IRC §2702 provides that an interest transferred in trust to or for the benefit of a family member is treated as a gift of the entire interest, even if the transferor retains a partial interest. In such case, the taxable gift is equal to the entire value of the property. The GRAT, an exception for retained “qualified interests” which pays an annuity for a term of years based on a fixed percentage of the initial value of trust assets, permits a reduction in the taxable gift to reflect the retained interest. Thus, the taxable gift may be small, especially if a long trust term is chosen and the assumed rate of growth of the assets is high.
Some appreciating assets, such as personal residences, produce no income stream which could fund a GRAT. §2702 thus provides for the QPRT, in which the grantor retains the right to live in a personal residence for a term of years. Like its close cousin, the GRAT, the QPRT results in a taxable gift of only the remainder interest. If the grantor, age 60, retains the right to live in a $1 million personal residence for 20 years, gifting the remainder interest to children, the taxable gift would be only approximately $150,000, versus $1 million for an outright gift. For estates whose assets may exceed the credit provided by §2010, the QPRT becomes attractive.
The QPRT may hold assets other than a residence, but they are strictly circumscribed: the trust may hold appurtenant structures, a reasonable amount of adjacent land, and cash for the immediate payment of trust expenses reasonably expected to be paid within six months, such as mortgage expenses. The trust may also permit improvements to the residence. QPRTs may hold a principal residence or vacation home, or both.
Regs prohibit the grantor from repurchasing the residence from the trust during the trust term. This rule is intended to prevent the grantor from repurchasing the appreciated residence near the end of the trust term, depleting the estate of those funds, and permitting the residence to pass to family members with a stepped-up basis. The grantor may, however, execute a lease at the end of the trust term and continuing to live in the residence. If the residence is sold during the trust term, the QPRT must require distribution of trust assets or conversion to a GRAT.
The QPRTs greatest limitation, one shared with GRATs, is that if the grantor does not survive the trust term, the entire value of the appreciated residence is included in the grantor’s estate pursuant to IRC § 2036. It is said that this result is estate tax neutral, in that the grantor is no worse off than if no QPRT transfer had been made. This holds true only if no other estate planning alternatives would have been considered.
To hedge against the possibility of the grantor’s not surviving the trust term, an irrevocable life insurance trust could purchase a term life insurance policy. If the grantor then died during the trust term, insurance proceeds could pay estate taxes occasioned by inclusion of the residence in the grantor’s estate.