Qualified Personal Residence Trust (QPRT)

What Is a Qualified Personal Residence Trust (QPRT)?

A qualified personal residence trust (QPRT) is a specific type of irrevocable trust that allows its creator to remove a personal home from their estate for the purpose of reducing the amount of gift tax that is incurred when transferring assets to a beneficiary.

Qualified personal residence trusts allow the owner of the residence to remain living on the property for a period of time with "retained interest" in the house; once that period is over, the interest remaining is transferred to the beneficiaries as "remainder interest."

Depending on the length of the trust, the value of the property during the retained interest period is calculated based on applicable federal rates (AFR) that the Internal Revenue Service (IRS) provides. Because the owner retains a fraction of the value, the gift value of the property is lower than its fair market value (FMV), thus lowering its incurred gift tax. This tax can also be lowered with a unified credit.

How a Qualified Personal Residence Trust (QPRT) Works

A qualified personal residence trust can be useful when the trust expires prior to the death of the grantor. If the grantor dies before the term, the property is included in the estate and is subject to tax. The risk lies in determining the length of the trust agreement, coupled with the likelihood that the grantor will pass away before the expiration date. Theoretically, longer-term trusts benefit from smaller remainder interest given to the beneficiaries, which in turn reduces the gift tax; however, this is only advantageous to younger trust holders who have a lower possibility of passing away prior to the trust end date. 

QPRT and Other Trust Forms

Many different types of trusts exist in addition to a qualified personal residence trust. Two additional ones are a bare trust and a charitable remainder trust. In a bare trust, the beneficiary has the absolute right to the trust’s assets (both financial and non-financial, such as real estate and collectibles), as well as the income generated from these assets (such as rental income from properties or bond interest).

In a charitable remainder trust, a donor may provide an income interest to a non-charitable beneficiary with the remainder of the trust going to a charitable organization. The charitable remainder annuity trust (CRAT) and charitable remainder uni-trust (CRUT) are two types of charitable remainder trusts.

Under two types of charitable remainder trusts, CRAT and CRUT, the donor receives an income tax deduction from the present value of the remainder interest.

Example of a QPRT

Consider a parent who wants to pass their house, which is valued at $500,000, to their child. Currently, the parent does not plan to move out of the house. To reduce the tax impact on their estate, the parent sets up a qualified personal residence trust for 10 years.

In 10 years, the house increases in value to $750,000. Because the house is under a QPRT, the $250,000 in gains will be tax-free. In other words, the parent will only have to pay gift tax on the $500,000 value of the house that is held within the trust. 

Importantly, if the parent dies prior to the end of the trust’s term, the tax benefits will fail to apply. In addition, QPRTs may have various caveats pertaining to the adjoining land, outliving the trust, and selling the home before the term’s end.