An oldie-but-goodie tax strategy is back in the limelight thanks to the Clintons' much-publicized attempts to soften the blow of estate and gift taxes. The qualified personal residence trust is back.
Bill and Hillary Clinton are making headlines for their use of the qualified personal residence trust or QPRT — lovingly pronounced “kew-pert” by tax geeks — to save on estate and gift taxes.
The couple drafted two such trusts in 2010, divided the ownership of their Chappaqua, N.Y., home into separate 50% shares and then moved those shares into the trusts, according to Bloomberg. The Clintons bought the home 15 years ago for $1.7 million and its estimated value for property taxes is $1.8 million, Bloomberg reported.
The strategy will save them a pretty penny: It allows them to remove the value of the home from their taxable estate and pass it to beneficiaries free of estate tax at the end of the trust's term, provided the grantors — Bill and Hillary — are alive at that time.
“It's a gift-tax savings tool,” said Gavin Morrissey, senior vice president of wealth management at Commonwealth Financial Network. “The people who benefit from this are the people who want to remove the home from the estate to reduce their taxable estate.”
It's not a tool that's for everyone, though.
For one thing, QPRTs make sense for extremely wealthy individuals who ideally own multiple homes and who are facing steep estate taxes. To get the biggest bang for your buck, the residence is appreciating in value, so that when it's passed to the beneficiary and out of the estate, it is worth much more.
Right now, the estate tax and gift tax exemptions are at $5.34 million for individuals, and $10.68 million for married couples filing jointly.
The ideal candidate for a QPRT is someone or a couple whose wealth is above those thresholds.
“If you're over that exemption amount, you're looking at paying estate taxes,” said Donna Barwick, administrative vice president and senior fiduciary officer at Wilmington Trust N.A. “If you're not over that, then it's not worth doing.”
With a QPRT, clients can split the ownership of the house, as the Clintons did, and each can create a QPRT with an interest in the home, explained Ms. Barwick.
There are criteria the home ought to meet before it goes into the trust. For instance, the strategy works best with a secondary residence — such as a vacation home — rather than a primary residence.
That's because at the end of the QPRT's term, the home passes to the beneficiary and he or she will have to start charging the grantor rent should the grantor reside there.
Indeed, some people aren't comfortable with paying fair market rent to their kids to live in their primary residence. Bear in mind, however, the rent can work out as a way for grantors to transfer wealth to their kids outside of the estate. The kids will have to count the rent as income.
“From an estate planning perspective, you pay rent to live in the house and it's a way to transfer assets without paying a gift tax,” said Ms. Barwick.
In other worst-case scenarios, there could also be an economic downturn, leaving the grantors with few assets and no access to home equity.
“I wouldn't be inclined to do it for a primary residence,” said Charles Douglas, editor of the National Association of Estate Planners and Council's Journal of Estate and Tax Planning. “You want to stay there [in the residence] and not get kicked out. You also should have plenty of money that you won't need the equity in the home.”
Additionally, the house shouldn't have a mortgage, which can bring plenty of baggage to the planning picture in the form of income tax problems, he added.
The next step is to determine the term of the QPRT: the grantor can live in the home for the length of the QPRT's term, and in that period he or she would handle typical home expenses but not pay rent.
There are a handful of factors that go into considering the term's length. For instance, there's the life expectancy of the grantor. If the QPRT's term is too long and the grantor dies before the period is up, the home passes back to his or her estate, where it can be subject to taxes.
There's also the IRS' Section 7520 interest rates, which are used to determine the value of the remainder interest of the gift — the residence — that will pass to the beneficiaries. Finally, there is the monthly interest rate the IRS sets for the month in which the asset is transferred.
“We are in a historically low [interest rate] environment, so from that standpoint, you would get a bigger break on the gift tax valuation if the Section 7520 rate were higher,” said Mr. Morrissey. Right now, the Section 7520 rate is 2.2%.
He was a big proponent of QPRTs in 2008, 2009 and 2010, when interest rates were low, but so were the valuations of the homes being transferred.
“It's almost like 'buy low, sell high,'” Mr. Morrissey said. “We're seeing appreciation of real estate now, and people who did this back then are seeing some leverage from doing this.”
Above all, drafting a QPRT is a job that will likely require a team of professionals, so advisers need to make sure they've brought in the best resources.
“You want someone who knows how to draft a QPRT, and you want someone with experience drafting estate documents and who understands the QPRT calculation,” Ms. Barwick said. “It's not without some expense on professional fees for drafting the document and appraisal fees for the valuation of the home and discount.”