A qualified personal residence trust is a type of irrevocable trust that can be useful if you are exposed to the federal estate tax. Before we examine the details, we should explain the federal transfer tax parameters so that you can determine your level of exposure.
Federal Estate Tax
The federal estate tax carries a credit or exclusion of $5.34 million in 2014. This is the amount that can be transferred free of taxation. There are ongoing adjustments to account for inflation, so this figure may be somewhat higher next year.
We should point out the fact that there is an unlimited marital deduction. You can leave unlimited assets to your spouse free of the federal estate tax. The $5.34 million exclusion applies to asset transfers to people other than your spouse.
The top rate of the estate tax is 40 percent.
In addition to the federal estate tax, there is also a gift tax on the federal level. The estate tax and the gift tax are unified. This $5.34 million exclusion applies to gifts that you give while you are living along with the estate that you are passing on to your heirs.
The gift tax carries the same 40 percent maximum rate.
Qualified Personal Residence Trusts
Now that we have provided the necessary background information, we can look at qualified personal residence trusts. If you are exposed to the estate tax, you could transfer your home at a tax discount if you execute this strategy properly.
You fund the trust with your home, and you name a beneficiary who will assume ownership of the home after the trust term expires. The term of the qualified personal residence trust is called the retained income period.
During the retained income period, you remain in the home as usual. The duration of the period can be five years, 10 years, 15 years, or whatever you choose.
When you convey the home into the trust, you are removing it from your estate for tax purposes. However, you are giving a taxable gift to the beneficiary.
Though you are giving a taxable gift, the taxable value of the gift will be far less than the true fair market value of the home. This is because of the retained income period.
No one would pay full price for the home if they could not move in for 10 or 15 years. The IRS take this into account when the taxable value of the gift is being calculated.
At the end of the term, the beneficiary will assume ownership of the home at a significant tax discount.
The taxable value of the gift is going to be tied to the duration of the retained income period. Longer is better when it comes to tax savings, but there is an important piece of information to consider. If you pass away before the expiration of the retained income period, the strategy fails, and the home goes back into your taxable estate.
Schedule a Free Consultation
If you would like to discuss tax efficiency strategies with a licensed attorney, contact us through this link to schedule a free consultation: Moline IL Estate Planning Attorneys.
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