With the recent distress of the US economy, many of us have seen a significant decline in the value of our assets. With the credit markets tightening and the foreclosure rate on real estate at an all time high, we have seen the value of home prices across the country declining at an alarming rate. However, the current state of the real estate market has presented us with a great opportunity to transfer our home to the next generation with significantly less estate and gift tax implications. 

As with many individuals, your personal residence is one of your highest valued assets. Unfortunately, after you pass on, liquidity issues may cause the next generation to sell off the family residence to meet the cash needs of the estate. Luckily, there is an estate planning technique that allows us to ensure that Grandma's house stays in the family and out of her taxable estate.

This technique is referred to as the Qualified Personal Residence Trust (QPRT) and here is how it works:

Parents transfer the title of their principal residence or vacation home to the trust and retain the right to live in the house for a fixed number of years (known as the QPRT term). At the end of this time period, if the parents are still living, the children, as the remainder beneficiaries, receive the house. The parents can continue to live there, but will have to pay rent at fair market value (another opportunity to transfer cash to their beneficiaries). The value of the house at the time it is transferred into the QPRT is considered a taxable gift to the trust's beneficiaries. However, each individual has the ability to give away $1 million of taxable gifts during their lifetime without any gift tax implications. The QPRT planning technique works best when you utilize that lifetime gift tax exemption when the home is contributed to the trust. The benefit comes in when you consider the current value of the residence in today's market and the likelihood of future appreciation on the real estate along with the discount on the taxable gifting of the house to the QPRT.

For example, if parents own a home worth $500,000 and contribute that home to a QPRT, the taxable gift to the children is discounted based on the term of the QPRT. Let's assume the value of the gift is $350,000.

When all is said and done, the home that is worth $500,000 is transferred to your beneficiaries with a taxable value of $350,000 (discounted because your children cannot use nor have access to the property during the QPRT term). Assuming 4% annual appreciation and a 10 year QPRT term, that home will be worth $740,000. Assuming you pass away in year 10, that $740,000 would have been included in your taxable estate. By utilizing a QPRT, only $350,000 (discounted gift tax value) was transferred for gift tax purposes. The difference ($390,000) was passed onto your beneficiaries, gift and estate tax free!

"But what happens if I pass away during the QPRT term?" Great question and the answer is simple. If the Grantors pass away during the QPRT term, it is basically as if nothing ever happened and the value of the home is included in your estate. Any gift tax you paid when the property was contributed is recovered.

With home values being as low as they are, this may be a great time to consider if a QPRT is the right choice for your family. Many factors will determine whether this planning technique is a good fit. Interest rates, capital gains rates, the makeup of your estate, and the likelihood of appreciation all factor into the equation. Be sure you have at least considered the options with your advisor.

The McKonly & Asbury Private Client Services Group specializes in helping families protect, enhance, and transfer their wealth and values. If you have any questions about the contents of this article or would like to speak to someone about other advanced wealth topics, please email Dan Matarrese at dmatarrese@macpas.com or Grant Curry at gcurry@macpas.com.