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VOL. CLXXXV– NO.

11 – INDEX 981 SEPTEMBER 11, 2006 ESTABLISHED 1878

FINANCIAL PLANNING
Eliminating the Home or her estate and only pay gift tax on
the value of the remainder interest, a
fraction of the asset’s then-current

From the Equation value. As a result, any gift tax due on


the transfer will be lower than the
estate tax that would be due on the res-
idence at the grantor’s death.
The primary downside of a tradi-
Sale of remainder interest can save on estate and gift taxes tional QPRT is that in order for a
QPRT to be an effective technique,
By Michael P. Spiro more beneficial— means of removing a the grantor must outlive the term of
taxpayer’s residence from his or her the QPRT. If the grantor dies during

A ccording to a report published


by the U.S. Census Bureau, in
the year 2000, equity in a per-
sonal residence comprised 33.7 percent
of the average net worth of American
estate is via the sale of a remainder
interest in the property.
In a typical QPRT, the grantor of
the QPRT transfers ownership of the
residence to the QPRT, retaining the
the term of the QPRT, the residence
will be included in the grantor’s estate,
and the grantor will have paid both
gift tax and estate tax on it (though a
credit will be allowed for gift tax
families. Since 2000, the real estate right to live in the home, and dispose of already paid). The sale of remainder
boom has continued and the extent to the home by will, for a term of years. interest, if structured using a Personal
which individual net worth is impacted The grantor is treated as making a gift Residence Trust (PRT), allows a tax-
by valuable real estate has increased of the remainder interest in the resi- payer to avoid this issue.
exponentially. As a result, many estate dence equal to the value of the resi- A remainder sale transaction
planners have found that removing the dence less the value of the grantor’s works very similarly to a QPRT with
personal residence from an individual’s retained interest. The transfer to the one important caveat: Rather than
estate is one of the most effective ways QPRT is generally a taxable gift, and making a gift of the remainder interest
to avoid and/or minimize the estate tax. does not qualify for the $12,000 in the residence to a trust, the grantor
One of the most popular means of Annual Exclusion. During the term of sells her remainder interest to the ulti-
removing an individual’s personal resi- the QPRT, the grantor has an unre- mate beneficiaries. The use of a sale
dence from his or her estate, while still stricted right to live in the property. At rather than a gift can eliminate gift tax
allowing him or her to remain living in the termination of the QPRT, the prop- on the transaction. It also allows the
the home, is through a Qualified erty is transferred to the remainder grantor to live in the residence rent-
Personal Residence Trust (QPRT). beneficiaries of the QPRT (usually, the free for the remainder of his or her life
While the QPRT is a valuable tech- grantor’s children). If the grantor of without generating inclusion in his or
nique, another —and possibly even the QPRT does not outlive the term of her estate at death. In a remainder sale,
the QPRT, the residence will be the grantor and the purchaser of the
Spiro is an attorney in the corporate included in the grantor’s estate and its remainder interest enter into a contract
law and taxation practice groups at disposition will be governed by the of sale whereby the remainder interest
Flaster/Greenberg of Cherry Hill. He terms of the grantor’s will. So long as is purchased for a fraction of the total
focuses his practice on providing advice the grantor survives the term of the value of the property, determined
in the areas of taxation, estate planning QPRT, a QPRT allows the grantor to using IRS actuarial life expectancy
and corporate transactions. remove an appreciating asset from his tables. This simple transaction has the

This article is reprinted with permission from the SEPTEMBER 11, 2006 issue of the New Jersey Law Journal. ©2006 ALM Properties, Inc. Further duplication without permission is prohibited. All rights reserved.
2 NEW JERSEY LAW JOURNAL, SEPTEMBER 11, 2006 185 N.J.L.J. 981

following tax benefits: avoided by structuring the contract for are not barred by Section 121. Thus a
For purposes of the estate tax, the sale of the remainder interest as a sale could potentially be structured
property with a retained life interest, PRT. between a grantor and his or her son or
which a grantor transfers during his A PRT is defined as “a trust, the daughter in law that would qualify for
lifetime, is included in his estate for governing instrument of which pro- exclusion under Section 121.
purposes of the federal estate tax. It is hibits the trust from holding, for the Fiduciary/Beneficiary. The use
for this reason that a QPRT is only duration of the term interest, any asset of a PRT raises the question as to
effective where the grantor outlives the other than one residence to be used or whether the sale is between a fiducia-
initial term. However, there is an held for use as a personal residence of ry and beneficiary. However, the
exception to this general rule: a “bona the term holder and qualified proceeds Regulations provide that “a transfer
fide sale for adequate and full consid- thereof.” The PRT must enumerate the of an interest in property with respect
eration.” Traditionally, the IRS had following provisions in the “governing to which there are one or more term
required that the fair market value of instrument”: (i) the personal residence interests is treated as a transfer in
the entire property be paid as the sale of the term holder may not be sold dur- trust.” Thus, a remainder interest sale
price for a remainder interest in order ing the term estate; (ii) any insurance is, by definition, a “transfer in trust,”
to qualify under this “bona fide sale” proceeds received due to damage to, or even if an actual trust is not used.
exception. In 1996, however, the Third involuntary conversion of, the personal Some commentators have advanced
Circuit Court of Appeals held, in residence must be held by the trustee in the notion that because the transfer of
D’Ambrosio v. Commissioner, that the a separate account and reinvested in a a remainder interest meets the defini-
proper way to determine whether there personal residence; (iii) the personal tion of a “transfer in trust,” the “gov-
had been a “bona fide sale for adequate residence may not be sold back to the erning instrument” of a PRT need not
and full consideration” was to “com- term-holder, the term-holder’s spouse actually be a trust instrument, but
pare the value of the remainder trans- or the term-holder’s estate when the rather could be a basic contract of
ferred [rather than the value of the term estate expires; and (iv) the trust sale, which incorporates the “govern-
entire fee-simple interest in the proper- must contain as its only asset the per- ing instrument” provisions of a PRT.
ty] to the value of the consideration sonal residence and the qualified pro- This leaves open the question of
received.” If the values are equal, the ceeds thereof. whether using a nontrust PRT would
property will not be included in the Generally, under Section 121 of actually allow exclusion under
gross estate. Thus, under the the Internal Revenue Code, a taxpayer Section 121 for the sale of a remain-
D’Ambrosio decision, a grantor can may (subject to certain restrictions) der interest. The IRS has not ruled on
(for adequate and full consideration) exclude up to $250,000 in gain from this question. To the extent that the
sell a remainder interest in the proper- the sale of a remainder interest in his or sale of a remainder interest is subject
ty, live in the property for the remain- her personal residence from gross to income tax, tax will be assessed at
der of her life, and not have the proper- income ($500,000 for married couples long-term capital gains rates, which
ty included in her gross estate. filing jointly). This general exclusion are substantially lower than the estate
Section 2702 of the Internal is, however, subject to two substantial tax rate.
Revenue Code provides that unless a hurdles: (i) the exclusion does not Use of a QPRT has tremendous
retained life estate is a “qualified” life apply to sales to family members; and benefits for those homeowners who
estate, the transferor of a remainder (ii) the exclusion does not apply to wish to make gifts of their personal
interest is treated as having made a gift sales between a “fiduciary of a trust residences with minimal gift and
of the entire property to the transferee and a beneficiary of such trust.” Each estate tax consequences. However,
(if the transferee is a member of the of these hurdles, can, however, poten- where the ultimate devisees of the
transferor’s family). Gift tax would tially be overcome: residence have the resources to pur-
therefore be due on the transfer. Family members. A remainder chase a remainder interest, the
However, the regulations provide an interest sale between a parent and child grantor can enjoy similar estate tax
exception from this general rule for will be subject to tax. However, sales benefits without the gift tax conse-
transfers in a “Personal Residence between parents and the spouses of quences and estate tax risk of a
Trust” (PRT). Thus, gift tax can be children (i.e. sons or daughters in law) QPRT. ■