The Personal Residence Trust is simply a Grantor Retained Annuity Trust (GRAT) or Grantor Retained Unitrust (GRUT) to which the Grantor transfers ownership of his or her personal residence.
The Grantor retains an interest in the Trust — the right to occupy the residence — for a term of years, usually five (5) to ten (10) years.
Because there is an actual transfer of property, there may be a Gift Tax due at the inception of the Trust. However, such Gift Tax could be wholly or partially offset by the remaining Unified Credit of the Grantor.
Basically, the amount of the gift is determined by subtracting the value of the Grantor’s retained interest (determined actuarially) from the fair market value of the property. At the end of the Trust term, the property passes to the remainder beneficiaries, according to the terms of the Trust.
The primary advantage of the Personal Residence Trust is that by paying a relatively small Gift Tax currently, an individual may remove the entire value of his or her residence, as well as future appreciation thereon, from his or her Estate.
If the Grantor outlives the term of the Trust, the residence will no longer be an asset of the Gross Estate for Federal Estate Tax purposes. So as not to draw scrutiny from the Internal Revenue Service, the Grantor may not continue to use the residence, unless he or she pays fair market value rent to the Trustee or beneficiaries, as the case may be. These rental payments serve to further reduce the Grantor’s Taxable Estate.
During the term of the Trust, the Grantor continues to be treated as the Owner of the property for other tax purposes. Thus, the Grantor must still pay real property taxes, but also can take advantage of any available State or Federal Tax deductions or credits available by reason of owning such property.
The downside to the Personal Residence Trust is that if the Grantor predeceases the term of the Trust, the residence is included in the Grantor’s Taxable Estate for Federal Estate Tax purposes. In actuality, this leaves the Grantor in no worse position than if the Trust had never been established, except that the opportunity for a step-up in the cost basis of the property at the Grantor’s death is lost.
The Internal Revenue Service allows an individual to establish a maximum of two (2) Personal Residence Trusts, and each such Trust may only own one (1) personal residence.