WHO MAKES UP THESE ODD ESTATE TAX LAWS?

Gambling on your life expectancy against the IRS actuary tables, used to standardize the average age of your death, in order to get a huge tax break is the type of legal strategy that really makes you wonder who writes these tax avoidance tools into law.

Are you feeling lucky? Here is a legitimate way to put your residence into a trust, then transfer ownership to your children and earn a great tax advantage for yourself – providing you live long enough.

It is called a Qualified Personal Residence Trust (QPRT). The IRS allows you to bet that you will outlive their actuary tables. Say you are 60 years old. You put your residence (or vacation home) in an irrevocable trust naming your children as final beneficiaries after a term of your choice of years. Let’s say 15 years.

If you live long enough to see your children own your house, you not only get full ownership rights to your house for those 15 years, but a big reduction by the IRS on the gift tax, and the residence is not included in your estate tax upon your death! That means no “carryover” of the cost basis to your heirs. At the end of the 15 year term, the transaction typically results in a “leaseback” to the transferor – that’s you. These lease payments will further decrease the size of the transferor’s estate.

The term of the trust is up to you, but the older you are, and the longer the term of the trust, the bigger the IRS tax credit. In other words you get bonus points if you outlive your predetermined age of death.

If you do not outlive the 15 year term of the trust, the residence is added back into your estate and there is no added benefit. It is simply a lost opportunity and you are out the money for the formation of the trust. However, you can do it for five years also; it will just give you a lesser tax break. But however many years you choose, you must outlive the term.

The QPRT is actually a good deal, but it has to be done for the right reasons. There are many reasons to gift your assets to your heirs, but tax reduction should not be the main one. Too many things can go wrong between the gifting and the afterlife. Once you gift an interest in your home or other property to your children under a QPRT it cannot be undone.

To illustrate such a gift gone awry here is a true scenario. When I became an attorney in 1982 I went to work in an office downtown where there was a much older and respected attorney. Let’s call him Bill. Bill always did his own taxes. He presented himself as having the expertise of a tax specialist, but while I doubt he was a certified specialist, he certainly had the experience.

He was an intimidating attorney and he worked constantly changing various aspects of his large estate plan. His family included two daughters by a previous marriage, and his very lovely, active and friendly wife. He was a multi-millionaire, and as part of the estate plan, he transferred ownership interest in several of his properties to his daughters while he was still alive, with the remainder to go to them after he was gone. Unfortunately, they did not want to wait for their inheritance.

Whatever their interest may have been, and whether it was a QPRT or not, makes no difference. The point is, because they had an ownership interest in the properties, they had the right to sue their father on whatever creative breach or tort an attorney could dream up regarding an interference with their prospective business advantage of their interest gifted to them by their father.

That is exactly what they did, despite the lack of legal credence. As a result, Richard was in litigation against his two daughters for the next two years. His heart was finally broken enough to give in to the emotional stress. He signed over his remaining interest in the properties to his daughters, and they never spoke again for the rest of his life.

That being said, the QPRT is actually a gift from the IRS. Of course your gift deduction would be greatly reduced if you chose a term of years rather then challenge the actuary tables, but that is not the actual advantage of the tax tool for normal Baby Boomers. In fact, the law is not for “normal” Baby Boomers; or is it? The question is, what kind of creative mind was able to get the QPRT into the IRS Code?