Minimize Federal and New Jersey Estate Taxes with a Qualified Personal Residence Trust

A qualified personal residence trust (QPRT) offers an opportunity for homeowners to minimize or avoid federal and New Jersey estate taxes. A QPRT allows a homeowner to transfer ownership of a primary or vacation home to a “grantor trust,” while keeping the right to live there for a specified period of time. When that specified time ends, ownership passes outright to the homeowner’s children or whoever is named as the remainder beneficiaries.

When you transfer your home into a QPRT, you make a gift to the beneficiaries which is subject to gift tax. The value of that taxable gift is not the full fair market value of the home, as it would be with an outright transfer. The value is discounted. In the current real estate market values are quite low, adding to the benefit of the QPRT. The gift is also discounted to reflect that you have retained an interest (the right to live in the home for the specified term). Internal Revenue Service tables and current interest rates are used to determine the amount of the discount. The federal gift tax exemption is currently $5,120,000.00 and you can utilize a portion of that exemption and pay no gift tax. As New Jersey does not have a gift tax, you can transfer the home without incurring any New Jersey gift tax.

Additionally, if you outlive the specified time period, your home, including any appreciation in value, will not be subject to estate tax because the home will have been removed from your estate. After the specified time period expires, if you want to continue residing in the home, you will have to lease the home from the beneficiaries and pay a fair market value rent. Those rental payments to your beneficiaries will also reduce your taxable property at death. However, if you die before the term expires, the home will be included property for estate tax purposes (just as it would have been had you not created the QPRT).

During the term of the QPRT, income, if any, and deductions are reported each year on your personal income tax return. For example, you will pay the real estate taxes and be entitled to take an income tax deduction for those real estate taxes paid. You will also continue to pay for all expenses related to the home, such as repairs and insurance.

However, there is a downside which must be considered before transferring your home to a QPRT. When beneficiaries receive property upon someone’s death, they generally receive an income tax cost basis that is “stepped up” to the fair market value on the date of death. However, if the property was passed to a QPRT during life and you have outlived the term of the QPRT, your beneficiaries will get the home as a gift rather than an inheritance, and they will instead receive a carryover basis (your cost basis in the property). If the fair market value of your home has appreciated substantially since the date the home was transferred to the QPRT, the increased capital gains tax that the remainder beneficiaries will owe upon the sale of the home may be greater than any estate tax savings, particularly if the total value of your estate is below the current $5,120,000 federal estate tax exemption. However, even if the value dramatically increases during the term of the QPRT, and your estate is only subject to New Jersey estate tax, this remains an excellent option for a vacation home, beach house or family home which is expected to be retained for the enjoyment of future generations.

The attorneys at McLaughlin & Nardi are experienced in drafting trusts. For more information, call McLaughlin & Nardi, LLC, 37 Vreeland Avenue, Totowa, New Jersey, by telephone at 973-890-0004, e-mail at info@esqnj.com or visit our website.