A Qualified Personal Residence Trust (“QPRT”) is a powerful estate planning tool that allows individuals to transfer a personal residence or vacation home to beneficiaries at a reduced gift tax cost while retaining the right to live in the residence for a specified term. Popular among high-net-worth individuals, the QPRT leverages interest rate assumptions to produce valuation discounts for federal gift tax purposes. However, the strategy requires careful planning and comes with some trade-offs.

Legal Foundation of QPRTs

QPRTs are authorized under Treasury Regulation § 25.2702-5(c), which provides an exception to the general rule of IRC § 2702 that values retained interests in certain trusts at zero for gift tax purposes when transferred to family members. When structured properly, a QPRT qualifies for favorable gift tax treatment, allowing the donor to retain a “qualified interest” in the form of a right to live in the residence for a fixed term of years.

Key Components of a QPRT

To qualify under § 2702 and Treas. Reg. § 25.2702-5(c), a QPRT must:

• Hold only one residence (a principal residence or one other personal residence).

• Provide the grantor a right to occupy the residence rent-free during the trust term.

• Terminate the grantor’s interest after the fixed term, at which point the remainder interest passes to the beneficiaries (typically children) or a continuing trust.

• Prohibit sales of the residence to the grantor or grantor’s spouse.

At the end of the term, if the grantor survives, the residence passes to the beneficiaries, often significantly reducing the taxable estate.

Gift Tax Consequences and Valuation Method

The transfer of a residence to a QPRT is a taxable gift of the remainder interest to the remainder beneficiaries. However, the value of that gift is discounted because the grantor retains the right to live in the residence during the QPRT term.

Under IRC § 7520, the value of the retained interest is calculated using the IRS’s Section 7520 interest rate in effect for the month of transfer. The value of the gift is computed as follows:

Value of Gift = Fair Market Value of Residence – Present Value of Retained Interest

For example, using IRS tables and a 7520 rate of 4.6%, a 10-year QPRT for a $1 million residence by a 65-year-old grantor might result in a taxable gift of only $400,000 or less.

If the grantor dies during the QPRT term, the full value of the residence is included in the grantor’s gross estate under IRC § 2036(a), negating the estate tax benefits. However, if the grantor survives the term, the value of the residence is removed from the estate, achieving the tax-planning goal.

Pros of Using a QPRT

• Gift Tax Efficiency: Reduces the taxable value of a residence gifted to heirs by discounting the value of the remainder interest.

• Retained Use: Allows the grantor to live in the home rent-free during the QPRT term.

• Estate Tax Reduction: Removes the future appreciation of the residence from the grantor’s estate, potentially saving significant estate taxes.

• Leverage of Unified Credit: Particularly effective when the federal gift and estate tax exemption is high, allowing for greater transfer at reduced gift tax cost.

Cons and Potential Pitfalls

• Mortality Risk: If the grantor dies during the QPRT term, the residence is pulled back into the estate under IRC § 2036, defeating the estate tax benefits.

• Loss of Control: After the term ends, the grantor must either vacate the home or lease it back at fair market rent, creating an additional expense and complexity.

• No Step-Up in Basis: Because the residence is a completed gift, the beneficiaries do not receive a step-up in basis at the grantor’s death, potentially increasing capital gains taxes upon sale.

• Limited Use Property: The strategy applies only to personal residences (primary or secondary), not to investment properties or business real estate.

Ideal Candidates for a QPRT

• Individuals with a large estate and a high-value residence who expect to outlive the trust term.

• Clients seeking to reduce future estate tax liability while continuing to reside in their home.

• Those who have used other gifting strategies and are looking to optimize remaining lifetime exemption.

Important Considerations and Alternatives 

QPRTs should be integrated into a broader estate plan, considering alternatives such as grantor retained annuity trusts (GRATs), intentionally defective grantor trusts (IDGTs), or outright gifting strategies depending on the client’s needs and risk tolerance.

In addition, post-term occupancy arrangements must be structured carefully to avoid IRS scrutiny. The grantor should enter into a bona fide lease with the remainder beneficiaries and pay fair market rent to avoid implied retained interest issues under IRC § 2036 and Estate of Maxwell v. Commissioner, 3 F.3d 591 (2d Cir. 1993).

Conclusion

A Qualified Personal Residence Trust can be a highly effective estate planning strategy when used properly. While it offers gift and estate tax savings, it carries some mortality and liquidity risks. Clients considering a QPRT must evaluate their life expectancy, the need for continued use of the property, and the long-term goals for family wealth transfer.

Professional guidance is critical to ensure proper trust drafting, IRS compliance, and integration into the overall estate plan.  For more information on how to structure an estate plan that meets your individual goals and objectives contact attorney Jim Hickmon, Board Certified Specialist in Estate Planning and Probate Law and Certified Financial Planner â, at 704-248-6325 or email us at info@charlotteestatelawyer.com