If you'll ever be worth $600,001, consider a 'Q-Pert' A way for homeowners to minimize those federal estate taxes

Nation's Housing

January 14, 1996|By Kenneth R. Harney

WASHINGTON -- With the first of millions of American baby boomers hitting the half-century mark in 1996, a little-publicized tax-cutting tool for homeowners is poised to hit the big time.

Welcome to the world of what lawyers and accountants call the "Q-Pert" -- shorthand for its formal tax code designation, "Qualified Personal Residence Trust." Though just as useful to -- homeowners who are now in or nearing their retirement years, QPRTs are expected to turn into one of the baby-boom generation's most popular techniques for minimizing federal estate taxes on real estate assets.

Here's a brief overview of how a QPRT works. As with all personal tax-planning issues, make sure you consult with an experienced professional to determine whether and how the technique applies to your specific situation.

First a baseline point: The whole idea of a QPRT is to reduce the exposure of what's probably your most valuable asset, your residential real estate -- primary home, vacation home or both -- from heavy federal estate taxation.

Since federal law exempts estates valued under $600,000 from taxation, you have no need for a QPRT if you never expect to be above that threshold.

Even if you consider yourself middle-income and definitely not wealthy, the fact that you own a home in the 1990s makes it increasingly likely that your total estate -- the house plus all your other assets -- will exceed that number.

The second thing you need to know is that when you create a QPRT you transfer ownership of your home to a trust, but retain the right to reside in the property rent-free for a fixed term of years chosen by you. If you're 53, for example, and you expect to move out of state when you retire at 67, you could pick a 14-year term for the trust.

At the end of the term, ownership of the property passes tax-free to the beneficiaries you specified when you created the trust -- typically your children. You can continue to live in the property indefinitely if you choose, but you must pay the kids a fair market rent. Or you can buy the property back at fair market value.

Now for the attractive tax-benefit features of a QPRT. Though you are essentially making a gift of your house to the persons you designate, Section 2702 of the tax code allows you to slice a hefty chunk off the valuation of the gift.

Since you're going to continue using the house for an extended period of years -- earning an economic benefit from the property that under IRS rules lowers its ultimate value -- only the "remainder interest" left over in it at the end of the term is considered a taxable gift. That tax gets charged off against your $600,000 estate tax credit.

In the view of Boston tax attorney Ameek Ashok Ponda, the QPRT rules "substantially undervalue" residences placed in trust overvaluing the economic benefit you receive during the period you retain use. Equally important: The rules ignore all appreciation that occurs after the property is placed in the trust.

Ponda provides this hypothetical example to illustrate the benefits. You're 60 years old and you own a $400,000 home. You create a QPRT with a 10-year term.

With the help of a tax professional, you consult IRS interest and mortality tables that apply to such trusts. These allow you to compute the valuation of your "retained" interest versus the "remainder" interest.

Guess what your $400,000 house turns into for QPRT purposes? Would you believe that you get to slash $227,924 off the $400,000 for your 10 years of use, leaving just $172,076 subject to gift tax? And look what happens at the end of the 10-year term. Your children take title, tax-free, to an asset at a fraction of its true market worth. It started out with a value of $400,000, but could be worth $50,000 to $150,000 more, thanks to inflation during the intervening decade.

It's a win-win for you and the kids. Only Uncle Sam -- whose estate tax rates range up to a voracious 55 percent -- walks away with less.

A couple of other QPRT wrinkles you ought to know about:

* The length of the term you choose for the trust is a crucial ingredient in maximizing tax savings. If you die before the term of the trust is up, the property reverts to your estate, where it's subject to full taxation. The name of the game, according to Ponda, is to pick a term that you're likely to survive. For a 60-year-old male in the example above, Ponda says the optimal term computed from mortality and IRS interest tables is no more than 14 years.

* While you're living in the house during the trust term, get tax advice regarding capital improvements you make to the house: If you put in an expensive new kitchen or rec room, you're adding to your gift, and will have to pay tax on it.

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