As part of the continued theme of planning for the inevitable estate tax, a helpful technique is planning through a Qualified Personal Residence Trust.
A QPRT is a trust to which you, as grantor, may transfer your residence and retain the ability to use the residence for a certain term of years. During that term of years, you would continue to pay the expenses of the residence (e.g., mortgage, insurance, and property taxes), and get any available income tax deductions with respect to those payments. At the end of the selected term, the residence would pass by gift in a manner you would provide in the trust instrument.
The advantage of a QPRT is that, for gift tax purposes, you can deduct from the value of the gift the value of your retained use of the residence for the chosen term of years. This will substantially reduce the amount of the gift. The ultimate value of the taxable gift will be based on the term of the trust, your age, and the interest rate (set by the I.R.S.) in effect for the month of the transfer.
After the initial term of the trust has expired, you would no longer have the retained right to reside in the residence, and the residence will pass in trust for the benefit of your spouse. Your spouse can then live in the residence for the remainder of his or her life. Upon the death of your spouse, the home will pass to the remainder beneficiaries as designated in the trust instrument. However, you may rent the property from the beneficiaries at fair market value. A benefit of these rental payments to you and the beneficiaries is that it would further reduce your gross estate without adverse estate or gift tax consequences, although the rent may be taxable income to the trust.
There are, however, some disadvantages to a QPRT. Typically assets transferred on the death of an individual are entitled to a "step-up" in basis to the asset's fair market value on the date of death. The effect of this basis step-up is to eliminate any taxable gain on the property, thereby resulting in substantial income tax savings. This "step-up" is lost if your residence is transferred to a QPRT and you survive the initial retained term. However, if you die during the trust term, the transaction is treated for estate tax purposes as if it had never occurred, thereby removing the potential benefit. In that case, the costs of the transaction would be the cost of setting up the trust and any trust administrative expenses.