A qualified personal residence trust is a specific type of arrangement used to pass on ownership of a property while minimizing gift tax and avoiding estate tax. It differs from a standard residence trust in that it offers more flexibility in selling on the property. The main downside is that the conditions to qualify for this status are tighter. Using a qualified personal residence trust can also mean the owner is unable to take out a second mortgage.
The general principle of a residence trust is that the homeowner transfers ownership of the property to the trust. When the person dies, the property will not be considered part of his estate. This means no estate tax will be payable on the property by the heirs.
A personal residence trust builds on this concept. It is a form of split interest trust, which does not refer to interest in same way as with a loan, but rather to a legal interest in the property. The split interest means that for a set period, known as the term of the trust, the former owner retains the right to live in the property without paying rent. At the end of the period, the remaining beneficiary or beneficiaries take complete control. This does mean that the original owner cannot refinance using the property as collateral.
As well as removing the estate tax, a personal residence tax will also be assessed at a lower level of gift tax. The gift tax is not assessed on the full value of the property. Instead, it is assessed on the value of the gift to the beneficiaries, which is calculated by a specified formula that includes a discount to take account of the period that the beneficiaries must wait before taking full ownership.
For this form of trust to remain exempt from full gift tax, certain conditions must be met. For a standard personal residence trust, there are three key conditions. First, the trust must only hold one property, and this must be the home of the original owner. Second, the property cannot be sold during the term of the trust. Finally, once this period has ended, the property cannot be sold to the original owner, or the original owner's spouse.
A qualified personal residence trust removes the restriction on selling the property during the trust period. In return, the trust must meet further conditions, such as that if the property is sold, some income must go to the original owner each year for the rest of the term of trust, while no money can go to the beneficiaries until the term of trust is complete. The main disadvantage of a qualified personal residence trust is that if the original owner dies during the trust period, the property will pass to the beneficiaries but estate tax becomes payable on the full value.
