Alan concentrates his practice in Estate Planning, Estate Administration, Elder Law, Estate and Trust Litigation, and Taxation. After receiving his B.A. in International Relations in 1996, Alan spent a year in Ehingen, Germany teaching conversational English. Upon returning to the States, he attended Thomas M. Cooley Law School where he was Assistant Editor of the Law Review and a legal intern at the Sixty Plus, Inc. Elder Law Clinic.
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With less than 5 months remaining in 2012, we have had many clients take advantage of the current $5,120,000 exemption from federal estate taxes by engaging in some form of lifetime gifting. We have helped clients to establish Family Limited Partnerships (FLPs), Grantor Retained Annuity Trusts (GRATs), and Intentionally Defective Grantor Trusts (IDGTs). In many cases, multiple strategies have been combined to provide the client with additional planning benefits, including the potential for even greater estate tax savings.
Although the above strategies are excellent ways to take advantage of the current planning opportunity, we have also been encouraging our clients to consider using Qualified Personal Residence Trusts (QPRTs). For those not familiar with a QPRT, it is simply the transfer of a personal residence to a trust, wherein the donor retains a right to reside and use the residence for a term of years. At the expiration of the term, the real estate passes to the trust beneficiaries or is held in further trust for them. The QPRT provides for an initial discount on the gift because of the donor’s retained right to live there and it also allows any appreciation in the value of the property to move out of the donor’s estate tax free. However, when discussing the QPRT strategy with fellow estate planners, CPAs, financial advisors, and in some cases, even the clients themselves, the strategy is often dismissed out of hand, on account of the low interest rate environment we are in. The stock response I usually get is… “QPRTs work better in high interest rate environments.” In many ways, the low interest rates have caused the QPRT to be forgotten. But it should not be.
While it is true that low interest rates decrease the value of the retained interest (right to live in the property for a term of years), which increases the value of the gift, there are a few factors currently in play which mitigate the higher gift value assigned to the transfer. The primary factor is the depressed real estate values. Most of our clients’ primary residences are located in Bucks and Montgomery counties, the Philadelphia suburbs, Princeton, New Jersey, and the Saucon and Center Valley areas to the north. Their vacation residences are often located in Florida or at the Jersey Shore. These locations are very desirable places to live and vacation, yet such properties are being appraised at 25%-50% below market values from just a few years ago. While we do not have a crystal ball, we feel such properties have the potential to increase in value, with such appreciation outside of the Donor’s estate. This would likely make up for the smaller discount attributable to the current low rates.
Another major factor in favor of using a QPRT, even in this low interest rate environment, is the current $5,120,000 lifetime exemption from federal estate tax. This unprecedented exemption makes the smaller discount on the gift less problematic than in prior years when the exemption was substantially lower. In my experience, the donor often does not feel as compelled to drive down the value of the gift given the larger exemption the donor currently has to work with.
Finally, gifts of fractional interests in real property allow for discounting of the gifts to the QPRT. Assuming clients don’t mind the added complication and cost associated with gifting fractional interests to two separate QPRTs, the transfer of fractional interests adds value to the trust.
Similar to a GRAT, a donor who transfers real property to a QPRT must survive the QPRT term for the strategy to work. However, like a GRAT, a QPRT is as close as you can get to a no lose proposition in that, if the donor does not survive the term, the donor is in no worse position than if the donor had done nothing, except of course for the legal fees incurred to implement the strategy.
One advantage the QPRT has over the GRAT or the FLP is that the strategy has not been under attack in recent years, and if done properly will be a safe harbor. Additionally, some clients feel more comfortable gifting an asset that is not generating income, which is the case with most personal residences. The retained right to live at and use the residence for a number of years also provides a measure of security not found with outright gifts. Finally, upon the end of the term, the QPRT will usually provide that the donor may lease the residence from the QPRT or the trust remainder beneficiaries. This provides another mechanism to move additional assets out of the donor’s estate (via rent) without using any gift tax exemption.
These are exciting times for estate planning, but the current opportunities may not be available on Jan 1, 2013. Some have even described the situation as the perfect storm, and in many respect it certainly is. So please carefully consider the use of GRATs, FLPs, and IDGTs, before year end, but don’t forget the QPRT.