INTERNATIONAL USE OF QPRTs

Qualified personal residence trusts ("QPRTs") are most often used in wholly domestic U.S. estate planning. A QPRT is a trust established to hold a personal residence of the grantor. The grantor retains the rent-free use of the residence for a fixed number of years. At the end of the term, the ownership of the residence passes to other named beneficiaries of the trust.

QPRTs provide a valuable transfer tax benefit. If the grantor survives the term of the trust, the amount of the taxable transfer is limited to the present value of the remainder interest of the trust, established at the time of the trust creation and funding. This means that the portion of the value of the property equal to the number of years of free use by the grantor is transferred free of gift and estate taxes to the other trust beneficiaries. Further, any appreciation in value of the residence during the term is also transferred to the other trust beneficiaries free of U.S. federal transfer taxes.

A recent article (Using a U.S. Qualified Personal Residence Trust in Cross-Border Planning, J.F. Meigs and R.R. Gager, 35 Estate Planning, No. 7, 22 (July 2008)) reminds us that the QPRT can also be used in an international context. For example, U.S. citizens or domiciliaries can fund a QPRT with a residence that is located outside the U.S. - there is no restriction to using domestic real property. The same transfer tax benefits will generally apply for both U.S. and non-U.S. residences. However, since not all foreign jurisdictions recognize the concept of a trust or allow trusts or non-locals to own interests in their real property, this planning may not be available for property in all jurisdictions, at least without additional planning to work around these limitations.

On the other side of the coin, foreign persons for U.S. transfer tax purposes (non-U.S. citizens who are not domiciled in the U.S.) may want to consider the use of QPRT when acquiring a U.S. residence, since such persons are subject to U.S. estate tax at death on their directly owned U.S. real property interests.  However, such persons are at a disadvantage as compared to U.S. persons. When a QPRT is established, a current taxable gift occurs, equal to the discounted present value of the remainder interest (that is, the value of the property, reduced actuarially to account for the fact that the beneficiaries will not receive the property for the term of the trust). For U.S. grantors, this gift is typically absorbed or covered by their $1 million unified credit, so that no current gift tax needs to be paid. Since nonresidents do not have such a unified credit, upon establishment of the QPRT it is likely that a current gift tax will be paid. The nonresident grantor, if he or she survives the term of the QPRT, will still obtain the same overall transfer tax benefits as a U.S. grantor, subject to this advance payment of transfer taxes (which a U.S. grantor would effectively not pay until a later gift, death or may never pay, depending on how the use of his or her unified credit from the lifetime gift at establishment of the QPRT ultimately effects other gift or estate tax obligations from subsequent transfers).

APPLICABLE FEDERAL RATES - JULY 2008 [CORRECTED]

July 2008 Applicable Federal Rates Summary:

SHORT TERM AFR - Semi-annual Compounding - 2.41% (2.07%/June -- 1.63%/May -- 1.84%/April -- 2.24%/March)

MID TERM AFR - Semi-annual Compounding - 3.42% (3.20%/June -- 2.72%/May -- 2.85% /April -- 2.95%/March)

LONG TERM AFR - Semi-annual Compounding - 4.55% (4.46%/June -- 4.17%/May -- 4.35%/April -- 4.23%/March)

DIRECTION OF RATES: Up

LIKE-KIND EXCHANGE PERMITTED WITH PARTNERSHIP INTERESTS

Internal Revenue Code Section 1031 allows taxpayers to swap a business or investment property for a new business or investment property without recognizing gain on the exchange. However, these “like-kind” exchange rules do not apply to exchanges of partnership interests (Code Section 1031(a)(2)(D)).

In a recent private letter ruling, the IRS did allow partnership interests received by a taxpayer in exchange for real property to qualify for like-kind exchange treatment. However, this was not a major departure from existing law.

In the private letter ruling, the taxpayer received 100% of the partnership interests in the partnership. In that situation, the IRS was comfortable in looking through the received partnership and treating the taxpayer as having received the underlying assets of the partnership. Since the underlying partnership-owned property was of like-kind to that exchanged away by the taxpayer, like-kind exchange treatment was allowed. The IRS noted that by acquiring 100% of the partnership interests, the partnership was deemed to have liquidated and distributed its assets to its partners, and thus the acquisition was essentially an acquisition of partnership assets.

Therefore, the effect of the ruling was not to open the door to like-kind exchanges of partnership interests, but simply to acknowledge the pass-through/disregarded entity treatment that arises when 100% of the partnership interests are being transferred. Nonetheless, the ruling is helpful since the IRS is acknowledging such pass-through treatment for Section 1031 purposes.

As with all private letter rulings, the ruling is only binding on the IRS as to the taxpayer that submitted the ruling. Nonetheless, such rulings are typically (but not always) indicative of the IRS’ approach to the subject matters of the ruling.

PLR 200807005