I was asked this question by M.C., of Kansas City, MO.:

My mother is asking how she can gift her house away while retaining the right to live there. May this be done?

Dear M.C.:

Yes. Sometimes you may have your cake and eat it too, or in this case, live in it too. In 1990, the Internal Revenue Code, Sec. 2702, created the right to establish a qualified personal residence trust (QPRT).

This is most useful for an individual, or couple, who has amassed significant wealth and wants to keep future appreciation of the personal residence from being taxed in their estate. In addition, you may keep a significant portion of the property's fair market value on the date of the gift, out of the estate. Let's take a look at how this is accomplished.

Based upon age and sex of the donor (grantor) at the time of the gift, as well as the term (number of years) of the trust, the IRS publishes tables which supply a factor for measuring the value of the interest transferred. Part of the property's value is considered an immediate gift and the remainder is considered a retained interest. The longer the term of the trust, the greater the retained interest portion. The gift is immediately taxed (but no tax may be due because of remaining unified credit available). The retained interest isn't taxed as part of your estate if you survive for the term of the trust - typically three to ten years.

The tricky part is for the grantor to survive the term of the trust, no matter how long. The retention of possession or enjoyment of the property means that if they don't, the fair market value of the personal residence at the date of death will be included in the deceased's gross estate. If you don't survive the term of the trust, the IRS has regulations which will try to put you in the position you would have been in, if you had never transferred the residence to the QPRT. Almost like the government is saying to take a chance and if it doesn't work you're not in much worse of a position.

You may only transfer two personal residences to QPRT's; luckily, for a married couple, they may have up to three residences in QPRT's due to the definition of a principal residence. The grantor generally must continue to use the property as a residence. Owning the property free and clear of mortgages is very helpful.

A house, stock in a Co-Op, a condominium, a boat, a mobile home, a time-share, or a similar property may all be acceptable residences as long as they have sleeping space, and cooking and toilet facilities. The size of the surrounding property must be appropriate for residential purposes, based upon the residence's size and location. The same for extra improvements on the property.

You can further reduce the gift portion and thereby increase the retained interest portion, by having a beneficiary pay for part of their interest. In this way, more of the asset passes outside of the gross estate. However, this approach is generally used to make the equities of several beneficiaries equal, such as when one of the beneficiaries is a child of a spouse or a friend of the family.

Under certain circumstances, the grantor may exchange cash equivalent assets for the personal residence and still retain many of the benefits sought by using the QPRT. This is best done in the final year(s) of the trust's term to allow appreciation of the asset to accrue before exchange, thereby excluding such appreciation. This also allows the grantor to continue use and enjoyment of the property beyond the trust term.

Trusts serve many useful purposes. However, the law of Trusts and Estates is a complex area which is constantly changing. Consulting with your legal and tax professional will help to ensure that the trust you establish provides the benefits you intend.