It was announced on May 24, 2011 that new home sales rose for the second month in a row; a fact that startled many economists. Have we reached the bottom? No one can be certain but a device from the estate planners portfolio is getting renewed interest and it is one that Domestic Relations lawyers like because it would appear to insulate family members from “increase in value” claims by spouses who are not part of the family.
The devise is called a Qualified Personal Residence Trust. The purpose from the estate planners viewpoint is to get appreciating residential property out of a person’s estate. Here is how it works.
Mr. and Mrs. Warbucks buy a house in Longport NJ in 1970 for $35,000. To quote Billy Joel, they live in Allentown but spend their weekends at the Jersey shore. Mr. and Mrs. Warbucks are now in their 70s and still enjoy the property but it is mostly a grandchild magnet today. At the height of the market in 2007, the property was worth $3,000,000 and thus had a $2,930,000 capital gain. The Warbucks children would like to keep the property after their parents die and pass it along to other family members.
The game with a QPRT is this. Today, the Longport property would appraise for $2,200,000. If the Warbucks deed the property into a QPRT, they do so at today’s appraised value and they report that as a gift depending on how long they want the trust to last. The key is deciding how long the trust should last because if you guess wrong and the grantors die before the trust term expires, the magic of the tax scheme turns into a pumpkin. But if they are still living when the trust does terminate (typically 5-10 years) any increase in the value of the property is not part of the Warbucks’ taxable estate for federal purposes. At the end of the trust, the property goes to the trust beneficiaries as owners in fee (i.e., complete owners) subject to the right of the grantors to remain in residence for their lives. In a world where prices are rising, this is a very efficient tax device.
This has a useful divorce device as well. Many folks with property like the Warbucks tried to do the same thing by turning the house into a partnership and conveying increasing interests to the next generation each year. This also is tax efficient. Once an interest is conveyed to the child, the increase in the value of the interest belongs not to the older generation but the new partners. But, as we saw in a case a couple of years ago, when the second generation couple split up, the daughter in law of the Warbucks laid claim to an increase in value on the partnership interest. It cost more than $100,000 to buy out the “increase in value” of the partnership interest when the divorce settlement was reached. Did Mr. and Mrs. Warbucks want to give their no good ex daughter in law $100,000 so that their son could settle his divorce case? Of course not. But the claim was made and the claim was real.
With the QPRT a similar result was achieved but because the son of Mr. and Ms. Warbucks never had a “possessory” interest in the trust assets, it is our impression that any increase in value up to the time the trust terminates would be excluded as property subject to equitable distribution. That probably changes when the interest becomes possessory and there is an interesting question as to whether the property is in possession but subject to a life estate by the grantors. The leading case on “increase in value” of trusts is Solomon v. Solomon, 611 A.2d 686 (Pa. Supreme 1992).
In any event, if your family is in the range of paying federal estate taxes and you have folks with very highly appreciated property, the QPRT is a device worth speaking to an estate planning attorney about. Because if prices do begin to rise again, this device has a means of seeing the fruit grow in the estate of a new generation.