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Short Term QPRT

Steven M. Chamberlain

Gainesville, Florida

April 25, 2002

Estate planning regarding Florida homesteads is often a difficult problem because of the Florida law requirement that if the decedent is survived by a spouse or minor child, the homestead must pass as a life estate to the surviving spouse with the remainder to the decedent’s descendants. [1]   Most clients simply do not want their homestead to pass in that fashion.  The fundamental problem cannot be solved via a transfer of the homestead to a revocable trust. [2]

Accordingly, whenever the Florida restriction on devise of homestead may apply and there is a desire to control the passage of the homestead on death, as a practical matter Florida law almost forces the estate planner to recommend the gifting of a remainder interest in the homestead to an irrevocable trust. [3]   But unless the gift is incomplete for gift tax purposes or the homestead is held in a trust which meets the technical requirements of the regulations under IRC §2702 (i.e., a QPRT, discussed below), the taxable gift in such case equals the entire value of the homestead without reduction for the value of the interest retained by the donor. [4]

QPRT’s in General

The qualified personal residence trust (QPRT) is a well-known and often used estate planning device.  The purpose of the QPRT is to achieve a valuation discount for a gift of the owner’s homestead or another personal residence or both.  Usually the gift is made to a trust in which the donor retains a possessory right to the residence for a term of years, after which the residence either continues to be held in trust for the benefit of other family members or title shifts to such donees. [5]

From a gift tax perspective, the benefit of a QPRT is that the gift is measured by subtracting the value of what the grantor retained from the value of the gifted interests in the residence, all measured at the time of the transfer to the QPRT. [6]   If the Grantor survives the term, title shifts to the remainderman without additional gift tax.  If the Grantor fails to survive the term, the net effect is essentially the same as what would have happened if the QPRT had not been established in the first place. [7]   Since there is no “downside” if the Grantor fails to survive the term, the technique fits into the category of “heads I win, tails we’re even.” [8]

The Remainder Interest

The above discussion is well-known and noncontroversial in the estate planning community.  The difficulties arise on planning for the remainder interest.

The primary question is how the grantor can continue to reside in the residence after the term expires.  The usual answer is that the residence can be rented to the grantor.  Since losing control is not particularly palatable to many clients, many estate planners recommend naming a trust for the benefit of the children (or other beneficiaries [9] ) as the remainderman – and with careful drafting, there is no reason why the grantor(s) could not be the trustee(s) of the remainder trust. [10]

The benefits of such an approach are quite impressive.  Since the remainder trust can easily be drafted to be a grantor trust for income tax purposes, [11] the grantor could continue to be considered as the owner of the residence for income tax purposes (but without being treated as the owner for estate and gift tax purposes.)  This means that a lease of the residence by the grantor as tenant would be considered as a lease by the owner to himself, a nonevent.  Thus the grantor can lease the residence from the trust after the term expires without adverse income tax consequences, and can also still have the same mortgage interest and ad valorem deductions as before, as well as qualify for the exclusion from gain on sale. [12]

The Short-Term QPRT

Suppose the QPRT is for only two years, instead of the typical ten to fifteen year period.  Besides the real-world effects (discussed below), there are two obvious tax effects.  The first is that the remainder interest, and thus the taxable gift on formation, is much larger.  For example, with a $1 million residence, the remainder interest with a two year QPRT would have a value of $867,430, [13] as compared to the $391,270 value of a twelve year QPRT.   The second obvious effect is that the risk that the grantor will die during the term (and thus that the transfer tax benefits will be lost) is much less. [14]   Thus, one effect is good, and one is bad.  Obviously, one has to “crunch” the numbers to see if such a tradeoff makes sense.

Assume (i) 60 year old spouses own a $1 million residence with no mortgage [15] , (ii) they divide their interests into an equal tenancy in common without rights of survivorship so as to achieve a 20% valuation discount, (iii) they each transfer their half interest to a separate QPRT with a twelve year term [16] ,  (iv) the §7520 interest rate is 6%, and (v) each spouse retains a reversionary right if he or she dies during the term. [17]   The combined value of the gifted remainder interests is only $313,016. [18]   If they each survive the term and the residence is worth $2 million at that time (i.e., the residence appreciates at 6% per year compounded annually [19] ), the net gift tax effect is the transfer of a $2 million asset for a gift tax value of $313,016. 

Now assume that each spouse sets up a two year QPRT instead.  The sum of the taxable gifts would be $694,944, which represents a reduction of only $105,056 from the $800,000 discounted value of the residence.  The $694,944 of combined taxable gifts with two two year QPRT’s is $381,928 larger than the $313,016 of combined taxable gifts if the grantors had set up two twelve year QPRT’s.   Is the “price” worth paying?

Assume each spouse survives the two year term and that both half interests pass to the same trust for the benefit of their children.  Assume further that the fair monthly rental value is 1% of the value of the residence, adjusted annually, the value of the residence increases 6% annually and the rental receipts are invested at a 6% compounded rate. [20]  

The net effect is that the remainder trust would not only have the residence, but would also have over $2.35 million in other assets (assuming no trust distributions.)  The additional $2.35 million in the remainder trust arrived at a gift tax “cost” of reporting only $381,928 more taxable gifts up front as compared to using twelve year QPRT’s.  The grantors also avoided the risk of including the residence in their gross estates during the additional ten year lease period.

For comparison purposes, if the grantors had established two twelve year QPRT’s and made additional taxable gifts of $381,928 up front to the remainder trust and if such gifted funds earned 6% compounded annually, the gifted funds would have roughly doubled to $768,000, as compared to the $2.35 million with the two year QPRT and the ten year lease. [21]

The obvious risk is that the IRS would successfully assert that the rent paid exceeded the fair rental value and that the excess is thus a taxable gift.  If the grantor does not disclose the issue on a gift tax return, the issue would presumably only arise in the context of an estate tax audit.  If properly disclosed on a gift tax return, however, the tax risk would be limited to the excess rent paid during the three year statute of limitations.  Either way, the gift tax liability would reduce the gross estate.  The net transfer tax result would be preferable to having paid a lower rent. [22]

The Loss of Basis Problem

From a global tax perspective, the only “downside” risk from use of the QPRT device is the loss of a step-up in basis of the residence on the death of the Grantor if the residence is not included in the Grantor’s gross estate. [23]   As is often the case, that risk can be controlled once the problem is properly identified. 

For QPRT’s established before May 16, 1996 the grantor can  simply purchase the residence from the remainder trust.  That solution eliminates the benefits of the lease arrangement, but the proceeds can be invested. [24]   

QPRT’s established on or after May 16, 1996 must provide that the residence may not be sold or transferred directly or indirectly to the grantor, the grantor’s spouse or an entity controlled by either during the QPRT term or any time thereafter in which the controlled entity is a grantor trust. [25]

Taking a closer look at the regulation reveals a loophole. [26]   If the remainder trust is not a grantor trust at the time of the transfer from the QPRT, then the remainder trust need not prohibit sales to the grantor of the QPRT.  A nongrantor remainder trust can easily be designed to convert to grantor trust status shortly after receiving the residence. [27]  

The Real World

All of the real world problems with the short-term QPRT concept stem from the fact that the grantor must pay the rent (or mortgage payments) for a longer term. [28]   Whether this makes economic sense depends on the rest of the grantor’s estate plan.

A useful way to think of the short-term QPRT combined with a longer term lease (or purchase money mortgage) is that the rent (or interest) payments are analogous to an increase in the available annual exclusions.  To see this, consider that many well-crafted gifting programs involve the annual transfer of funds to an irrevocable trust for the benefit of the grantor’s children coupled with the use of withdrawal powers and “Crummey” letters.  The rent (or interest) payments to the remainder trust accomplish the same results without the withdrawal powers.  The difference between the gifting program and the rent (or interest) payments is that the gifting program is voluntary and the rent (or interest) payments are mandatory.


A QPRT is a device to transfer a remainder interest in a residence in an efficient manner from a gift tax perspective.  If the grantor dies while holding the term interest, the technique yields no tax benefit.  On the other hand, extending the term interest lowers the value of the remainder interest, and hence the taxable gift on formation.  In setting the length of the QPRT term many estate planners engage in a macabre balancing act of guessing when the client will die.

The balancing act is often not the optimal strategy.  Where the goal is to shift as much as possible to the ultimate donees free of transfer tax and without losing control over the gifts, the combination of a short-term QPRT with a long-term lease from a remainder trust which is a grantor trust is often far superior to the long-term QPRT, especially where the clients are already using or contemplating an aggressive gifting program.

[1] Fla. Stat. §732.4015(1).

[2] Fla. Stat. §732.4015(2).

[3] Article X, §4(c) of the Florida Constitution provides that the homestead may be alienated by “mortgage, sale or gift”.  Accordingly, care should be taken that the transfer be considered as a gift for purposes of Florida law in order to avoid an argument that the transfer to the trust was not valid. 

[4] The rules of IRC chapter 14 generally require the gift of a remainder interest to be measured as the full value of the property if the donee is related to the donor.  That is, if the beneficiaries are not related to the grantor, then the pre-chapter 14 rules apply and meeting the technical requirements of a QPRT would not be necessary.

[5] To be qualified as a QPRT, the trust instrument must provide that if the trust ceases to qualify as a QPRT (e.g., via cessation of use as the grantor’s residence or sale of the residence and failure to reinvest the proceeds in a replacement residence within two years) the trust assets will be distributed to the term holder or the trust will convert to a GRAT.  (Treas. Reg. 25.2702-5(c)(8).)

[6] Accordingly, it is possible to have a “zeroed-out QPRT” by the grantor retaining not only the right to possess the residence for the QPRT term, but also the  right to receive the original value of the gift at the end of the QPRT term.  Together the retained rights equal the value of the property transferred, reducing the taxable gift to zero.  The benefit of the arrangement is that the appreciation passes to the beneficiary free of gift tax.  The technique may be attractive for a client who has already used up his or her exemption equivalent.

[7] Regulation §25.2702-6.

[8] Splitting gifts under IRC §2513 would often reduce the gift tax exposure.  However, if the grantor dies during the QPRT term, the split gift may result in higher estate taxes than if the gift had not been split.  The problem is that the spouse’s adjusted taxable gifts are not reduced by the gift included in the grantor’s gross estate.  Accordingly, it is generally preferable to avoid split gifts on contributions to a QPRT. 

If the election to split gifts is made, IRC §2013(a)(2) requires all gifts made during the year to be split.  To avoid that outcome, the spouse could be given a beneficial interest in the remainder trust.  The split gift election does not apply to the extent the gift may benefit the spouse.  (IRC §2513(a)(1).

[9] If only one spouse owns the residence, the other could be a beneficiary of the remainder trust.

[10] A key is to use ascertainable standards per IRC §2041 to avoid holding a power which would invoke inclusion under IRC §§2036 or 2038.

[11] Cf., IRC §671, et. seq.  The grantor of a grantor trust is treated as owning all of the trust assets and income.  The trust is thus a “disregarded entity” and all transactions between the grantor and the trust are ignored for federal income tax purposes. 

[12] IRC §121 allows up to $250,000 of gain to be excluded from income ($500,000 on a joint return.)

[13] While beyond the scope of this article, where the residence(s) involved have values well in excess of the available exemption equivalents (IRC §2010), one should consider using short-term QPRT’s for smaller partial interests in the residence.  One could even consider combining the short-term QPRT’s with income-tax-free installment sales to the remainder trust of the remaining partial interests. The rent could be used to make the installment  payments.  Where valuation risks are a concern (e.g., due to aggressive discounting of the partial interests), a GRAT may be preferable to an installment sale. 

[14] The risk of inclusion with a longer-term QPRT can be reduced by a post-contribution sale of the grantor’s retained interest to another person.  The technique works especially well if the sale is to the grantor’s spouse.  If the grantor survives three years after the sale, the residence will not be included in his or her gross estate.  (IRC §§2035(d) and 2036.)

[15] A mortgage complicates the administration of the QPRT because each payment is an additional taxable gift of a portion of the principal.  Payments properly attributable to an income interest, such as ad valorem taxes and repairs, can be made by the term holder without gift taxation.

[16] Cf., PLR 200121015.

[17] The reversionary right not only reduces the up front gift, but it also assists in marital deduction planning, if desired.

[18] No annual exclusions would be available because the gift is of a future interest.  (A Crummey clause would be inconsistent with the QPRT requirements.)  

[19] Applying the “rule of 72’s”, which is a rough indicator of how many years it takes to double an investment at a compounded interest rate.  E.g., 4 years at 18%, 8 years at 9%.

[20] Note that the grantors would be liable for any income taxes generated by such growth. The initial rent would be $11,236 per month and the monthly rent payment during the tenth year of the lease would be $18,868.

[21] Also for comparison purposes, if the monthly rent were only 0.75% of the value of the residence, instead of 1%, the balance in the remainder trust would have only been about $1.76 million – but that would still have been 229% larger than the $768,000 which would have been in the trust if the plan had been to use 12 year QPRT’s with an up front gift to the remainder trust of the difference in taxable gifts between the twelve and two year QPRT’s.

[22] See, Pennell, “Economics of Prepaying Wealth Transfer Taxes”, So. Fed. Tax Inst., 1998.

[23] IRC §§1014 and 1015.  Note that this risk is higher with the short-term QPRT than with the long-term QPRT because the residence is brought back into the grantor’s gross estate if the grantor dies during the QPRT term.

[24] If the purchase price is paid via an installment note, interest – to the extent thereof – replaces the lost rent. If the interest is substantially less than the rent, then there is an obvious conflict between making the purchase and retaining the benefits of the lease arrangement, in which event the ideal time for the grantor to purchase the residence from the trust would be immediately prior to his or her death.

[25] Regulation §25.2702-5(c)(9).  The regulations go on to provide that although a transfer to another grantor trust of the grantor or the grantor’s spouse is considered a sale or transfer to the grantor or the grantor’s spouse for purposes of the direct or indirect restrictions on sale or transfer, a transfer to a grantor trust of the grantor or grantor’s spouse without consideration on or after expiration of the QPRT pursuant to the express terms of the governing instrument will not be considered a sale or transfer to the grantor or grantor’s spouse if such other grantor trust prohibits the sale or transfer of the residence to the grantor or the grantor’s spouse or an entity controlled by either of them.

[26] The regulation may also be invalid as outside the scope of the statute.

[27] Even if a consequence of the transfer was that the QPRT was not qualified (and thus that the gift had to be valued as a transfer without a retained interest), in many short-term QPRT cases the reporting of an additional gift would be a reasonable price to pay in order to achieve the beneficial tax consequences of both a short-term QPRT and a step up in basis.  Note that rental income would be taxable during the period the remainder trust was not a grantor trust.

[28] Florida’s $25,000 ad valorem homestead exemption (worth, say, $700 per year) can continue to be available while the grantor is paying rent if he or she retains a small interest in the homestead as a tenant in common.  Beneficiaries facing a 50% marginal estate tax rate may consider such a strategy penny wise and pound foolish.  The minimum reduction in rent would be $3,000 per year (i.e., 1% per month x 12 months x $25,000 = $3,000.)

©2002 Steven M. Chamberlain, Esq. All rights reserved. Republication with attribution is permitted.