NOTE: State and federal laws change frequently and the following information may not reflect recent changes in the laws. For current tax or legal advice, please consult with an accountant or an attorney since the information contained in this article is not tax or legal advice and is not a substitute for tax or legal advice.
A Qualified Personal Residence Trust, or QPRT for short, is a special type of irrevocable trust that is designed to hold and own your primary or secondary residence and remove its value from your taxable estate.
Here is how a QPRT works:
1. Step One - Write the irrevocable trust agreement.
The first step in establishing a QPRT is writing the actual irrevocable trust agreement. You'll need to decide who will serve as the initial and successor trustees, how long you want to retain the right to live in the residence (this is called the "retained income period") before it passes to your ultimate beneficiaries, and then who will be the ultimate beneficiaries of the trust when the retained income period ends. These decisions will be very important since the QPRT is an irrevocable trust and its provisions cannot be easily changed.
2. Step Two - Fund the trust with your residence.
The next step is to transfer ownership of your residence into the name of the QPRT. This is done by recording a new deed from your name into the name of the trust in the land records where the property is located.
3. Step Three - Obtain an appraisal of your residence for gift tax purposes.
The next step is to obtain an appraisal of the residence as of the date you transfer it into the name of the QPRT from a licensed real estate appraiser. This is necessary to establish the fair market value of the property for gift tax purposes.
4. Step Four - Report Your gift to the IRS.
The next step is to file a Form 709, United States Gift (and Generation-Skipping Transfer Tax) Return, with the IRS, which will be due on April 15 of the year after you transfer the residence into the QPRT. This is necessary because the transfer of the residence into the QPRT is deemed to be a gift to the ultimate beneficiaries of the trust for federal gift tax purposes. If you live in a state that also has a state gift tax, then you'll also need to file a state gift tax return. Refer to How a Qualified Personal Residence Really Works to Reduce Your Taxable Estate to learn how the value of the gift into the QPRT is calculated.
5. Step Five - Go about your business as usual.
6. Step Six - Transfer ownership of the residence to your ultimate beneficiaries.
When the retained income period ends, the trustee of the QPRT must transfer ownership of the residence from the name of the trust into the names of your ultimate trust beneficiaries. This is done by recording a new deed from the name of the trust into the names of the trust beneficiaries in the land records where the property is located.
7. Step Seven - Pay fair market rent.
Once the retained income period ends, you'll need to pay fair market rent if you want to continue to live in the residence full time or if you want to use it periodically such as for vacations. Payment of rent will help to further reduce the value of your taxable estate and pass more of your assets on to your ultimate beneficiaries without using any more of your gift tax exclusion since the rent payments won't be considered gifts to your beneficiaries.