Qualified Personal Residence Trust

California Qualified Personal Residence Trusts

The Legacy Lawyers strive to provide estate planning services that will carry out your express wishes while minimizing the tax burden to your estate and preserving your assets for the future use and benefit of your heirs. When properly set up, a California qualified personal residence trust is a valuable tool. It can save you money now and save your estate money later.

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What Is a California Qualified Personal Residence Trust (QPRT)?

If you have a primary or secondary home such as a vacation home that you intend to pass along to your children or others, a California qualified personal residence trust may allow you a significant savings on transfer taxes. The QPRT accomplishes this in two ways:

  • First, it allows you to value the property for gift tax purposes at the time you transfer the residence to the trust.
  • Second, if you die after the trust term expires, your estate will not pay estate taxes on the property because you will not own the property at death. It will already have passed to the beneficiaries.

A California qualified personal residence trust is irrevocable. This means that once the trust is in place, there are very few conditions under which you can undo it. The trust must be irrevocable to take advantage of the federal tax savings, which would likely not exist if a grantor could dissolve the trust at will. The court will set up the trust for a specific term of years, after which the property will pass to the beneficiaries, not back to you. But, during the term of the California qualified personal residence trust, you will retain the right to live on or use the property. This reservation of the right to live in the home is called a retained interest.

Saving Transfer Taxes With a California Qualified Personal Residence Trust

A California qualified personal residence trust can provide excellent asset protection for wealthy estates. That savings will begin when the property is transferred into the trust. The property is valued for gift tax purposes at the time of the transfer. The IRS will treat the transfer as a gift of the remainder interest — essentially fair market value of the property less the value of the interest you retain that allows you to continue to live on the property. The value of your retained interest is calculated according to the length of the term and certain interest rates (the Applicable Federal Rate) published by the IRS for use in determining present value. (See IRC Section 7520).

As the calculation goes, the longer the term, the higher the value of your retained interest, and the lower the value of the remainder to the beneficiaries. This would suggest that the longer the term of the California qualified personal residence trust, the lower the value of the remainder interest and the resulting gift tax.

You Will Be Required to File a Gift Tax Return for the Transfer

A California qualified personal residence trust can provide a significant savings to your estate in another way. If you die during the term of the trust, the property will:

  • Revert to your estate,
  • Be administered accordingly, and
  • Be subject estate taxes.

If, however, the trust term expires before you die, the property will not become part of your estate because title will already have passed to the beneficiaries.

An Example

Barry wants to leave the family home to his daughter Vanessa. He sets up a California qualified personal residence trust to last for a term of 25 years. He also names Vanessa the beneficiary and transfers the family home into the trust. Barry retains the right to live in the home during the 25-year term. Because the term is long, the gift tax calculation places a higher value on Barry’s retained interest. It also places a lower value on Vanessa’s remainder interest. The tax is based on the lower-value remainder interest. Therefore, Barry will realize a significant gift tax savings over what he would have paid had he given Vanessa the family home outright.

After Barry’s property is transferred to his California qualified personal residence trust, one of two things will happen. Either Barry will die during the term of the trust or he will survive past the term of the trust. The tax consequences for these two situations can be significantly different.

  1. Barry dies before the trust term ends. If Barry does not survive 25 years, the property will revert to his estate upon his death and will be subject to estate taxes.
  2. Barry survives the trust. If 25 years pass and the term of the trust expires, the property will be transferred from the trust to Vanessa. The transaction will incur no new gift tax obligation. When Barry eventually dies, the property does not become a part of his estate because he no longer owns it. It already passed to Vanessa. Therefore, no estate tax will be due.

Additional Issues to Consider

A California qualified personal residence trust can provide a significant tax savings under the right conditions. Many variables can influence whether a QPRT is the right vehicle for you. We will carefully study your personal circumstances to evaluate the tax benefits and consequences of a California qualified personal residence trust. Some of these variables include:

  • Alternatives to an irrevocable trust
  • The potential cost of the loss of an asset that someone could sell or mortgage
  • Whether the property will be within the reach of creditors
  • Whether the trust can sell the property
  • The potential loss of living arrangement when the property passes to the beneficiary
  • The effect of an increase in property value on capital gains
  • The administration and cost of maintaining the trust including annual tax returns
  • Property tax issues
  • Conditions that can disqualify the trust

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