Case — Qualified Personal Residence Trust

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TL Case Summ

THE QUESTION

Does an estate have to include the value of a home transferred to a qualified personal residence trust?

THE DISPUTE

Taxpayer Says: Though the decedent paid no rent after the term of the trust expired, she intended to do so to comply with the tax rules. The value of the home should not be included in the estate.

Internal Revenue Service Says: Because no rental income was paid after the trust terminated, the decedent retained an interest in the home, and the value should be included on the estate return.

THE LAW

From Internal Revenue Code Section 2001(a): Imposes a tax “on the transfer of the taxable estate of every decedent who is a citizen or resident of the United States.”

From Internal Revenue Code Section 2033: “The value of the gross estate shall include the value of all property to the extent of the interest therein of the decedent at the time of his death.”

From Internal Revenue Code Section 2036: Transfers With Retained Life Estate. (a) General Rule.–The value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money’s worth), by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death–(1) the possession or enjoyment of, or the right to the income from, the property, or (2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.

THE CAUSE OF THE DISPUTE

Your estate consists of all assets you have an interest in at the time of your death, including your home. One way to remove the value of your home from your estate is to establish a qualified personal residence trust. These trusts transfer ownership of your home to your heirs via a gift, yet still allow you to live in the home and have control over it during the trust’s existence.

One of the requirements for making sure a qualified personal residence trust stays in compliance with tax law (and meets your goal of escaping estate tax) is that you agree to lease the property from your heirs if you continue to live there at the end of the trust term. Failing to pay rent could indicate you retained a “life estate”, which is an interest in the property. Generally, having this type of interest means the value of your home is included in your estate.

In this case, the taxpayer transferred her home to a qualified personal residence trust three years before she died. She paid gift tax on the transfer, and discussed and understood the requirement of paying rent when the trust terminated.

The trust terminated in April 2003, and the taxpayer died in October of the same year. She did not pay rent during the six months between trust termination and her death, though she did talk about doing so with her attorney, who advised her to have the agreement in place by the end of the year.

The executors of her estate left the value of the home, which was sold a year after her death for $6,820,000, off the estate tax return. They believed that because the decedent always intended to pay the rent, there was no agreement that would imply she intended to retain a “life estate”, which would bring the value of the home into the estate despite the qualified personal residence trust.

The IRS argues an implied agreement can be inferred from the fact that nothing changed after the trust expired. Because the taxpayer continued to live in the residence without executing a lease or paying rent, the value of the home should be included in the estate.

WHAT WOULD YOU DECIDE?

Make your selection, then see “The Court’s Decision” below for a full explanation

For the or for the

THE COURT’S DECISION

Download (PDF, 27KB)

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HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit TaxingLessons.com and HLCarpenter.com.

This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.

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Right answer!
Sorry, wrong answer :(
For the taxpayer. Many factors, e.g., the creation of the trust, the payment of gift tax, the several instances in which decedent agreed to pay rent, all lead us to find that there was no agreement or understanding that decedent would retain an interest in the residence for life without paying rent. There was no understanding, express or implied, at the time of transfer that decedent could occupy the residence rent free. Accordingly, the value of the residence was properly excluded from the gross estate.
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