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Shelter a personal residence from tax

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in Small Business Tax

The generous federal estate tax exemption—$5.49 million in 2017—can shield most estates from the federal estate tax, but some wealthy individuals need extra protection, especially if they own a lavish home.

Strategy: Set up a qualified personal residence trust (QPRT). This allows you to remove your home from your taxable estate with a reduced or no gift tax obligation.

In some cases, a QPRT can save your family hundreds of thousands of tax dollars.

Here’s the whole story: With a QPRT, you create a trust and transfer a home to it, naming yourself as trustee. The place can be your primary residence or a vacation home.

As the grantor, you retain an interest after the transfer to the trust, just like you would with a grantor retained annuity trust (GRAT). Usually, the interest is the ability to live in or use the home for a certain period of time.

Note, however, that unlike GRATs, QPRTs don’t generate a stream of income during the trust term. At the end of the term, the home passes to the trust beneficiaries, usually your children, so you’re making a taxable gift. Because it’s a deferred gift, the taxable gift may be a fraction of the current value, based on the prevailing Section 7520 rate.

Example: You transfer your $1 million home to a QPRT in 2017 at age 60 and retain the right to live there until age 80. If you outlive the trust term, the home passes to your three children.

Assuming a Section 7520 rate of 2.4% (the rate in June 2017), the initial taxable gift is valued at around $361,000. As long as your lifetime gifts don’t exceed the unified $5.49 million estate and gift tax exemption, no federal estate tax will be owed, although a federal gift tax return must be filed. (Caution: There may be state tax consequences.)

If you survive the 20-year term, the residence passes to your children, free of any federal gift or estate tax consequences.

Suppose that the home is worth double its current value at that point. As a result, you’ll have passed a $2 million home to your children at a gift tax cost of a mere $361,000. Because this is a gift of a future interest, the $14,000 annual gift tax exclusion isn’t available.

Tip: This is just a quick overview. Obtain more details from an estate planning pro.

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