You've probably heard the chatter regarding tax law changes, and while we don't know what will pass, we do know that current estate tax exemption amounts will sunset in 2026. So if you have a large estate with significant value in your residence or vacation home, it might be time to give your house to the kids!
The current lifetime exemption amount (also known as the unified credit) is at a record high of $11.7 million. That means that you can transfer up to $11.7 million during your lifetime or at death without paying gift or estate tax! Under current tax laws, that amount will be reduced by approximately half beginning in the year 2026. New tax proposals could cut the exemption sooner and maybe even further. Suppose you are reviewing strategies to take advantage of the higher unified credit amount to reduce your federal estate tax. In that case, you might consider establishing a Qualified Personal Residence Trust.
Qualified Personal Residence Trust
A Qualified Personal Residence Trust (QPRT) allows you to transfer your residence or vacation home to the next generation at a gift value that is less than the home's fair market value. Through this transfer, you are removing a highly appreciated asset from your estate.
The QPRT document typically names the property owner as the trustee and the children as the beneficiaries. When ownership of the home is transferred to the trust, the gift is irrevocable and cannot be reversed. However, the parent retains a "life interest" in the house and may continue to live there during the trust term. The term can be for any period but is usually within five to twenty years.
Calculating the Gift Value
At the end of the trust term, the ownership of the residence passes from the trust to the children, and this remainder interest is subject to gift tax. The parent's age, the length of the trust, and the residence's fair market value determine the value of the gift. If you die before the trust term, the home goes back into your estate.
It's important to note that your children will inherit the residence with your income tax basis when the gift is made to the QPRT. Therefore, when the home is sold, capital gains taxes will be owed and calculated on the difference between the home's basis at the time of the gift and the sale price. Therefore, a QPRT is ideal for a home that heirs plan to keep in the family for many generations.
Continue to Live in Residence
You can live in the residence during the trust term. You'll remain responsible for payment of property taxes, maintenance and repairs, and insurance, but qualified expenses may be deducted on your tax return. If you want to continue to live in the property at the end of the trust term, you'll have to pay rent to your kids. On the plus side, paying rent provides another opportunity to transfer wealth to your children!
The House Can Be Sold by the Trust
With the QPRT, you still have the flexibility of downsizing or relocating. If the residence is sold during the trust term, the sale proceeds must be retained by the trust. The funds can be invested in another residence, and you can live in the new residence under the trust's provisions.
If a different residence is not purchased and the funds are invested in securities or other assets, you continue to have a life interest in the asset. Therefore, payment would be made to you by the trust, similar to an annuity payment, to satisfy the life interest provision. At the end of the trust period, the children would own the securities or other assets.
The Qualified Personal Residence Trust provides an opportunity to remove your residence or vacation home from your estate. While not appropriate for everyone, it may be the perfect strategy for you and worthy of a conversation with your attorney or financial planner. Are you ready for your kids to be your landlord?
Schedule a Consultation
We have helped our clients answer these questions and more. If you want a clear understanding of your financial future, and need help making changes to reach your goals, schedule a consultation and we can get started.
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