Non-Qualified Personal Residence Trust NQPRT

Non-Qualified Personal Residence Trust (NQPRT)

A Qualified Personal Residence Trust (QPRT) is a trust that is typically created by parents for the purpose of transferring their home to a trust for their children.

Potential Estate Tax Advantages of a QPRT

The idea is that the parents make a gift of the home to the trust, but retain the right to live in the trust for some period of years, such as 12 years. The amount of the gift is reduced by the parent's right to live in the house during that period. In the interim, the parents typically will not have to pay rent, but will have to pay for upkeep, etc.

If the parents survive the 12 years, then the house will pass outside the parents' estate at their death for federal estate tax purposes. Probably more importantly, the appreciation of the house during this period will also pass outside the parents' estate at death and no tax at all will have been paid on that appreciation. The parents then lose any right to live in the house and will have to start paying rent to the trustee. Thus, QPRTs are best for parents who anticipate that they are going to sell or pass their home to their children anyway and take up more modest digs, such as a retirement condo.

If the parents do not survive the 12 year period in our example, then the QPRT will have failed and no estate planning advantage would be gained.

This is an over-simplified overview of how a QPRT works for estate planning purposes, but you should get the general concept.

Asset Protection Features of a QPRT

Some planners attempt to sell QPRTs as an asset protection vehicle. The idea is that because the parents are giving up title of the house to the QPRT, the house is no longer available to the parents' creditors. Creditors have at least two avenues of attack against a transfer to a QPRT during the period while the parents may still live in the house:

The transfer of the house to the QPRT was a fraudulent transfer. In most states, the creditor must make a fraudulent transfer claim within four years of the date of the transfer (seven in California in some circumstances). This is a difficult argument for a creditor to make, unless there is evidence that the transfer was made in part for the purpose of creditor protection. But the creditor has a head start since the transfer by the parents to the trust was a gift and not for reasonably equivalent value.
The parents' right to live in the house is a tenancy-for-years, and thus a property asset like any other. The creditor can take over the interest and lease the house out to tenants and collect the rents for the balance of the years that the parents would have lived there. Subject to homestead exemptions in various states, this is an easy argument for a creditor to make.

Barring these scenarios, the QPRT probably does provide some asset protection to the house since after the period it will be held in the trust and not available to the creditors of either the parents or the children.

Downsides of a QPRT

There are at least three potential downsides to a QPRT:

Not surviving the period. If the parents (or whichever one of them is chosen as the measuring life) do not survive the period, then the estate planning fails and the value of the home and all appreciation will be trapped within the estate.

Parents lose their home. At the end of the period, the parents actually lose the house. With many QPRTs, the parents liked the idea at the outset of losing their home to their children's trust, but as they grew older and closer to the end of the period they decided that it wasn't such a hot idea after all, but by that time were stuck and without any rights or abilities to unwind it.

Asset protection uncertainty. As noted above, the transfer to a QPRT may be challengeable as a fraudulent transfer during the first few years, and the parents' right to live in the house is an asset that may be foreclosed upon by creditors.

QPRTs are thus a mixed bag. Some planners really believe in QPRTs, and use them often. Other planners are skeptical that they work and use them either very sparingly or not at all. Put us in the latter category.

The NQPRT

A better alternative to the QPRT is the NQPRT, which does not attempt to qualify under the IRS guidance relating to QPRTs but which has greater and more certain benefits. The NQPRT does not attempt to qualify under the QPRT tax rules, but instead accomplishes the same objectives as a QPRT and more by the sale of the personal residence to a specially-drafted irrevocable trust taxed as a grantor trust to the homeowners.

The NQPRT compared to the traditional QPRT is shown by the following chart:

Non-QPRT		Traditional QPRT
Home is sold to the trust		Home is gifted to the trust
Because sale is for reasonably equivalent value, a fraudulent transfer claim is much more difficult for creditors to make		Gift is subject to fraudulent transfer claim made within four years of the date of the transfer (seven years in California)
Trust is not self-settled		Trust is self-settled, and susceptible to being set aside as a self-settled spendthrift trust at least to the retained interest in most states
House passes outside the parents' estate without regard to any period		House passes outside the parents' estate if they live past the period
House passes outside the parents' estate without regard to any period		QPRT fails and house stays inside the parents' estate if they do not live past the period
Parents' may live in home without regard to period		Parents lose the right to live in the home past the retention period

The Non-QPRT is available to both existing and new clients of the firm. Please contact us for more information.