Your daughter Lupita and her husband Armando love your $5 million home and cherish the memories they have had there. After you have passed away, and they inherit the home, they decide not to sell. You have arranged for them to own the house outright, and they don’t have to pay any estate taxes (and you haven’t had to pay any gift tax either). Lupita and Armando feel that the home is a family heirloom and do their best to preserve it to pass down the family history and traditions. Let’s just throw in that they live happily ever after.
Compare that picture with the more common scenario that occurs after many people pass away. Your daughter Lupita and her husband Armando inherit the $5 million home that they love and cherish. They don’t plan to sell the home, but a few months after your passing, they learn they will owe $2mm in in estate taxes on the home within 9 months, and don’t have the cash unless they sell the home. Reluctantly, they put it on the market, and accept the first offer of $3.5 million in hopes that they will close in time to pay Uncle Sam. Of the $5 million value you thought you left them, they only pocket $1.5 million and lose the home. They owe more in taxes than they get to keep.
Scenario 2 is easy to achieve. Do nothing. But most people would prefer the first scenario. They just may not know how to get there. May we suggest a solution? Here it is (drumroll please):
A Qualified Personal Residence Trust (QPRT)
With a QPRT, you can give your home to your children at a future date (of your choosing) and continue living in the home now. By creating a trust who will receive your home, you remove it from your estate, and your children avoid estate taxes entirely.
Timing is everything
Because the estate and lifetime gift tax exemption limit is currently at an all time high of $11mm per individual/ $22 million per couple (until 2026), any gift tax that you would otherwise have owed (as long as it is below the limit) will be waived. So no gift tax for you, and no estate tax for your kids. It’s a win win.
How it Works:
- You set up a QPRT, which will transfer ownership of the house to the trust.
- You set a term (for example 10 or 15 years) during which you live in the house. At the end of that period, ownership of the house goes to the trust beneficiaries.
- Because the gift is in the future, only a percentage of the full house value would be calculated for gift tax purposes (based on factors that include your age, the QPRT term and prevailing interest rates). But as long as you use your lifetime gift exemption prior to 2026, you need not pay the gift tax.
You knew it wouldn’t be that simple, right? Here is the catch:
1) If you die before the QPRT term expires, then you technically haven’t transferred ownership of the house to the trust yet. The property goes back into your estate, and estate taxes may be incurred. However, except for the time and cost of setting up the QPRT, you are no worse off than you started. The goal is to choose a term that you can reasonably expect to outlive.
To mitigate this risk, you can take out a term life insurance policy (for the length of the QPRT term) to cover the estimated tax on the home in the event that it reverts to your estate. Also, you may want to transfer ownership of the home to the younger, healthier spouse prior to transferring it to the trust. This would increase the likelihood of outliving the term.
2) If you die after the QPRT expires, you are now living in the property of the trust beneficiaries.
But you can continue to live it it by coming to a rental agreement with the trust beneficiaries (presumably your children).
3) If your children do want to sell the home after they receive ownership of it, then they will have to pay capital gains taxes.
But if they live in it for 2 years, they can write off $500K or less of the profits when they sell the home. And if they keep the home, they won’t ever have to pay taxes on it.
If you or your affluent clients would like help in determining whether a QPRT would be a good fit for your estate, or need help setting it up properly, feel free to give us a call. It is our goal to make a measurable difference in your financial life.
Note: the statements above should not be considered financial, legal or tax advice, but ideas for careful consideration with your trusted financial advisors and lawyers. For current tax or legal advice, please consult with an accountant or an attorney.
About Axia Global
J. Michael Roney, Founder of Axia Global, has worked alongside the best financial and legal professionals in the field to craft profitable solutions for even the most complex wealth preservation and estate planning cases. Together, the team at Axia Global has nearly a century of combined experience in the financial services sector.