How a QPRT Can Help Reduce Estate Tax

October 16, 2023
Qualified Personal Residential Trusts (QPRTs) can be effective estate planning tools that may help you pay fewer gift and estate taxes when passing on a house to your heirs.

At the end of 2025, the lifetime gift and estate tax exemption—currently $12.92 million per individual—is scheduled to be cut in half when portions of the 2017 Tax Cuts and Jobs Act expire. As a result, many more estates may face federal estate taxes. This is especially true for homeowners in high-cost areas, where rising home values could push their estates into taxable territory.

One solution to this potential problem is a Qualified Personal Residence Trust (QPRT), which lets you transfer your personal residence to an irrevocable trust that grants you the right to live in the house for a specified number of years before passing it to your beneficiaries.

"By transferring the asset now, you not only remove the current value of the house and any future appreciation from your estate, but you can also transfer it to your heirs with a reduced gift tax burden," says Austin Jarvis, director of estate, trust, and high-net-worth tax at the Schwab Center for Financial Research.

That's because your trust lawyer first calculates the value of your time in the house under the terms of the trust—a.k.a. your retained interest. He or she then subtracts that amount from the house's fair market value at the time of the transfer to the trust to determine the remainder interest, or reportable gift tax value.

Consider Mary, a 50-year-old widow with a $3 million home she transfers to a QPRT with a 20-year occupancy term. The remainder interest in the home—which is calculated using the home's assessed value, the trust's term, Mary's age, and the prevailing Section 7520 interest rate1—is $1,137,122, which she deducts from her lifetime gift and estate tax exemption. After 20 years, the home passes to Mary's son with no further gift or estate tax obligation—no matter how much it may have appreciated in the meantime.

Some caveats:

  1. You no longer own the house: Once your designated trust term ends, you legally lose access. However, you may rent the residence from your beneficiary at fair market value, which would help transfer additional assets to your heirs without affecting your annual gift exclusion.
  2. You must outlive the trust term: A QPRT is a "bet-to-live" strategy, meaning you must survive the trust term for it to be legally binding. If not, the property is returned to the taxable estate.
  3. You could face higher property taxes: Depending on where you live, transferring your property to a QPRT could nullify any state and local property tax exemptions, meaning you would be responsible for potentially higher property taxes during the trust's term.
  4. Your heir won't receive a step-up in cost basis: If the beneficiary sells the home after the trust term ends, any gains will be calculated using the home's fair market value at the time of the trust's creation. In Mary's son's case, if the home were worth $5 million when he decides to sell, he'd owe taxes on the $2 million gain.

"QPRTs are complex and not without risks, so it's best to discuss your situation and goals with an experienced CPA or estate-planning attorney," Austin adds.

1The Section 7520 interest rate is set monthly by the IRS and used to value gifts for tax purposes.

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The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

This information does not constitute and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, or investment manager.

Charles Schwab & Co., Inc. ("Schwab"), is affiliated with Charles Schwab Trust Company ("CSTC"), the corporate trustee for Schwab Personal Trust Services ("SPTS").

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