If the residence ceases to be the term holder's personal residence or the trust otherwise ceases to be a QPRT then, within 30 days of the cessation, the assets must either be distributed back to the term holder or converted to and held in a qualified annuity trust; and

The trust must prohibit the sale of the residence to the grantor, the grantor's spouse, or any entity controlled by the grantor or the grantor's spouse.

What are the tax savings of a QPRT?

The key element in understanding the estate/gift tax benefits of a QPRT, is that the value of donor's retained term interest in the trust is not included in the value of the gift. This is because, a person can not make a gift to himself or herself. Accordingly, when a residence is transferred to a QPRT, the actual gift is only the present value of the remainder interest in the trust. Since the term interest retained by the donor delays or postpones the remainder beneficiaries' enjoyment of the residence by 5, 10, 15 or other fixed term of years, the value of the remainder interest will be significantly less than the current entire value of the residence. While this may seem like a minor distinction, the resulting tax savings are quite significant in comparison to both an outright gift or the transfer of the residence upon death. The reason for this is quite simply the result of a gift from the IRS! That's right, a gift from the IRS.

The IRS tables that must be used to value the QPRT's term and remainder interests presume that the QPRT earns income and distributes that income to the term holder. Therefore, since a personal residence is not an income-producing asset, the IRS tables have a tendency to overstate the true value of the retained term interest. This is great news for taxpayers because, of course, the greater the value of the retained interest, the lesser the value of the remainder interest and the resulting taxable gift.

As previously mentioned, the primary objective of using a QPRT is to remove an appreciating asset from one's taxable estate at a discounted gift transfer value. In order for the residence to be removed from the donor's gross estate, the donor must survive the term interest of the QPRT. Should the donor die during the QPRT's term interest, the residence is included in the donor's gross estate at its fair market value at the time of death. This is the same result that would occur as if the donor never transferred the residence to the QPRT. Therefore, from a tax standpoint there is no downside to transferring your residence to a QPRT. The absolute worst case is that you (your taxable estate) will be in the exact same position had you not used a QPRT and simply died owning the residence.

In establishing a QPRT, the most important decision to be made is selecting the term of years for the QPRT to exist. Remember, for the tax benefits of the QPRT to be realized, the donor must survive the selected term. If not, as stated above, the full date of death value of the residence will be included in the donor's taxable estate. Therefore, if there were no other factors to consider, a taxpayer would probably be inclined to select a short period of time for the QPRT's term interest. However, remember that the shorter the QPRT's term interest, the greater the value of the taxable gift (i.e. the gifted remainder interest in the QPRT). Put another way, “increasing the term interest of the QPRT, while resulting in a smaller taxable gift, will increase the risk that the donor will not survive the term interest causing the residence to be included in the donor's taxable estate.Therefore, as a general rule, it is usually advisable to select a term of years for the QPRT which is several years less than the donor's life expectancy.

Perhaps the best way to truly illustrate the QPRT's tax savings is through an example.

Example:

John is 65 years old, and his wife, Mary, is 62 years old, and they have two children. They own a personal residence that is currently valued at $500,000 (which is an inherently depressed value that is based on the currently poor real estate market) John and Mary reasonably expect that their residence will soon start to appreciate in value at a rate of 4% per year. Based on the IRS life expectancy tables, we assume John’s life expectancy is 18 years, Mary’s life expectancy is 20 years and their joint life expectancy is 24 years. Further, we assume that the estate of the survivor of John and Mary will be subject to a 55% marginal estate tax rate. John and Mary, like most couples, wish to minimize the impact of estate taxes on their estates so that their surviving children (instead of the IRS) will receive more of what they worked a lifetime to accumulate.

Since Mary's life expectancy is longer than John's, we determine that Mary will be the sole donor of the QPRT for an initial term of 15 years (5 years less than Mary's assumed life expectancy. Remember, the goal is for the donor (Mary) to survive the term of the QPRT. After the 15 year term, the QPRT will convert into a continuing trust for John during his remaining life, and upon the surviving spouse’s death, the residence with be distributed out of the trust to their two children.

For federal gift tax purposes, the present value of Mary's retained 15-year term interest in the QPRT is $263,460 (based on the April 2011 IRS Section 7520 rate of 3.0%). Therefore, the resulting value of the gifted remainder interest in the QPRT is reduced to only $236,540 for a personal residence that is currently valued at $500,000. Furthermore, all of the anticipated appreciation of the residence during the 15 year period of the QPRT ($400,000) will not be subject to estate taxes in the surviving spouse’s estate. However, more compelling is the fact that if John and Mary survive their entire 24 year “joint” life expectancy then all the future appreciation ($781,000) will be removed from their taxable estate. In other words, by establishing the QPRT, John and Mary could potentially reduce the value of their combined taxable estate by over $1,015,000 (the value of the appreciated residence at time death of the surviving spouse’s death minus the value of the taxable gift upon formation of QPRT), which will save over $558,000 in estate taxes!

Additional QPRT Benefits

During the term interest of the QPRT you can continue to deduct the QPRT's payment of the residence's real property tax payments, as well as any payments of mortgage interest, for federal income tax purposes.

During the term of the QPRT, a Florida personal residence will continue to qualify for the important “homestead” benefits afforded under Florida law. Namely, Florida’s homestead benefits are: (i) the exemption against a creditor’s forced sale and/or judgment lien, (ii) the ad valorem property tax exemption of up to $50,000, and (iii) the so-called 3% “Save Our Homes Cap” on annual assessments to the homestead for ad valorem property tax purposes.