Personal Residence Trust & Qualified Personal Residence Trust
A Personal Residence Trust (PRT) is a term we apply to a trust intended to hold property and apply restrictions, which protect it against possible loss. This type of trust is designed to be ignored for tax purposes so that no tax issues are created and the tax benefits are preserved. There are many different formats and strategies which can be used for creating this type of trust, depending upon the particular circumstances of the case.
One popular technique is to provide in the PRT that your children or other family members take ownership of the house after a certain number of years. The trust reserves your right to live there for a period of time—perhaps ten or twenty years. In addition to powerful asset protection advantages, this arrangement, depending on the exact terms, may provide excellent estate tax benefits by freezing the value of the house at its current amount and removing it from your taxable estate. This estate planning strategy is known as a “Qualified Personal Residence Trust” (QPRT) and is specifically sanctioned under Section 2702 (b) of the Internal Revenue Code. The period of years and the important terms can be modified or tailored to meet most circumstances.
Sometimes we reverse this arrangement if the circumstances are appropriate. Rather than reserving a right to live there for a period of years, the PRT can provide that the home belongs to the trust but can be leased back to you for a period of years. Although you would pay rent to the trust, the usual tax benefits would apply because of the Grantor Trust rules. At the end of the term of the lease, full ownership could be returned to you or passed to your children. It can go either way, depending upon your view of any future potential liability you may have.
In a slightly different vein, the PRT could be provided with an option to purchase or a right to exercise some other authority over the property within the trust. As an illustration, rather than a recommendation, assume your home is worth $1 million with a loan of $500,000. A Personal Residence Trust is created, which grants the trust an option to purchase the property for the loan amount, any time within the next fifteen years. The option agreement is recorded and acts the same as a lien on the property. The equity in the home cannot be seized by a successful plaintiff, since the home itself is subject to the option to purchase for the $500,000 amount. Under this arrangement you can live in the house without restriction and subject only to whatever terms are provided in the option agreement. There are a number of issues that must be addressed in this type of strategy, but this illustration gives you an idea of the direction that planning can be taken.