s loyalty belongs with the beneficiaries, not the grantor.) Short of a nonjudicial modification or some other allowance under applicable state probate law, that challenge could be onerous.
Treasury Regulations effective for all QPRTs created after May 16, 1996 prevent the grantor from repurchasing the house from the QPRT so that is not an available avenue. The grantor and QPRT could enter into a lease that represents less than the fair market value rent, which would cause estate inclusion under a strict reading of IRC Section 2036. However, the Tax Court has found that failure to pay fair rental value does not result in inclusion in the gross estate (Estate of Riese v. Commissioner, T.C. Memo 2011-60). Thus, it would seem inadvisable to rely on that approach.
It may be possible for the remaindermen of the QPRT to receive the property outright, and in turn gift the property back to the grantor. This will, of course, utilize the remaindermen’s exemption. Whether that is a sound decision will depend upon the future status of our gift and estate tax laws. A crystal ball would surely come in handy at this point!
This is not meant to be a comprehensive discussion of the pros and cons of a QPRT nor the reporting associated with setting up or maintaining a QPRT. For a more in depth discussion of such planning, please contact your advisor.
If you have any questions, please contact Jean McDevitt or your BNN tax advisor at 800.244.7444.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.