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Your Vacation Home Can Save You Estate Taxes

Jeffrey W. Clark, CPA, MST
Jeffrey W. Clark, CPA, MST Director, Tax Strategies, Small Business Advisory

Your vacation home can save you estate taxesThe primary residence and vacation homes are among the most valuable assets for families. Accordingly, these homes should be given careful consideration during the estate planning process. One of the more appealing techniques is a Qualified Personal Residence Trust (QPRT). Gifting a vacation home to a QPRT is a fairly common way for grantors to significantly reduce the value of a taxable estate and ultimately pass more assets along to heirs without making drastic lifestyle changes.

How Does it Work?

First, determine the property’s fair market value by obtaining an appraisal from a certified real estate appraiser. The grantor then transfers the title of the home to the QPRT for a term of years. During that term, the grantors continue to use and enjoy the property as they always have. At the end of the term, the home will then pass to the designated beneficiaries who become the new owners. The grantors may still use the vacation home, but are now required to pay fair market rent to the new owners. If the grantor does not survive through the term of the QPRT, the home would be pulled back into the grantor’s taxable estate at its current fair market value. So, it is important that the grantor be expected to outlive the term of the trust.

The Benefits

The utilization of a QPRT has multiple benefits from a gift and estate tax planning perspective. When the property is transferred to the QPRT, the result is deemed to be a taxable gift to the beneficiaries. However, for gift tax valuation purposes the value of the home is not the fair market value at the time of transfer, but rather it is the projected residual value at the end of the term. The longer the term, the greater the discount that may be applied. For gift tax purposes, the value of the gift could be much less than current market value. If the value of the gift is determined to be less than the grantor’s lifetime gift tax exemption amount, the exemption is applied and no cash is needed to pay the gift tax liability at the time of the transfer.

The use of a QPRT will also freeze the value of the home at the time the gift is made, meaning that any future appreciation of the property will happen outside of the grantor’s estate. One downside is that beneficiaries will receive the grantor’s basis in the property and not the stepped-up basis they would receive if the property passed to them through the grantor’s estate. However, given the differential between the current capital gains tax rate and the highest marginal estate tax rate, the tax savings by transferring the property to a QPRT will, in most cases, exceed the benefit of the stepped-up basis.

Terminating the Trust

Upon termination of the trust the property passes outright to the beneficiaries of the trust, usually the grantors’ children. At this point, the grantors can still use the property as they always have. However, they will have to pay the new owners fair market rent. The rental payments usually cover the current expenses of maintaining the property. Additionally, the rental payments allow for funds to be transferred out of the grantor’s estate without utilizing the annual gift tax exclusion. Still, some may not like the idea of renting property they once owned from their children. For this reason, it often makes the most sense to gift a second or vacation home to a QPRT rather than the primary residence. Additionally, practical consideration should be given to the family’s intended future use of a treasured vacation home before transferring it to a trust and ultimately to the children.

Jeffrey W. Clark can be reached at Email or 215.441.4600.

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Jeffrey W. Clark, CPA, MST

Jeffrey W. Clark, CPA, MST

Director, Tax Strategies, Small Business Advisory

Small Business Advisory Specialist

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