How qualified personal residence trusts work

The IRS sample reserves use until the earlier of the stated termination date or the transferor's death. The instrument designates who receives the trust property at termination. Bring the proposed trust instrument, deed, mortgage documents and intended occupancy arrangements to the drafting attorney.

Research notice: This guide draws on Treasury regulations, federal statutes, the IRS annotated sample QPRT and the Form 709 instructions. Confirm current rules with an estate attorney or CPA.

How a QPRT reserves use of a home

The IRS sample QPRT is irrevocable and gives the transferor exclusive use, possession and enjoyment of the residence without rent until the earlier of its specified termination date or the transferor's death. The instrument designates the recipients at termination. The home does not necessarily pass outright to children.

Use the sample as an annotated reference rather than a requirement to reproduce its wording verbatim. Review the proposed termination provisions with the attorney, including the named recipients and the provisions addressing the owner's death.

QPRT qualification provides an exception to section 2702's special valuation rules for retained interests in family trusts. The transfer must meet the personal residence trust regulation, and its required governing instrument provisions must remain effective throughout every term interest. When section 2702 applies, a retained interest that is not qualified generally has zero value.

The instrument must require distribution of any trust income to the term holder at least annually. Before the retained term expires, the instrument must prohibit distributions of principal to anyone other than the transferor. The instrument must also prohibit prepayment of the term holder's interest.

The instrument must prohibit direct or indirect sales or transfers of the residence to the grantor, spouse or an entity they control during the retained term. The prohibition continues afterward while the trust is treated as owned in whole or in part by the grantor or spouse under sections 671 through 678. Entity control uses the regulation's specified definition. A sale or transfer to another grantor trust of the grantor or spouse counts as a sale or transfer to that person.

If the grantor dies before the term expires, the prohibition does not apply to a distribution without consideration under the instrument's express terms or a power retained under the instrument. The prohibition also does not apply to an outright distribution without consideration to the spouse after the term expires under the instrument's express terms. Another exception permits a distribution without consideration upon or after the term's expiration to another grantor trust of the grantor or spouse under express trust terms. That receiving trust must prohibit sales or transfers to the grantor, spouse or an entity they control.

Ask counsel to review entity control and any proposed transfer between trusts against the regulation itself. Keep the transfer restrictions beside the termination provisions when reviewing the draft.

How the remainder gift is valued

The gifted remainder is valued at its actuarial present value using the applicable section 7520 factors for the gift date, with age taken at the nearest birthday. The valuation uses the applicable standard or special factors, interest rate and, when applicable, mortality component. Commercial contracts and exceptions to prescribed tables have separate rules.

Ask the valuation adviser to identify the rules applicable to the transfer date and account for the instrument's retained interests and contingencies. A calculation that subtracts only the retained residential term may overlook other interests or contingencies.

Fair market value is the price at which property would change hands between a willing buyer and willing seller, neither compelled to act and both reasonably informed.

The ordinary section 7520 interest rate uses the month in which the gift becomes complete. The rate equals 120 percent of the applicable federal midterm rate, compounded annually. Round it to the nearest two tenths of one percent, with midpoint ties rounded upward.

The prescribed mortality component cannot be used if the measuring individual has died or is terminally ill when the gift becomes complete. A known incurable illness or deteriorating physical condition is terminal for this purpose if the probability of death within one year is at least 50 percent. Survival for at least eighteen months after the completed gift creates a presumption that the individual was not terminally ill at completion. Clear and convincing evidence can rebut that presumption.

Bring the proposed term, appraisal, ownership percentage, relevant health information and complete trust draft to the valuation discussion. Request the supporting explanation rather than relying on a comparison of interest rates alone.

What happens if the grantor dies during the term

Death before the reserved residential term ends causes estate inclusion of the transferred residence interest under section 2036. The transferor retained enjoyment for a period that did not end before death. Inclusion concerns the transferred residence interest, rather than merely the original remainder gift. Surviving the term alone does not resolve other retained rights.

For a United States citizen or resident decedent, the gross estate generally uses the value at death of property wherever situated. The gross estate reaches beyond property owned at death to specified transfers with retained rights and qualifying prior QTIP property. QTIP inclusion requires a qualifying income interest for life and an allowed marital deduction under section 2056(b)(7) or section 2523(f). That inclusion does not apply if section 2519 applied to the decedent's disposition of part or all of the income interest. Nonresident estates have separate statutory coverage.

An executor may make an irrevocable alternate valuation election only if it decreases both the gross estate's value and the combined estate and GST tax with respect to property includible in the gross estate. The election generally uses values six months after death. Property distributed, sold, exchanged or otherwise disposed of within those six months is valued on its earlier disposition date.

Keep the trust instrument, original transfer appraisal, termination provisions and records of any later rights together for the executor's review. Ask the estate's advisers to address inclusion and the applicable valuation election using the actual circumstances.

Mortgage payments during the trust term

A mortgage does not disqualify a residence, and the instrument may permit limited cash additions for mortgage payments and other trust expenses. Those expenses must already be incurred or reasonably expected to be paid within six months of the addition. Cash already held for the purpose counts toward the permitted amount.

The instrument may also permit cash additions for improvements payable within six months of the addition. Cash for an initial residence purchase requires a prior purchase contract and a purchase within three months of trust creation. Cash for a replacement residence requires a prior purchase contract and a purchase within three months of the addition. For each purpose, existing cash counts toward the amount the trust may hold.

The instrument must require the trustee to check for excess expense cash at least quarterly and distribute the excess immediately to the term holder. Unused expense cash must be distributed outright to the term holder within thirty days after termination. Amounts used for expenses due and payable at termination, including termination expenses, are excepted.

These permissions address cash the trust may hold and administer. Ask the gift tax adviser to analyze the tax treatment of actual mortgage contributions separately. Give the attorney and CPA the loan documents, payment history, source of each contribution and trust accounting records.

Continued occupancy after the term

An express or implied understanding at the original transfer that residential enjoyment would later be conferred can support estate inclusion under section 2036. The rule covers enjoyment retained for life, for a period tied to death or for a period that does not end before death. A bona fide sale for adequate and full consideration is excepted. Paying rent alone does not establish that estate inclusion is prevented.

Discuss intended occupancy after the term before signing the original trust. Give counsel the complete history of conversations, agreements and actual use when reviewing a later occupancy arrangement. Keep those records with the original planning documents.

A vacation home in an owner's estate plan

Eligible property includes the term holder's principal residence, one qualifying other residence or an undivided fractional interest in either. The other residence must meet section 280A(d)(1), without regard to section 280A(d)(2). Residential appurtenances and adjacent land reasonably appropriate to the residence's size and location may qualify. A mortgage does not disqualify the residence. Household furnishings and other personal property do not qualify.

Residential use must predominate while the term holder occupies the property and during nonoccupancy. Transient lodging accompanied by substantial services fails that standard. Business use of a principal residence qualifying under section 280A(c)(1) or (4) is permitted when secondary to residential use.

A grantor already holding term interests in two qualifying personal residence trusts cannot add a third qualifying trust. Trusts holding fractional interests in the same residence count as one trust for this purpose.

Bring a description of actual use, any lodging or business activity, the land and structures, ownership shares and existing residence trusts to the eligibility review. Discuss the furnishings separately from the residence transfer.

Sale, damage and loss of qualification

Sale or loss of residential use can end QPRT qualification for affected assets. The instrument may permit a sale subject to the transfer restrictions described above. Sale proceeds may be held in a separate account if the instrument permits it. Without that permission, qualification ends on sale. With permission, qualification of remaining proceeds ends no later than the earliest of two years after sale, termination of the retained term or acquisition of a new residence.

A residence held for the term holder's use must remain available at all times. No other person may occupy it except the term holder's spouse or dependent. If damage or destruction makes the residence unusable, repair or replacement must be completed before the earlier of two years after the damage or termination of the retained term.

Once qualification ceases for affected assets, the instrument must require their outright return to the term holder or conversion to a separate qualified annuity share within thirty days. A converted share lasts for the balance of the retained term, and the instrument must contain all required qualified annuity provisions. The instrument may give the trustee discretion between the prescribed alternatives.

Contact the trustee's advisers before a sale, replacement purchase or change in use. The grantor retained annuity trust guide covers annuity payment mechanics and conversion calculations.

Gift reporting and disclosure

A United States citizen or resident making a completed remainder gift to a nonspouse individual outside the marital and charitable deductions must report the future interest gift on Form 709, even if no tax is ultimately due. Completion requires relinquishing dominion and control over disposition. Reserved dispositive powers can leave a gift wholly or partly incomplete.

A gift required to be reported but omitted or not adequately disclosed can be assessed at any time. Adequate disclosure must identify the nature of the gift and the basis for its reported value. Adequate disclosure starts the regular assessment period, generally three years after filing. Disclosure does not itself bar assessment.

Have the return preparer review the signed instrument, appraisal and valuation explanation together. Ask which attachments and disclosures are needed for the actual transfer and retain a complete copy of the filed return.

Use the lifetime gift guide for the annual exclusion review and the GST timing guide for allocation and inclusion period questions. Take gift tax basis adjustments and detailed return attachment questions to the adviser handling the corresponding reporting work.

Common questions

Resources to check out

• Treasury regulations: Personal residence trusts: Qualification, eligible property, permitted assets and transfer restrictions.
• IRS annotated sample QPRT: Trust provisions and annotations: The sample instrument and its termination discussion.
• Treasury regulations: Actuarial valuation: Valuation dates, monthly interest rates and mortality components.
• IRS Instructions for Form 709: Gift reporting: Future interests and valuation documentation.
• IRS revenue ruling: Grantor trust basis at death: A reference for the separate basis review.