You Could Potentially Reduce Your Exposure to the Federal Estate Tax Through the Creation of a Legal Device

Called a Qualified Personal Residence Trust

WHAT IS A QUALIFIED PERSONAL RESIDENCE TRUSTININDIANAPOLIS?

PAUL A. KRAFT Indiana Estate Planning Attorney

What is a Qualified Personal Residence Trust in Indianapolis? www.FrankKraft.com 2

If you are exposed to the federal estate tax, you must take action to gain estate tax efficiency. You could potentially reduce the burden through the creation of a legal device called a qualified personal residence trust. Before we get into the details, let's look at the federal transfer tax parameters

so that you can determine your level of exposure.

ESTATE TAX EXCLUSION

Everyone is not exposed to the federal estate tax, because there is a federal estate tax credit or exclusion. A $5 million exclusion was installed for the 2011 tax year. This base has been retained since then, but there have been annual adjustments to account for inflation. After a series of inflation adjustments, the exact amount of the federal estate

tax exclusion in 2014 is $5.34 million. It is likely that this figure will be somewhat higher in 2015 after yet another inflation adjustment is applied. Estate tax efficiency is important if you are exposed to the estate tax, because the rate of the tax is quite high. The maximum rate is 40 percent at the present time, and this can significantly impact your financial legacy.

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FEDERAL GIFT TAX

In addition to the federal estate tax, there is also a federal gift tax. If there was no gift tax in place, people could simply give lifetime gifts to avoid the death

tax. The federal gift tax and the federal estate tax are unified. In other words, the

parameters encompass asset transfers in general, regardless of when the transfers take place.

This $5.34 million exclusion is a unified exclusion, and it applies to lifetime asset transfers along with the value of the estate that you are passing on to your heirs. The 40

percent maximum rate also applies to the gift tax. To clarify through a simple example, if you give $5.34 million in tax-free lifetime gifts using your

unified exclusion, the entirety of your estate would potentially be subject to the estate tax.

Estate tax efficiency is important if you are exposed to the estate tax, because the rate of the tax is quite high. The maximum rate is 40 percent at the present

time, and this can significantly impact your financial legacy.

QUALIFIED PERSONAL RESIDENCE TRUSTS

Now that you understand the lay of the land with regard to transfer taxes, we can explain the value of qualified personal residence trusts.

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Your home may well be your most valuable asset. If you could reduce its taxable value, you could gain a great deal of transfer tax efficiency. A qualified personal residence trust can facilitate the transfer of the property to a beneficiary at a significant tax discount.

To implement this strategy, you fund the trust with your home, and you name a beneficiary. The beneficiary would assume ownership of the home after the

term of the trust expires. When you fund the trust with your home, you are removing it from your estate for estate tax purposes. This sounds great, but unfortunately, you are giving a taxable gift to the beneficiary. You can remain in the home as usual for a period of time that you determine when you are creating the trust agreement. This is referred to as the retained income period. The beneficiary does not assume ownership of the home until after the retained income period has expired.

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When the Internal Revenue Service is calculating the taxable value of the gift, the retained income period is taken into consideration. Because you are remaining in the home for a number of years, the taxable

value of the gift is going to be considerably less than the true market value of the home. You could not sell the home to a neutral buyer at full market value under the stipulation that the buyer could not

assume ownership for 10 or 15 years. This is the rationale behind the reduced

tax assessment. When the term expires, the gift is completed, but the tax on the gift is

based on a value that is significantly less than the fair market value of the home.

It should be noted that the strategy falls apart if you pass away before the retained income period expires. Longer is better from a tax savings perspective, but you do have to be conservative with regard to your anticipated lifespan.

CONCLUSION

Your home is part of your taxable estate. If you could reduce its value for tax purposes, you could gain a great deal of tax efficiency. This can potentially be accomplished through the creation of a qualified personal residence trust. If you would like to obtain more in-depth information, schedule a consultation with a licensed estate planning attorney.

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REFERENCES

The CPA Journal http://www.nysscpa.org/cpajournal/2005/1205/essentials/p52.htm

Journal of Accountancy http://www.journalofaccountancy.com/Issues/2006/Oct/TheAbcsOfQprts.htm

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About the Author Paul A. Kraft

Paul Kraft is Co-Founder and the senior Principal of Frank & Kraft, one of the leading law

firms in Indiana in the area of estate planning as well as business and tax planning.

Mr. Kraft assists clients primarily in the areas of estate planning and administration, Medicaid planning, federal and

state taxation, real estate and corporate law, bringing the added perspective of an accounting background to his work.

In addition to his practice, Mr. Kraft has lectured extensively in the areas of living trust planning, Medicaid planning, and

presenting public and private seminars on the importance of proper estate planning. He has also authored various articles

on estate planning and is a contributing author of LEGACY: Plan, Protect, and Preserve Your Estate–Practical Answers from America’s Foremost Estate Planning Attorneys.

Mr. Kraft is a co-founder of the Indiana Network of Estate Planning Professionals, a charter member of the AmericanAcademy of Estate Planning Attorneys and a founding member of the National Network of Estate Planning Attorneys. He is also a member of the Indianapolis

Bar Association, including the Taxation, Business Law and Estate Planning sections; the Indiana State Bar Association, including the section on Taxation Law; the Indiana CPA

Society; and the Estate Planning Council of Indianapolis. Mr. Kraft is admitted to practice law before the Supreme Court of Indiana, U.S. District Courts, and U.S. Tax Court.

Frank & Kraft

A Professional Corporation Attorneys at Law www.FrankKraft.com 135 N. Pennsylvania Street Suite 1100 Indianapolis, IN46204-2485

Phone: (317) 684-1100 Fax: (317) 684-6111