In the good old days, a taxpayer that owned a piece of property could sell the remainder interest, retain a term or life estate, and adopt a position that (a) no gift occurs, per the sale of the remainder for fair market value, and (b) at the end of the term interest or the death of the taxpayer, no estate tax applies to the retained term interest or life estate (which expired at death). Section 2702 of the Internal Revenue Code and the Regulations thereunder now impose a gift tax on the establishment of such an arrangement.
A recent private letter ruling effectively allows the old rules to operate in context of the transfer of a personal residence to a qualified personal residence trust (QPRT). Due to the special exception from the operation of Section 2702 to qualified personal residences, the IRS has confirmed that a simultaneous sale of the remainder interest in the residence with the transfer of the residence to a QPRT will not run afoul of Section 2702. So what does this arrangement accomplish?
First, unlike a typical QPRT setup, there is no taxable gift upon establishment (which would usually be measured by the value of the remainder interest in the QPRT).
Second, it allows the use of a life estate in the grantor, and not just a term of years as is typically required to avoid gross estate inclusion for estate tax purposes at the death of the grantor (assuming the grantor survives the term of the trust). Unfortunately, the PLR does not confirm that there is no estate tax exposure to this arrangement (and indeed specifically declines to address that issue), but many believe that Section 2036 would not operate to tax the arrangement since the remainder interest would be sold at fair market value. This is an unresolved issue, with a split of opinion among the federal courts. More conservative planners desiring to avoid Section 2036 exposure can still use the ruling, but in more traditional QPRT manner with a term of years arrangement and with fingers crossed that the grantor outlives the term of years.
Third, it can facilitate the use of one QPRT for a married couple, instead of two separate QPRTs for their respective 1/2 interests.
Note, however, that there will be income tax consequences on the sale of the remainder interest. Also, the buyers will need funds to make the purchase – an existing funded trust for beneficiaries of younger generations than the grantor may be well suited to make such a purchase. Therefore, the transaction may not be viable for all situations.