Perfect Time to do Estate Planning for that Vacation Home


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Sometimes in a bad economy, opportunities present themselves.

One great planning opportunity that currently makes a lot of sense is a special trust known as a QPRT (Qualified Personal Residence Trust).

A QPRT is great way to pass on wealth to your heirs in a tax efficient manner and without affecting your more liquid assets.

Here’s generally how it works:

  1. The owner of a property places a personal residence (or vacation home) in trust. The owner can continue to live in and use the property for a set number of years. At the end of the term, the property goes to whomever the owner wants, typically the owner’s child or into another trust for the benefit of the child.
  1. This gift is a legally enforceable promise to make a gift of the property to the child in X years from now. So, if the house is worth $500,000, and you promise to give it to your daughter 7 years from now, it is not really a $500,000 gift due to the time/value of money. The actual amount of the gift depends upon a variety of factors including the age of the donor and the current interest rate.
  1. This plan can produce large estate tax savings. Giving away property while you are alive is an estate planning tax strategy known as an estate freeze. You are giving away property now so that future growth occurs in the estate of your heirs, rather than in your own estate. A QPRT leverages this strategy so that you are combining a discounted gift with an estate freeze.
  • Assume the following hypothetical. A wealthy 70 year old woman (worth $3,500,000) lives in New Jersey and has one adult son. She owns a shore home worth $1,000,000. Now, upon this woman’s death, in New Jersey, she may bequeath $675,000 before having a NJ estate tax. Under current federal law, she can bequeath $3,500,000 before she has a federal estate tax. There is no limit to what she may gift away during life according to NJ, but the federal limit is $1,000,000. After that, there is a federal gift tax.
  • This woman decides to give away her shore home, worth $1,000,000, to her daughter. She structures the transaction so that the term of the QPRT is 7 years. This results in a taxable gift for federal gift tax purposes of $657,300 based upon the woman’s age, the term of the trust and the March 2009 Section 7520 rate. There is no NJ gift tax.
  • Now, let’s fast forward 7 years and 1 day, when the woman passes. I will assume the value of the shore property increased to about $1,300,000 and the rest of her estate only modestly increased from $2.5 Million to $2,700,000. If she had not given anything away, then at the time of her death her estate would have equaled $4,000,000. Assuming that the federal estate tax exemption remains at $3,500,000 and the New Jersey Estate tax exemption remains at $675,000, then her estate would have a combined estate tax liability of approximately $505,400 ($225,000 federal and $280,400 New Jersey). By making this gift via a QPRT, we completely elimiate the federal estate tax and the New Jersey estate tax would be reduced to approximately $155,600 – a savings of $349,800. (To compare with an outright gift of property, the combined estate tax would be $245,600, a savings of only $259,800.)

Traps to be wary of:

  1. Be careful about giving away highly appreciated real estate unless you are quite sure the donees plan to keep it in the family for a long time. This is because the donees receive the gift with a carryover basis and could be subject to a very large capital gains tax upon the sale of the property.
  1. Do not use this technique if the donor is in poor health. Setting up a QPRT is most effective when the donor survives the term of the trust. If the donor does not survive, then the property is included in his gross estate for both federal and state estate tax purposes.
  1. For the same reason as Trap #2, it is best not to set up too long of a term. The longer the term, the greater the risk that the donor will pass. In my opinion, a term longer than 10 years usually produces a risk that outweighs the benefits of obtaining a discount on the gift. This is especially true now that the federal estate tax exemption has increased.
  1. If the donor is married, it is usually best to set up two QPRTs, with the wife giving away her half in one QPRT and the husband giving away his half in the other. This technique increases the chance that at least one person will survive the term.

In conclusion, this is still a great time to do gift planning, but you should consider doing so with assets that are not as liquid.

Note: QPRT calculations done courtesy of Adam Epstein at Bernstein Wealth Management.

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