When planning their estate, many individuals consider setting up some form of trust to avoid family squabbles over assets, particularly the home. To achieve the goal of a smooth transition of assets and maintaining family harmony, most folks choose to set up some form of trust to avoid probate and reduce the amount of time and money executors need to spend in court.
Although many may not realize the significant wealth they have accumulated over the course of their life, the reality can quickly set it when it comes time to pay estate or gift taxes when passing on a home to heirs. After decades of skyrocketing real estate prices, home that were once purchased for several thousand dollars may now be worth millions, depending on the condition of the home and location.
One way for highly wealthy people to pass on their home with as little tax liability to heirs as possible is the creation of a qualified personal residence trust. Just like any type of estate plan, there are benefits and drawbacks to consider and it is strongly advised individuals consult with an experienced estate planning attorney to draw up trusts and wills.
The idea behind a qualified personal residence trust is to create a trust and fund it with the home for a designated period of time after which a beneficiary will take ownership of the property. Homeowners can choose whatever period of time they like for the trust to exist, during which time they can remain in the home and keep ownership.
At the end of the trust term, the home goes to the beneficiary with only a fraction of the property’s tax liability had it been gifted or was subject to state or federal estate taxes. The longer the trust term, the less tax liability the home will be subjected to. This is because the IRS takes the delayed transfer of the home into account when calculating the property’s value.
However, the major drawback to creating a qualified personal residence trust is that if the home’s owner dies before the trust term ends, the property will revert back to a taxable part of the deceased’s estate and need to go through probate. For that reason, homeowners will need to carefully consider the length of the trust term, one that is long enough to reduce tax liability but short enough to see the strategy play out to the betterment of the beneficiaries.