QRPT Qualified Personal Residence Trust...Q-Bert is a 1980's Video Game

I am lucky enough to have parents that own a vacation home on the Jersey shore…no, it is not like the MTV show. From time-to-time, I have been able to use their vacation home for New Year’s Eve parties with my friends. Over the years, the parties have transformed from a rowdy up-all-night group of 20-somethings that ended with people sleeping on couches, or the floor, to a group of three or four families with their children trying to stay up thirty minutes after the ball drops in Times Square. Without my parent’s vacation home, I am not sure what would have filled those memories. Many others have comparable memories about vacationing at their parent’s beach house, ski cabin or country cottage.

With most assets, the question becomes what legal steps are available to protect a vacation home within a person’s estate. In this case, a special trust called a qualified personal residence trust (“QPRT”) can be created. A QPRT can be used for any type of residence, after meeting certain guidelines, but, normally is created to ensure a vacation home is not lost to estate taxes, competing priorities, or family squabbles.

A QPRT is sometimes referred to as way to give your home away but still live in it. In legalese, a QPRT takes advantage of certain tax provisions to allow a gift to the QPRT by its creator (the “grantor”) of the personal residence, usually for the ultimate benefit of children, at a “discounted” value. The theory is that the present value of the right to receive something in the future, e.g. the value today of the right to receive $1 in 5 years, is less than the value of the right to receive it now. It is simply a way of transferring a residence to another party (usually children) at a reduced transfer tax cost. As with all estate plans, there are some requirements along with several advantages and disadvantages in creating a QPRT.

The basic procedures of a QPRT are fairly simple. An irrevocable trust is created, and the grantor transfers ownership rights in the residence into the trust. The grantor retains the right to live in the home rent-free for a period of time. If the grantor lives to the end of the specified period, the house (including all post-gift appreciation) passes to the named beneficiaries free of any additional federal or state estate or gift taxes. If the grantor dies before the end of the period, the house will be included in the grantor’s estate for estate tax purposes. But in most cases, the grantor is no worse off than if the grantor had done nothing.

The major advantage of the QPRT is the reduction in estate and gift taxes on the property. The transfer of the residence to the trust is subject to gift tax and will consume part of a person’s $ 1 million lifetime gift tax exemption. However, the taxable gift will be significantly less than the value of the property, since the taxable gift is only a percentage of the value of property transferred to the QPRT because of the discount value applied. The discount value is determined by a number of factors, including your age at the time of the transfer, the length of time you retain the right to occupy the home and the applicable federal rate for the month in which the transfer is made. The applicable federal rate is computed using tables issued by the Internal Revenue Service.

As an example of how a QPRT works, suppose a husband and wife, both age 65, own a primary residence in town and a vacation home at the beach. The vacation home is appraised at $1 million. In 2009, the couple transfers ownership of the beach home to a QPRT. The QPRT has a 10-year term and names the couple’s two children as beneficiaries. Let’s say the current applicable federal discount rate is 6 percent (it changes monthly), the discounted value of the home at the end of the 10-year term, and thus the value of the taxable gift, would be discounted to approximately $526,000 (or $263,000 per spouse). There is no out-of-pocket tax liability due because this figure is below each grantor’s lifetime gift tax exemption of $1 million.

Further, suppose that over the 10-year term of the trust, the $1 million home appreciates in value to $2 million. Therefore, using estate tax exemption in the amount of $526,000, husband and wife have passed a $2 million asset to their heirs. In addition, the couple will not notice any appreciable change in their enjoyment of the property during the term of the trust, or afterward, as long as reasonable rent is paid to the new owners i.e., their children.

The main benefit is the tax savings that an estate can receive if the grantor outlives the QPRT time period. In the above example, the couple has transferred a multi-million dollar asset outside the estate for about a quarter of a million dollars of gift tax credit. Though there is no federal estate tax in the year 2010, I can guarantee there will be a federal estate tax in 2011…though I do not know what the estate tax rate or exemption will look like. Right now, if there are no Congressional changes to the 2011 federal estate tax, federal estate tax will have a $1 million exemption and any estate over $1 million will be taxed at a fifty-five (55) percent tax rate plus a five (5) percent surcharge. Thus, a QPRT holding a home worth $2 million could save a taxable estate $600,000 ($2 million for the property less the $1 million exemption multiplied by the sixty (60) percent tax rate).

There are several other advantages to a QPRT. The first is that the grantor is still able to enjoy the property. The grantor can continue to exercise control of the property by serving as trustee of the trust during the initial term of the trust. Since the grantor is creating an irrevocable trust and the residence would no longer belong to the grantor, the grantor's creditors would not be able to execute a judgment lien on the residence.

One other advantage, assuming the grantor survives the trust time period, is that full control of the properties transfers to the beneficiaries providing another estate tax saving opportunity. Because the grantor no longer has any rights in the QRPT property, the granter must pay the beneficiaries a fair market rent if the grantor wishes to keep living in the QRPT property. Though a grantor might seem disturbed in paying rent for a property the grantor once owned, in the long run it further diminishes a grantor's estate, and estate taxes owed, as rent is considered obligatory and not counted for gift tax purposes.

However, there are a number of disadvantages to a QPRT. The most obvious is that the grantor no longer owns the QRPT property and the grantor's ability to stay in the property is at the whim of the new owners, in most cases, the grantor's children. That is one of the biggest reasons, QRPT's are used for vacation properties and not a grantor's primary home. I would not want to be at a dinner table where Mom and Dad are getting evicted by their children under the children's legal rights as owners of the property. Second, the transfer is irrevocable and can not be stopped once the property is transferred into the QRPT. The other big issue is that the beneficiaries of the QRPT property do not receive a stepped-up tax basis in the property because the transfer to a QRPT freezes the property at its fair value at the time of the transfer. This could mean higher capital gains tax for the beneficiaries when the property is sold. Lastly, family strife could arise as a property is passed down from one owner to potentially several co-owners, each with their own idea on what to do with the property.

There are several other issues to be considered when creating a QPRT. The grantor is on the hook for maintenance, insurance and real estate taxes for the term of the QPRT. A grantor or grantor's spouse are forbidden from purchasing the home at the end of the QPRT term. Also a grantor may sell the home and purchase another home but the new home is still subject to the trust provisions. If a grantor does sell a QPRT property that is a primary residence, the grantor can claim capital gains exemptions if they meet the requirements. A taxpayer may only have two QPRTs and a QPRT can only hold the interest of one home. While QPRTs can be created at any time, the best time to create one is during a time of high interest rates because a grantor gets a better discount value from the IRS reducing the gift tax implications.

With the eventual return of the federal estate tax in 2011, QPRTs will be an excellent way to reduce estate tax liability and to leverage the value of a gift to heirs while ensuring that a beloved property remains in the family. However a QPRT could be a good planning tool at any time.

Basics of Estate Planning: To Trust or not to Trust...that is the Question? - Part III

In the last two months, I have described several factors to consider when transferring their assets into some type of revocable living trust. The third, and last, installment of this series describes the factors when to consider postponing creating a revocable living trust or when not creating one at all is a better decision. While having assets in a living trust will mitigate an in-depth probate administration (regardless of how well an estate plan is draft most estates have small issues to resolve in probate like a newly purchased car), the upfront costs and time expenditures in establishing a living trust might weigh against creating a living trust.

One of the most important factors in determining whether to create a living trust is a person's age. A majority of younger clients do not have the same worries about health - physical or mental - as that of an older person. But how young is young? Well, a person under 30, unless there is some known health issue, is likely too young to consider a trust. Someone under 40, depending on individual medical issues, probably can also hold off on establishing a living trust.

Another important factor, deriving from a person's age, is the time necessary to fund a trust. While an attorney creates the legal documents, it is usually up to the client to transfer assets into a trust. It takes time to re-title a person's real property from the person's name to a living trust or to go to the bank and change the title on a bank account. Many younger people, with work, raising children and other outside activities, may lack the free time in their daily lives to follow through on funding a trust. That may seem harsh, but, I see younger clients draft living trusts and then never following through with funding the trust, but rarely see an older client not take the time to fund a trust.

Another factor is a person's financial situation. A person with minimal wealth likely does not want to pay, nor need to pay, the upfront costs. It costs more to establish a living trust because an attorney needs to draft more documents beyond just a will. The more complex the trust established the more the plan will cost. Why should a person spend X dollars in 2010 for a person to create a trust when it might only cost X plus some percentage many years down the road for person's estate to be administered. If a person has a simple estate, it makes more sense to create a simpler plan that is flexible and then later address creating a living trust, when necessary. It just is an ordinary business decision.

Another factor is the complexity with which a person owns assets. Complexity can be divided into two aspects. The first aspect deals with what type of assets are owned. For example, if a single person only has a basic financial portfolio of accounts like a checking account, a savings account, 401(k)/IRA account, or other types of Paid-on-Death ("POD") account then transferring those assets into a trust makes less sense. As I described in my January NewsletterJanuary Newsletter, POD accounts are not controlled by a person's will or probate court order but by the designation of a beneficiary. POD accounts would be distributed outside of probate, and probate administration's impact on those accounts is limited. The more basic the type of assets a person owns, the less a trust is needed.

The second aspect of complexity is the ownership of assets with another person and what type of ownership relationship exists between the co-owner(s). I could not possibly describe the different ways people own assets with each other, but it can range from the simple ownership of a house, like a husband and wife in tenancy by the entirety, to complex business relationships like an LLC, a corporation, or a partnership that requires thousands of dollars in yearly professional fees to keep in compliance with state and federal regulations. The more basic the relationship, the less need for a trust. For example, if a husband and wife only own a bank account in joint tenancy (see January Newsletter) then ownership of that asset would transfer to the surviving spouse upon the death of the non-surviving spouse. Probate would not impact that transfer because a person's rights in the asset disappear when one of the co-owners die, under the operation of law. Thus, if a couple owns a majority of their assets in some type of joint tenancy, the absolute need for a living trust is reduced. In comparison, if a person's owns several different pieces of real property or business that might require a trustee to step in and run business upon the passing of a business owner a trust of some type would be advised.

In part II, I noted that a more complex family relationship might require establishing a trust to limit family strife. The converse of that is also true. The less complex a family relationship, the less the need for a trust exists. So, if a potential decedent is a single individual and not necessarily worried about what happens to the decedent's estate upon death, a trust might not be needed. Another example of a simple family dynamic is the first marriage for both people, verse, a second or third marriage that has a number of children from previous marriages and the current relationship. However, if there is inherent family animosity, for whatever reason, and it is expected that problems will arise no matter how simple the family arrangement, having court oversight from the onset maybe preferred.

Each of the above factors, on an individual basis, might support delaying or not establishing a living trust, but taken together, those factors might point a person toward creating a trust. Each individual situation is different and a full legal analysis is necessary to determine whether to create a trust or not.

Estate of the Month: Dennis Hopper

The American film industry lost the multi-faceted actor, filmmaker and artist Dennis Hopper in late May. Hopper was well known for playing off-the-wall characters in such esteemed films like Apocalypse Now and Easy Rider. Dennis Hopper’s estate demonstrate the need for reviewing estate plans and making sure an estate plan works with other personal legal documents like a prenuptial agreement. Hopper’s legacy is tragically being tarnished in a bitter divorce dispute that has bled into Hopper’s probate administration.

At the time of his death, Hopper was in a protracted divorce battle with his fifth wife, Victoria Duffy that was filed five months before his death. Hopper had been married to Duffy for over eighteen years and has a seven-year-old child with Duffy. Hopper was also survived by three adult children from his four previous marriages. Now, the unfinished divorce battle will move to probate court where, from all media reports, it is going to get much nastier, as Hopper’s estate and Duffy, battle it out in the courts and in the media.

Ironically, the primary issue the probate court might have to confront is whether Hopper even intended to divorce Duffy. Duffy has two strong arguments supporting her claims to why Hopper might not have wanted a divorce. The first is Hopper’s competency to make legal decisions. At the time of his filing for divorce, Hopper was undergoing extensive treatment for cancer and taking a high dose of painkillers. The high level of drugs in his system to treat the cancer could raise the issue of his competency in filing the divorce. There are also a number of reports saying Hopper had been acting erratically over the last several years, which could impact the validity of a will that Hopper reworked back in the summer of 2009.

The second argument that Duffy will make is undue influence by Hopper’s children, particularly Marin Hopper. Most of the media reports state that Duffy and Marin Hopper did not get along, and there are allegations that Marin would try to cut off Duffy from Hopper’s estate. In fact, the sides are so contentious that Marin Hopper banned Dennis Hopper’s child with Duffy from the funeral. Toward the end of Hopper’s life, Marin Hopper managed his professional career. She was his booking agent. This fact would lend support to a claim of undue influence by Marin Hopper in reworking Hopper’s estate plans and possibly even his divorce. While each state’s elements are slightly different, a claim of undue influence would be found if there was the existence and exertion of such influence that the effect was overpowering the testator’s mind and free will, and that the will would not have been made but for that influence.

The prenuptial agreement will also impact the probate court’s decision. Hopper and Duffy’s prenuptial agreement stated Duffy was entitled to 25 percent of his estate and $250,000 of a $1 million life insurance policy as long as the couple remained married and living together. That seems simple enough, except that Duffy was granted a court order in April to live in a separate house right next to Hopper on his compound. So the question the court will rule on is whether Duffy and Hopper were still “living” together and how that will impact her ability to collect on the prenuptial agreement or as a beneficiary from Hopper’s estate. I have my doubts that Duffy’s “living” argument will work given the imminent plans for divorce and the claim by Hopper that even being close to Duffy was a “threat to [Hopper’s] life.” But, it is California, and stranger things have happened.

What can be taken from this acrimonious dispute is that probate and litigation over Hopper’s estate will result in a long and unsettled estate administration. Further, it is also likely that a good deal of Hopper’s estate will be exhausted by lawyer’s fees. What can also be learned is that a person’s other legal actions, like a prenuptial agreement, can impact how an estate plan is administered. If the two documents do not go hand-in-hand and the parties have a history of discord, litigation will follow.