A qualified personal residence trust is an estate planning device that can potentially provide estate tax efficiency if own valuable real property. Before we examine the value of qualified personal residence trusts, we will provide some information about the estate tax parameters.
We will also look at the federal gift tax, because it is relevant when you are talking about qualified personal residence trusts.
Taxes on Asset Transfers
The federal estate tax looms over the horizon if you have been very successful from a financial standpoint.
There is an estate tax credit or exclusion. This is the amount that you can transfer before the estate tax would kick in. Anything that you want to transfer that exceeds this amount would be subject to the death levy and its 40 percent maximum rate.
For the remainder of the 2016 calendar year, the exact amount of the federal estate tax credit is $5.45 million. This figure may sound a bit odd, but there is a logical rationale behind it.
A $5 million exclusion was established for 2011. Each year there are adjustments to account for inflation. This is where the $5.45 million figure is coming from. Next year it may be somewhat higher after another inflation adjustment is applied.
When you hear about the estate tax, you may get a logical idea: you can just give away your assets to your children while you are living to avoid the estate tax. People used to do that way back in the day before the gift tax was enacted.
There is a federal gift tax that closes this loophole, and it is unified with the estate tax. As a result of this unification, the $5.45 million exclusion that we have in 2014 applies to large gifts that you give along with the value of your estate.
To be clear, there is just one exclusion that encompasses both lifetime gifts and your estate. If you give away $5.45 million tax-free while you are living using your unified lifetime exclusion, there would be nothing left to apply to your estate.
Qualified Personal Residence Trusts
Now that you have the necessary background information, we can move on to an explanation of qualified personal residence trusts.
Your home is probably your most valuable asset, and you can reduce its taxable value if you place it into a qualified personal residence trust.
When you create the trust you name a beneficiary who will assume ownership of the home after the trust term expires. You decide on the length of the term, and you can remain in the home as usual during this interim. The term of the trust is called the retained income period.
The act of conveying the home into the trust is going to remove it from your estate for tax purposes. However, that’s not the end of the story, because you are giving a taxable gift to the beneficiary.
Ultimately, the transfer will be taxed at a significant discount because of the retained income period.
You are retaining interest while you remain in the home. If you wanted to sell the home to a neutral buyer with the stipulation that he could not assume ownership for 15 years, you could not get full market value.
This is the principle is used by the Internal Revenue Service to determine the taxable value of the gift.
In the end, the tax savings will be considerable when the beneficiary assumes ownership of the home after the retained income period expires.
There is an important fact to take into consideration when you are setting the duration of the retained income period. If you die before the term expires, the property goes back into your taxable estate.
Longer is better from a tax perspective, but you do have to consider your anticipated longevity.
Taxation Can Impact Your Legacy
We have looked at one particular estate tax efficiency strategy in this brief blog post. A qualified personal residence trust can be useful for wide range of people who are exposed to the tax, but other possibilities exist.
Plus, here in the state of New Jersey we have another looming threat to contend with. There is a state-level estate tax in the Garden State, and the exclusion is much lower than the federal exclusion. In fact, the New Jersey exclusion is the lowest state-level exclusion in the country at just $675,000.
Action is required if your estate is going to be exposed to taxation. If you would like to discuss your situation with a licensed estate planning attorney, give us a call at (908) 222-8803 or send us a message through our contact page to set up an appointment.
Alan Augulis, Estate Planning Attorney
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