Final QPRT regulations (IRS regulations on qualified personal residence trusts)(Brief Article)

In late December 1997, the IRS released final regulations on qualified personal residence trusts (QPRTs).

Prop. Regs. 25.2702-5 (issued in April 1996) caused a flurry of concern among estate planners. Prop. Regs. Sec. 25.2702-5(c)(9) had provided that a grantor could no longer purchase a residence from a trust (or cause it to be purchased) in such a way that would avoid the recognition of gain on the purchase. Prior to that time, it was common practice for the grantor to repurchase the residence from the trust, thereby enabling him to continue to live in the residence. In addition, any gain on its sale would be taxed to the grantor; if not sold prior to the grantor's death, the residence would receive a stepped-up basis to date-of-death value.

The final regulations now confirm the requirement that the governing instrument prohibit trustees from selling or transferring the residence to the grantor, the grantor's spouse, or an entity controlled by the grantor or the grantor's spouse, during the trust's retained term, as well as at any time after the original duration of the term interest during which the trust is a grantor trust.

The preamble to the regulations notes that the grantor may lease the residence after the termination of the retained term by paying adequate consideration, without concern that it will be included in the grantor's estate under Sec. 2036. The preamble goes on to note, however, that if the property is leased from a trust that is a grantor trust, "the IRS under some circumstances may contend that the grantor has retained the economic benefit of the property." This is yet another example of the Service's dislike for dealings between a grantor and a grantor trust.

The preamble also states that "Treasury and the IRS wish to clarify that the IRS will apply these regulations only to post-effective date trusts. Nevertheless, Treasury and the IRS have the authority to apply established legal doctrines to disqualify a pre-effective date trust in cases where the statutory purpose has clearly been violated." In other words, if the Service feels that the repurchase of the residence from a QPRT created before the governing instrument requirement creates too good a result for the grantor, it may nevertheless apply the governing instrument requirement retroactively.

Finally, the regulations provide that, if a QPR-T does not meet the governing instrument requirement, a proceeding to reform the trust may be started within 90 days of the due date (including extensions) for filing the gift tax return reporting the transfer, For trusts created before 1997, the period for reformation has expired.