A qualified personal residence trust can be a useful wealth preservation tool if you are exposed to the estate tax as a homeowner. Before we look at these trusts in detail, we should explain the estate tax parameters.
There is a federal estate tax that carries a credit or exclusion of $5.34 million in 2014. This is the amount that you can transfer before the estate tax would be applicable. If your estate is valued at less than $5.34 million, there will be no estate tax exposure on the federal level.
There are some states that impose state-level estate taxes. Our firm practices in Oklahoma and Kansas. These states do not have their own estate taxes.
The maximum rate of the federal estate tax is 40 percent.
Qualified Personal Residence Trusts
When you are determining the value of your estate, your home is certainly going to count. Your place of residence may be your most valuable possession. When you convey your home into a qualified personal residence trust, you are removing the value of your home from your taxable estate.
However, there is a gift tax in the United States, and it is unified with the estate tax. The $5.34 million exclusion applies to taxable gifts that you give coupled with the value of your estate.
If you convey your home into a qualified personal residence trust, you name a beneficiary who will inherit the home after the trust term expires. Because the beneficiary will ultimately be inheriting the home, the act of funding the trust is considered to be an act of taxable gift giving by the Internal Revenue Service.
When you are creating the qualified personal residence trust you decide on a retained income period. During this interim you will remain in the home as usual, living rent free.
Let’s say that you set a retained income period of 15 years. If you were going to sell the home on the open market with the stipulation that the buyer could not assume ownership for 15 years, it would not sell for full fair market value.
As a result, the taxable value of the gift is going to be much lower than the market value of the home that has been conveyed into the qualified personal residence trust.
The taxable value will be directly tied to the duration of the retained income period. Because of this, you may want to remain in the home as long as possible. This make sense on the one hand, but there is a risk involved.
If you were to pass away before the retained income period expires, the home would once again become part of your taxable estate, and the strategy would not succeed.
Parman & Easterday