The qualified personal residence trust, or QPRT,1 has faded in popularity due to declining interest rates (lower interest rates make QPRTs more expensive), stock market losses (which make clients less rich), and the prospect of estate tax repeal (why plan for a tax that's disappearing?). Despite the tarnish, however, the QPRT is still as good as gold, and smart planners continue to offer them to clients who are wealthy enough to consider giving away a personal residence to reduce estate taxes. Here are five points the estate planner must not overlook.

  1. The QPRT is a guaranteed tax bargain.

    A QPRT is an irrevocable trust that holds no assets other than an interest in one personal residence of the trust donor (and certain related assets), and that otherwise complies with the requirements of Treasury Regulation Section 25.2702-5(c).

    When an individual gives his residence to a QPRT, he makes a gift to his descendants, but also holds something back. Specifically, the donor reserves the right to continue to occupy the residence for a certain period of time (the QPRT term). When that term expires, ownership of the residence will pass to the remainder beneficiaries of the trust. Typically, the QPRT also provides that, if the donor dies before the end of the QPRT term, the trust terminates and the residence reverts to the donor's estate. Therefore, the remainder beneficiaries receive the trust property only at the end of the term, and then only if the donor is still living.

    Why would someone make such an odd gift? The structure of our gift tax system makes the QPRT gift a tax bargain for the donor. The donor gets a discount in computing the value of his taxable gift for the interest he retains. If he survives the QPRT term, the entire property is out of his estate — even though he paid gift tax on only a discounted value. If he does not survive the QPRT term, the residence comes back into his estate and the QPRT did not save any taxes; but the taxes in that case are no higher than if the donor had never made the gift at all.2 In other words, the QPRT is a gift-tax bet that the donor can't lose. Either the donor wins or he gets his money back. The QPRT discounts offer a highly tax-efficient way to make use of the client's limited $1 million gift tax exemption.

    The no-lose nature of the QPRT bet is not its only attraction. Unlike the popular family limited partnership technique, which is an invitation to battle with the Internal Revenue Service, the QPRT is a safe-harbor planning device. The IRS created QPRTs and has even issued a sample QPRT trust form.3 Also, unlike such techniques as grantor retained annuity trusts (GRATs) and installment sales to defective trusts, the QPRT does not require, in order to save estate taxes, that the trust property appreciate more rapidly than the IRC Section 7520 rate or at all.

    The prospect of estate tax repeal causes some clients to delay or forego QPRT gifts, but this shows faulty thinking. The estate tax has not been repealed yet4 and may never be; the cost of waiting for Congress's final answer on the estate tax may be substantially higher taxes on an appreciating house that was never put into a QPRT. If the client gives her residence to a QPRT and Congress eventually does repeal the estate tax, the only loss is that the client transferred her residence to her offspring somewhat sooner (during her life) than she might otherwise have done (at death).

    It's true that if the donor dies before the end of the QPRT term, the trust's assets revert to her estate; in effect canceling the trust and producing no estate tax savings. This negative effect can be eliminated, however, by having term insurance on the donor's life. If the donor survives the QPRT term, the QPRT saves estate taxes. If the donor doesn't survive the term, the children receive the insurance proceeds instead of the estate-tax savings.

  2. Don't leave the QPRT remainder to a donor's issue.

    It would be nice if the QPRT could be used to leverage the donor's GST exemption the same way it leverages the donor's gift tax exemption — but it does not work that way. For gift tax purposes, the donor's gift transfer is complete when the residence is transferred to the QPRT.5 The gift tax value is finally established as of that date, and that value is a discounted value because of the donor's retained interests.

    Unfortunately, the donor cannot make the QPRT forever GST tax-exempt, at the time of his gift, by allocating to the trust an amount of his GST tax exemption corresponding to the discounted gift tax value. What's different about QPRTs is the ETIP (estate tax inclusion period) rule. The ETIP is the period during which, if the donor died, the transferred property would still be included in his or his spouse's estate.6 The Internal Revenue Code provides that, for purposes of determining the trust's inclusion ratio, any allocation of GST exemption to such property shall not be made before the close of the estate tax inclusion period.7

    The QPRT property will be included in the donor's gross estate if the donor dies during the QPRT term.8 Thus, a QPRT is subject to the ETIP rule for the entire QPRT term. Any allocation of GST exemption to a QPRT cannot take effect until the end of the QPRT term, at which time the valuation discounts for the donor's retained interests will no longer be available (because those retained interests will have expired) and the value of the residence may have increased.

    Generation assignment using the deceased parent exception9 takes place when the transfer is complete for gift or estate tax purposes. Accordingly, in the case of a gift to a QPRT, generation assignments take place when the QPRT is created, not when the QPRT term expires. Under the deceased parent exception, if a child of the donor is already deceased at the beginning of the QPRT term, the descendants of that child move up a generation. Thus, children of the donor's deceased child will not be skip persons, and later distributions to them will not be generation skipping.

    However, if a child of the donor dies after the commencement of the QPRT, his descendants do not move up a generation. So, the children of a child of the donor who dies after the commencement of the QPRT term are still skip persons. Thus there is a lag between the time generation assignments are irrevocably fixed (at the commencement of the QPRT term) and the time that distributions to the donor's grandchildren (if permitted or required by the trust) could occur (namely, at or after the expiration of the QPRT term).

    This disconnect creates a major vulnerability for any QPRT that uses the most popular form of ultimate wealth distribution (in non-QPRT trusts), which is “to my then-living issue.” If the QPRT simply requires distribution “to my then-living issue” at (or after) expiration of the QPRT term, and a child of the donor has died after the date of the original QPRT gift, there will be a taxable termination, as trust assets flow to the children of the deceased child.

    Because of the ETIP rule and deceased child problem, GST planning for QPRTs normally focuses on avoiding generation skipping altogether. Most QPRT experts use one of the following three approaches to avoid generation skipping:

    • Approach 1: The QPRT remainder passes to a “spray trust” for issue, if a child died during the QPRT term. Under this flexible and tax-efficient approach, the QPRT remainder passes outright to the donor's issue living upon termination of the trust unless that disposition would result in a GST-taxable event (because a child of the donor died after the QPRT was initiated), in which case the trust property stays in a “continuation trust” for two more years. The continuation trust gives the trustee discretion (“spray power”) to distribute income and principal to such persons as the trustee chooses from among the class consisting of the donor's issue. This format allows the trustee, in coordination with the donor and/or the donor's spouse, to use his distribution power to cause each descendant to receive an equal amount of assets. The living children receive equal shares of the terminating QPRT, while the donor or donor's spouse makes compensating gifts to the issue of the deceased child. The compensating gifts are not GST-taxable because of the deceased parent exception.

    • Approach 2: QPRT remainder passes only to living children. Here, the QPRT assets pass only to the donor's living children (that is to say, only to non-skip persons) at the end of the QPRT term, so no GST exemption will need to be allocated to the QPRT. The donor would then plan to make compensating gifts (GST-exempt due to the deceased parent exception) from her other assets to the issue of a child who died after the QPRT began (if that contingency occurred).

    • Approach 3: Force deceased child's share of QPRT remainder into the deceased child's gross estate, to make him the new transferor of that asset for GST purposes. As with the second approach, the goal of this method is to avoid the necessity of allocating GST exemption to any part of the trust. Unlike the second, this approach seeks also to avoid the need to make compensating gifts (from other assets) to the issue of a child who dies during the QPRT term. Under the third approach, if a child of the donor dies after commencement of the QPRT term, leaving issue, the share of the deceased child is left to the deceased child's estate. The theory is that, because the deceased child's share of the QPRT is now includible in his federal gross estate, the deceased child becomes the new transferor of the asset for GST purposes, and thus transfers from him to his children (the donor's grandchildren) are not generation skipping. This theory has yet to be validated by any court or IRS pronouncement that can be cited as authority.

  3. Allow the trust to be severed.

    A QPRT may hold no assets other than one personal residence of the donor. If the residence is sold, the regulation permits the sale proceeds to be reinvested in a replacement residence. To the extent the sale proceeds are not reinvested in a replacement residence within two years, such proceeds must be distributed back to the donor, either in the form of annuity payments or all at once.

    What if the QPRT sells the residence and the donor wants the proceeds reinvested in two separate replacement personal residences?

    • Shirley Example: Shirley contributes the big old family home in Suburbia, Mass., to a 10-year QPRT. In Year 6 of the term, she decides to sell the big old family home for $800,000 and replace it with two new residences, a $450,000 condo in Boston and a $350,000 condo in Sunny, Fla. The QPRT can sell the old house and buy one of the new residences as a replacement, but it cannot buy both of them, due to the requirement in the regulations that the governing instrument of a QPRT must prohibit the trust from holding, for the entire term of the trust, any asset other than one residence.10

      Shirley's dilemma could be avoided by splitting the QPRT, prior to sale of the original residence, into two separate identical trusts, each holding an undivided interest in the original residence. This type of split-up or severance would have to be authorized by the trust instrument, state law, or judicial proceedings. Then the two QPRTs acting together could sell the old residence, and each trust could reinvest its share of the proceeds in a different replacement residence. Including the severance provision in the trust instrument would make this transaction possible without court proceedings, and could also have advantages for generation skipping transfer tax purposes.11

  4. Anticipate donor's holding over after end QPRT term.

    Many a QPRT donor wants to continue to live in the residence after expiration of the QPRT term even though, at that point, the residence belongs to his children (or a trust for their benefit). However, if the donor continues to reside there without paying rent, there's a problem: The residence may be brought back into the donor's gross estate as a gift with retained life interest,12 nullifying the tax-saving purpose of the QPRT.

    If a parent gives his residence to his children, subject to an understanding by all parties at the time of the transfer that the parent would retain the use of the property, and in accordance with this understanding the parent continues to occupy the residence rent-free for the rest of his life, the residence will be included in the parent's gross estate on his death. This is a classic gift-with-retained-life-income-interest, fully includible in the estate.13 Furthermore, if a parent gives his residence to his children, and the parent continues to occupy the residence rent-free, the IRS infers the existence of such an understanding among the parties, even if there is nothing in writing.14

    This imputed-understanding rule applies just as much in the case of a gift of a residence made via a QPRT as it does to an outright gift of a residence. Once the beneficial ownership of the QPRT passes to the donor's children, if the parent-donor is to continue living in the residence, it's essential that the parent-donor pay fair market value rent for his use. This rental arrangement should be established in writing prior to the end of the QPRT term so it is obligatory on the parent-donor the moment the parent's occupancy rights under the QPRT expire.

    However, sometimes clients ignore advice and do not get around to signing that all-important lease. The author has heard of one case in which a QPRT donor died one week after expiration of the QPRT term, which should have meant that the QPRT was a success and the residence was out of the donor's estate. Unfortunately, because the donor had paid no rent for his one-week holdover, the IRS asserted estate inclusion under IRC Section 2036, citing Rev. Rul. 78-409.

    Avoid this potential fight with the IRS by including a provision in the QPRT: “If the donor holds over after expiration of the QPRT term, the donor is deemed to have exercised an option to rent the property at a fair market value rent, and is legally obligated to pay rent for such occupancy regardless of whether a lease has been signed.”

  5. Provide exit strategies.

    Changing circumstances can upset QPRT plans. If the estate tax is repealed, or the client suffers a decline in health or wealth, the client will appreciate a trust design that allows changes to be made.

For example, the trust instrument should not prohibit the donor from transferring his interest. The donor may want to give his remaining interest to the remainder beneficiaries prior to expiration of the QPRT term for any of several reasons: as a hedge in case of the donor's declining health,15 if the estate tax is repealed but the donor believes the repeal is temporary,16 or to reduce vulnerability to the donor's creditors if that becomes a concern.

Similarly, the trust should permit the donor's children (the QPRT remainder beneficiaries) to assign their interests to the donor or the donor's spouse. Such an assignment might become desirable if the estate tax is really, permanently repealed, or if the donor's financial circumstances decline radically. An assignment back to the donor would be a gift by the children (subject to gift tax under present law), but could be a useful safety valve for unforeseen events.

Consider including a provision that allows an independent trustee to amend the trust. The power should not permit any amendment that would cause the trust not to be qualified under the QPRT regulation. Also, (to avoid an IRS assertion that the donor gave away his entire interest in the property, by relinquishing all control) the power should not permit the trustee to diminish the donor's retained interests in the trust without the donor's consent.

The QPRT continues to be an attractive estate tax reducing technique for wealthy families. Thinking through, and drafting for, the various contingencies that can arise during and after the QPRT term will make the QPRT a happier experience for both planner and client.


  1. This article assumes the reader is familiar with QPRTs. For definition, see Treas. Reg. Section 25.2702-5. To learn the basics of QPRTs, see any comprehensive estate planning text, such as Stephan Leimberg et al., The Tools & Techniques of Estate Planning (NU Law Services, National Underwriter Co.), or see Natalie B. Choate, The QPRT Manual (Ataxplan Publications, 2004;, from which this article is excerpted.
  2. See IRC Section 2001(b).
  3. Rev. Proc. 2003-42, 2003-1 C.B. 993. Note that, without tweaking, the IRS form will not work in certain cases (such as when the QPRT is to be funded with a fractional interest in the residence rather than the entire residence, or when part or all of the residence may be rented to others). Also, the IRS form goes beyond the requirement of the QPRT regulation in prohibiting sale (as well as commutation) of the donor's interest. Finally, the IRS form does not deal with the most difficult part of drafting a QPRT, the disposition of the remainder after expiration of the QPRT term. Despite these drawbacks, the IRS form shows that this is a planning technique the IRS endorses rather than challenges.
  4. As of now, the estate tax (but not the gift tax) is scheduled to disappear (it is repealed) effective for deaths in years after 2009. The gift tax stays in effect in 2010, but the rate drops to equal the maximum income tax rate (currently 35 percent). However, the law (EGTRRA) that decreed these rules for 2010, as well as the current rules regarding the gift tax rates and exemption, contains a sunset provision, under which, after 2010, all of EGTRRA's changes are repealed, and, supposedly, the estate tax is reinstated, and the gift tax continues, both with the rates and exemptions that applied prior to the 2001 changes. Thus, supposedly, there will be an estate tax for deaths in 2009 or 2011, but not for deaths in 2010; and the gift tax will apply in every year, but its rates and exemptions will gyrate wildly in the years 2009 to 2011.
  5. Treas. Reg. Section 25.2511-2(b).
  6. IRC Section 2642(f)(3), (4); Treas. Reg. Section 26.2632-1(c)(2).
  7. IRC Section 2642(f)(1).
  8. IRC Section 2036.
  9. IRC Section 2651(e)(1).
  10. Treas. Reg. Section 25.2702-5(c)(5)(i).
  11. IRC Section 2642(a)(3); Prop. Treas. Reg. Section 26.2642-6.
  12. IRC Section 2036.
  13. Rev. Rul. 70-155, 1970-1 C.B. 189.
  14. Rev. Rul. 78-409, 1978-2 C.B. 234. The IRS does not impute such an understanding when the donee is the donor's spouse; it is assumed that the donee would want her spouse to live with her. Therefore, one way for the donor to “retain possession” of the residence after expiration of the QPRT term is to give his spouse a life estate in the residence following the QPRT term. Then, as long as the spouse is living and well disposed towards the donor, she can continue to let him live there with her, rent-free, without triggering adverse estate tax consequences. This is not tax-efficient, because the donor's payment of rent to his children would reduce his future gross estate, while living rent-free with his spouse does not do so.
  15. If the donor dies prior to the end of the QPRT term, the entire property is back in the donor's gross estate under Section 2036. By accelerating the remainder (through a gift or sale of his interest to the remainder beneficiaries), the donor can get the trust property out of his estate immediately (in the case of a sale of the remainder interest; but in that case the sale proceeds are in his gross estate) or within three years (in the case of a gift of the remainder interest; see IRC Section 2035), thus salvaging some of the QPRT's hoped-for tax savings.
  16. Such voluntary acceleration by the donor would itself constitute an (additional) gift to the remainder beneficiaries, and current estate tax repeal provisions do not repeal the gift tax. After the other transfer taxes have been repealed, the gift tax stays in force, with tax rates equal to the federal income tax rates. See IRC Section 2502(a)(2), as effective for years after 2009.