Not only is it important to review your estate plan for probate purposes on a regular basis and to consider any new additions to your family, the acquisition or disposition of property, or the loss of a loved one, it is equally important to consider the current fiscal climate when evaluating new and re-evaluating existing estate planning opportunities.

Those of our readers who have recently secured a mortgage or refinanced their homes may have noticed that interest rates are rising. Although this obviously makes borrowing more expensive, it also brings about new estate planning opportunities.

Rising interest rates, in particular, make two estate planning strategies very attractive: the qualified personal residence trust (“QPRT”) and the charitable remainder trust (“CRT”). This article will focus on QPRTs and we will highlight the benefits of rising interest rates on CRTs in a future newsletter issue. By way of background, the IRS utilizes interest rates to determine the present value of assets placed in a trust. The benchmark is the applicable federal rate (“AFR”) which is tied to the prevailing Federal Reserve interest rate which generally changes each month.

A personal residence or second home/vacation home is often the most valuable and highly appreciated asset in your estate. A QPRT allows the property owner to move that home into a trust but still retain a proprietary use of the residence for a preset number of years. When the trust period finally ends, the home is passed on to the trust beneficiary. When the property owner creates the QPRT, he or she has made a present taxable gift to the beneficiary. But the taxable value of the gift is reduced by the owner’s right to continue using the residence through the life of the trust. The present value of the gift is determined by the prevailing AFR at the time when the trust is established and by the length of the trust. The higher the interest rate and the longer the term of the trust, the lower the present value of the gift.

For example, suppose a 65-year-old grandmother has a $1,000,000 vacation home. If she were to put that home into a QPRT for a 10 year term at a time when the AFR was 4.6 percent, the IRS would determine the value of the final gift to her heirs to be worth $483,000. If the prevailing AFR was 6.5 percent, then the present value of the final gift to her heirs is reduced to approximately $400,000. In that case, Grandma has an additional $83,000 to use toward her $1,000,000 lifetime gift tax credit. In addition, the value of the house is locked for gift tax purposes. Therefore, any appreciation in the value of the house after it is transferred to the QPRT is not subject to gift tax.

The problem is that, for the QPRT to be worthwhile, Grandma must outlive the QPRT. If she dies before the QPRT terminates, the full value of the house is included in her estate. Effectively, it is as if no gift had been made. On the other hand, in the event she outlives the QPRT and wants to continue using the house after the trust concludes, she can simply rent it from the heirs.

If you own your residence or a vacation home, a properly drafted and executed qualified personal residence trust may eliminate federal estate tax and minimize federal gift tax on that asset as described above. We welcome the opportunity to discuss how this estate planning technique might apply to your situation, and assist with any probate issues you may have.

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