Personal Residence Protection Trust
PRPT v. QPRT
 An Executive Summary  

PERSONAL RESIDENCE PROTECTION TRUST (“PRPT”)

COMPARED TO THE QUALIFIED PERSONAL RESIDENCE TRUST (“QPRT”)  

What is a QPRT?  A Qualified Personal Residence Trusts (QPRT) is an irrevocable trust in which the client (usually parents) gives a personal residence to the QPRT whose beneficiaries are the client’s family members (usually children) while retaining the right to live in the residence for a period of years. 

What is the purpose of a QPRT.   A QPRT is used to transfer a client’s residence out of his/her estate at a low gift tax value.  Once the QPRT is funded with the client’s residence, the residence and any future appreciation of the residence is excluded from the client’s estate, if the client survives the term of the QPRT. 

How Does the QPRT Work?  During the client’s lifetime, the client transfers their residence to the QPRT. The trustee must allow the client to continue to use the residence rent-free for a fixed number of years specified in the trust instrument (the “fixed term”).  During the fixed term, the client will continue to pay mortgage expenses, real estate taxes, insurance, and expenses for maintenance and repairs, and will continue to deduct mortgage interest and real estate taxes on their individual income tax return.  When the fixed term ends, the residence is distributed to the client’s beneficiaries (children) or remains in further trust for them. After the fixed term ends, the client can continue to use the residence by entering into a lease with the QPRT which will allow the client to live in the residence for as long as they wish.  (If the client leases the residence the client must pay fair market value rent to the QPRT after the fixed term ends in order to keep the residence from being subject to estate tax on the client’s death.) Although the transfer of the residence to the QPRT is a taxable gift, the client is allowed to subtract, from the fair market value of the residence, the value of the client’s right to live rent-free in the residence for the fixed term.  Thus, the amount of the taxable gift will usually be substantially less than the fair market value of the residence.  If the amount of the gift is less than the client’s available exclusion from the gift tax (currently $1,000,000, reduced by amounts allowed for gifts in previous years), no gift tax will be due as a result of the gift to the trust. If the client survives the fixed term of the QPRT, the value of the residence will not be included in the client’s estate for estate tax purposes. A QPRT is an effective way to remove a residence's value from an estate at a greatly reduced gift tax cost.  The above is an over-simplified overview of how a QPRT works for estate planning purposes, but it explains the general concept. 

Asset Protection Features of a QPRT.  There are planners who promote QPRTs as an asset protection vehicle.  Their analysis is that because the clients are giving up title of the residence to the QPRT, the residence is no longer available to the client’s creditors.  There are several flaws in that analysis.  Creditors have at least two avenues of attack against a transfer to a QPRT during the period while the client has the right to live in the residence.   

Attack No. 1.  The transfer of the residence to the QPRT was a fraudulent transfer. In most states, the creditor must make a fraudulent transfer claim within four years of the date of the transfer.  This is a difficult argument for a creditor to make, unless there is evidence that the transfer was made in part for the purpose of creditor protection.  However, one of the factors that determines whether or not a fraudulent conveyance occurred is if the client received adequate consideration in return for the transfer.  The transfer of the residence to the QPRT is a gift by the client, and the client does not receive reasonably equivalent value in return. 

Attack No. 2.  The client’s right to live in the residence is a personal property interest (term of years interest) that is subject to creditor claims.  The creditor can foreclose on the client’s interest and lease the residence to tenants and collect the rents for the remainder of the fixed term.  If a creditor forecloses on the client’s interest to live in the residence, then the tax regulations require the trustee of the QPRT to distribute the residence back to the client or sell the residence and convert it to a qualified annuity interest.  If the trustee sells the residence and converts the residence to a qualified annuity interest, then the remainder interest will be protected and the annuity interest will be subject to the reach of creditors, unless the applicable jurisdiction exempts such annuities from the reach of creditors.  (Missouri and many other states do not exempt annuity payments from creditor claims.)  In either event, the trust will not qualify as QPRT and all estate tax savings will be lost.   

Downsides of a QPRT.  There are at least three potential downsides to a QPRT: 

Not surviving the fixed term.  If the client does not survive the fixed term, then the estate planning fails and the value of the residence and all appreciation will be back in the client’s estate. 

Client loses their residence.  At the end of fixed term the client loses their residence as it is owned by the QPRT.   

Asset protection uncertainty.  As noted above, the transfer to a QPRT may be challengeable as a fraudulent transfer and the parents' right to live in the house is an asset that may be foreclosed upon by creditors. 

The Personal Residence Protection Trust.  A better alternative to the QPRT is the Personal Residence Protection Trust (“PRPT”) which does not attempt to qualify under the IRS guidance relating to QPRTs but which has greater and more certain estate tax and asset protection benefits.  The PRPT does not attempt to qualify under the QPRT tax rules, but instead accomplishes the same objectives as a QPRT and more by the sale of the personal residence to the PRPT which is a specially-drafted irrevocable trust taxed as a grantor trust to the client/residence owner (the income tax consequences of the PRPT are tax neutral.)  The mechanics of how the PRPT is implemented are not set forth in this Executive Summary.  The mechanics are shared with a client or client’s advisor upon the signing of an engagement and/or scope of services letter.  Instead, the comparison of a QPRT with a PRPT is set forth below to demonstrate why the PRPT can be more beneficial to a client than a QPRT. The PRPT compared to the traditional QPRT is shown by the following chart: 

PRPT

 Traditional QPRT
   
Residence is sold to the trust Residence is gifted to the trust
   
Because sale is for fair market value, a fraudulent transfer claim is very difficult if not impossible for creditors to make. Gift is subject to fraudulent transfer claim made within four years of the date of the transfer (each state has its own time limitation)
   
Trust is not self-settled Trust is self-settled, and susceptible to being set aside as a self-settled spendthrift trust at least to the retained interest in most states (not in Missouri).
   
Residence passes outside the clients' estate without regard to any period of the PRPT.   Residence passes outside the clients’ estate only if the client survives the Fixed Term.
   
Avoids risk that residence will be includable in client’s estate because client did not live for a certain period of time.   QPRT fails and residence stays inside the clients’ estate if the client does not live past the Fixed Term
   
Clients may live in the residence without regard to any time period. Clients lose the right to live in the residence past the Fixed Term.
   
Allows for more efficient use of client’s Generation Skipping Tax (“GST”) Exemptions No Use of GST Exemption allowed.
 IRS CIRCULAR 230 DISCLOSURE:  To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in the communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.   

 

 
 
 
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