Most of us won't be hit by the estate tax when we shed this mortal coil. Even adding in the value of a home, the vast majority of Americans won't owe an estate tax, so their homes can be passed on to their heirs and avoid most taxes. Those who would be hit by the estate tax can do some prior planning to pass on a home with as little tax implications as possible. One sophisticated strategy is a qualified personal residence trust.
Here's how a QPRT works. Say a retired doctor in Florida wants to give his $1 million beachfront home to his two daughters. This strategy would require the doctor to put his home into an irrevocable trust for several years, while he continues to live in it. Through a complex IRS calculation based on interest rates, the length of the trust and his age, the IRS values his right to live in the house at, say, $600,000.
For the purposes of his taxable estate, that knocks the value of his house down to just $400,000 -- regardless of how much the house appreciates in the meantime. (That $400,000, though, comes out of the doctor's federal gift- and estate-tax exemptions.) When the trust is up after the stipulated number of years, if he chooses to continue living there, he can pay his daughters rent, further reducing the size of his taxable estate.
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