While several strategies can work, one of the most effective is to put your property into a qualified personal residence trust (QPRT) and name your heirs as its beneficiaries. Under the terms of this type of trust, you reserve the right to continue residing in the home for a fixed period of time, after which ownership transfers to the trust's beneficiaries.
How does that cut your estate taxes? When you create a QPRT, the IRS considers that you have made a gift of your home to the trust's beneficiaries. But because they do not take immediate title, the value of that gift, for tax purposes, is significantly less than its fair market value. Accordingly, your gift consumes less of your estate's $650,000 exemption from gift and estate taxes. If you've already passed that threshold, you still reduce the amount of gift tax you must pay.
The value of your "gift" is determined by IRS actuarial tables, which take into account your age and the length of time you agree to reside in the residence. The longer the time period, the smaller the taxable value of the gift. For example, a $3 million residence put into a 15-year QPRT by somebody 55 years old would be valued at about $840,000 for tax purposes, while the same home placed in a 20-year QPRT would be valued at only about $498,000.
Why not make the term of the trust as long as possible? Because, warns trusts and estates attorney Bruce Wexler of New York law firm Loeb & Loeb LLP, you must outlive the trust to reap its tax benefits, if not, your home goes back into your estate, where it will be taxed on its then-current fair market value. Inevitably, that will be much higher than the discounted rate that applied when the home went into the trust.
Tax law allows you to create QPRTs for up to two properties (your principal residence and one other). If you have several homes and are trying to decide which to shelter, choose the two with the highest cost basis to gain the maximum tax benefit. Why? Because if and when your heirs decide to sell the property, their capital gains will be based on the price you paid for the property, which could be many orders of magnitude below its current value. (By contrast, real estate that passes to your heirs outside a QPRT enjoys a step-up in basis; that is, any gain on its subsequent sale is based on its fair market value at the time of your death, not on what you paid for it.)
Perhaps the biggest drawback to a QPRT - other than the danger that you might die before it reaches full term - is having to find a place to live once the trust expires. Many people simply rent the property from their heirs once their heirs assume ownership. This has the advantage of transferring more of the estate to the children or grandchildren without incurring gift or estate taxes.
CEOs who don't want to deal with the shortcomings of the QPRT have two other alternatives: One is to put it into a family limited partnership, in which you retain a general partnership interest. You then gift the remaining ownership to your heirs in the form of limited partnership units, either in one fell swoop or more gradually, to take advantage of the $10,000 per person annual gift tax exclusion. Because your heirs are receiving limited interests in the property, their shares are valued at below fair-market value for tax purposes; thus you enjoy some of the same benefits of a QPRT while retaining control of the property until death.
A simpler solution, at least legally, is to just give interests in your property to your heirs over a period of time, executing deeds for each one of them. As in the case of the family limited partnership, the value of each annual gift will be lower than fair market value, since it represents only fractional ownership in the property. Evelyn Capassakis, a partner at PricewaterhouseCoopers and head of the firm's trusts and estates group in New York, notes that if you have a sufficient number of heirs and a sufficient number of years to dispose of the property, you can keep each annual gift below $10,000 and avoid paying any gift tax on the transfers. The only problem, she warns, is that you won't retain exclusive control of the property. If that's a concern, you'll probably prefer a family limited partnership.
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|Title Annotation:||qualified personal residence trusts|
|Publication:||Chief Executive (U.S.)|
|Article Type:||Brief Article|
|Date:||Oct 1, 1999|
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