When we think of asset protection planning, we think of many things….like heading South to Florida or Texas, for example. But most estate planning attorneys do not think of QPRTs for asset protection. Rather, we think of them as a way of getting value out of the estate and down to the children or other beneficiaries at a discount.

However, in a recent newsletter (Asset Protection newsletter #219) on Steve Leimberg’s website (www.leimberservices.com), author Jay Adkisson discusses a bankruptcy case from the Eastern District of New York, In re: Yerushalmi. If you are a subscriber to Leimberg Services, be sure to take a look at the newsletter. (If you wish to subscribe to the service, click here.) (I forwarded the newsletter to the Members of the American Academy of Estate Planning Attorneys, with the kind permission of Steve Leimberg, of course.)

How can one use a Qualified Personal Residence Trust for asset protection? With a QPRT, the grantor contributes their residence into a trust, the QPRT. The QPRT allows the grantor to use the residence as their own during the initial term of the trust, say 10 years, while the remainder goes either outright or in further trust to various beneficiaries, like children, at the end of the initial term of years. The value of the gift is the discounted present value of the remainder interest, using the rate under section 7520. The asset protection benefit comes in because the debtor/grantor only has a right to use the residence for a term of years. This property right is not nearly as marketable as the full bundle of property rights in the home. Not only does this reduce the value of the property rights which can be attached, but it increases the inconvenience to the creditor because the debtor/grantor (and hence the creditor standing in their shoes) cannot force a sale of the home.

As with most asset protection planning, the key to using a QPRT for asset protection is doing it before the creditor problems arise and while the client is still flush with assets. Essentially, in Yerushalmi, the court determined that the QPRT was a valid asset protection device because it had been set up before the debtor/grantor’s creditor issues arose. Therefore, the home which was worth millions was out of reach of the creditors.

If that ship has already sailed and creditors are already knocking at the client’s door, it may be too late to do a QPRT or most other asset protection strategies. There are many cases in which the creditors have been able to pursue claims against the attorney who assisted the debtor with asset protection strategies when the debtor had creditor claims in excess of their assets.

Again, I encourage you to take a look at www.leimbergservices.com. The service is a valuable tool to stay current with commentary in many areas of the law, including asset protection.

Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
www.aaepa.com

In my last two posts, we’ve been looking at James and Susan, married business owners in their late 50’s. James and Susan have a net worth of just under $20 million, and they’ve come to you with some pretty simple estate planning goals: they want to provide first for each other, and then for their two children, Mark, 35, who is married with three children, and Emily, 33, who is a newlywed with no children. Of course, they also want to minimize their overall tax bill as much as possible.

One of the strategies we explored at the Academy Spring Summit that would be particularly useful for a couple such as James and Susan is to establish Qualified Personal Residence Trusts (“QPRTs”) for their primary residence and one secondary residence. If they expect the homes to appreciate significantly, QPRTs may be a great way to move that wealth out of their estates and transfer it to their children in trust.

With a QPRT, an owner gives a residence to the trust while retaining the right to use the property during a term of years. After the term of years, they can retain an option to rent the property from the trust for fair market value rent or the spouse can be given a right to live rent-free. While clients often are not crazy about having to pay rent to live in their own home after the term, this strategy is a great way of removing even more value from their estates.

IRC §2036 provides that if the grantor of the trust dies during the term, the property is included in the grantor’s taxable estate. However, if the grantor survives the term, the property is removed from the taxable estate without further use of applicable exclusion. This can be a powerful way to remove wealth from the grantor’s estate. This is especially powerful when the value of the underlying real estate is depressed in value, as in today’s market.

So, James and Susan can transfer up to two residences into QPRTs and, assuming they outlive the terms designated for the trusts, ownership of the properties will ultimately be transferred to trusts for James and Susan’s children with the following benefits:

• James and Susan can retain the use of the residences
• Because the trusts for the children don’t receive ownership of the properties until the expiration of the specified term of years, the value of the gift to the children is discounted
• Assuming James and Susan survive the term of years specified when the QPRTs are established, the value of the residences are removed from their taxable estates without further use of the applicable estate tax exclusion

Another trick to minimize both the use of applicable exclusion and the mortality risk is doing multiple QPRTs on each residence. For example, James could take his 50% interest in the residence and set up three QPRTs of different terms, let’s say 5-, 10-, and 15-years. Susan could do likewise. If James dies after 8 years and Susan lives 17 years, we would have been successful in removing all of the QPRTs Susan set up and one out of three that James set up. The 10- and 15-year QPRTs which James set up will be included in his estate because he failed to outlive the terms. An additional bonus to fractionalizing the residence with multiple terms is a fractional interest discount. Typically, a fractional interest in real estate would qualify for a valuation deduction of at least 10%. So, 1/4 of a $1 million property would not be worth $250,000, but, rather, would be worth $225,000.

Between the discount inherent in giving only the remainder interest in the QPRT, and the fractional interest discount, this is a very cost-effective way to transfer the asset. Typically, clients may refrain from doing QPRTs because the strategy can use a large amount of applicable exclusion. However, with the new, temporary $5 million applicable exclusion, QPRTs may make more sense than ever.

We also explored other strategies at our conference, including Grantor Retained Annuity Trusts and a sale of the business to the intentionally defective grantor trust.

Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
6050 Santo Rd Ste 240
San Diego, CA 92124
858-453-2128
www.aaepa.com