The past two years sent wealth managers on a volatile ride, as all manner of client wealth was decimated in some fashion. Equity markets have since made an enviable comeback, with government-sponsored stimulus and loose monetary policy leading to an optimistic bid-up of shares. But, as summer 2010 comes to a close, there continues to be plenty of concern regarding economic growth and the sustainability of the resurgence. And to be convinced that the few positive indicators represent a recovery, you would have to be wearing your rosiest-colored glasses.
One sector of the economy at the forefront of the downfall was real estate. Viewed by many economists as the primary reason for the credit crisis, it is now seen by others as the glimmer of hope in the move toward recovery. The recent annual increase of 3.6% in the S&P/Case-Schiller Home Price Index, for example, has given optimists a reason to cheer (though many observers have dismissed the number as a product of the government’s recently expired tax-credit program).
Where the real estate market will go from here is difficult, if not impossible, to predict. Still, some markets around the U.S. have indeed seen considerable price increases when compared with those of the same period last year. If we are in fact experiencing a price rebound, how can clients who own real estate take advantage of that good news from the wealth transfer perspective?
What is a qualified personal residence trust (QPRT)?
A QPRT is an irrevocable trust funded by a homeowner’s interest in the residence. The homeowner transfers title of the home to the trustee of the QPRT while retaining the right to reside in the house throughout the trust’s term of years. At the end of the trust term, the house passes to the QPRT beneficiaries (commonly the homeowner’s children).
Implementation of a QPRT may provide a homeowner with significant wealth transfer tax savings because the initial title transfer is considered a gift to the beneficiaries of the irrevocable trust. Although all of the interest in the home is transferred to the QPRT, the value of the gift is reduced because of the homeowner’s retained interest to live in the home during the trust term. The longer the homeowner retains a right to live in the home (i.e., the term of the QPRT), the bigger the reduction of the gift tax valuation at transfer.
Further, any appreciation in the home’s value from the date of transfer to the QPRT is removed from the homeowner’s taxable estate. It should be noted, however, that, if the homeowner fails to survive the term of the QPRT, the home will be included in the homeowner’s taxable estate—as if the QPRT had never been implemented. This possibility is a significant consideration when determining the length of the trust term.