Christine Carlstrom, Esq., Law Offices of Christine Carlstrom
When a client has misgivings about paying rent after his QPRT term expires, or is unable to afford it, there are limited options. One of them is a relatively new, IRS-sanctioned technique known as a “Reverse QPRT,” which can avoid the potential income, gift, and estate tax consequences of alternatives such as using a promissory note or simply foregoing rent payments.
In a Reverse QPRT, the Settlor creates an irrevocable trust and transfers to it his interest in a residence, just as in a standard QPRT. Rather than retaining a right to live in the residence for X years and making a gift of the remainder, however, in a Reverse QPRT the Settlor makes a gift of the term interest and keeps the remainder interest.
Imagine a client, Don, who at age 65 created a QPRT. Don is a widower with one child, Ben. Through his QPRT, Don retained the right to live in his home rent free for 10 years, after which it would be distributed outright to Ben. At the end of the 10 years, the Trustee conveyed the residence to Ben, and Don began paying fair market rent. It is now some months later, and Don, having reassessed his financial situation, determines it would be best to postpone making rent payments for some time.
One way to accomplish this would be for Ben to create a Reverse QPRT. Specifically, Ben, now the owner of the residence, can create an irrevocable trust, transfer the home to it, and direct the trustee to allow Don to live in the home rent free for 5 years. At the end of that time, the trust could be liquidated and the property conveyed back to Ben.
Normally, such a transfer in trust to a family member with a retained interest would be subject to the Code’s special valuation rules, I.R.C. §§ 2702(a)(1) and (2). Under these rules, Ben’s remainder interest, which he would like to deduct for gift tax purposes from the value of his gift of the residence to the trust, would be deemed to have a value of zero.
These special valuation rules do not apply to QPRTs, of course, which are exempt under I.R.C. § 2702(a)(3)(A)(ii) and regulations at § 25.2702-5(c). Since 2008, the IRS has recognized in over a dozen Private Letter Rulings that Reverse QPRTs are likewise exempt from the special valuation rules. 
Accordingly, the value of Ben’s remainder interest can be determined using the I.R.C. § 7520 rate, which for June 2012 is 1.2%. This historically low rate depresses valuations for income interests and increases valuations for remainder interests, compared with higher rates. So from a gift tax standpoint, it discourages the use of QPRTs, but produces quite favorable results for Reverse QPRTs. Unless Ben has made substantial lifetime gifts, he can create a Reverse QPRT and give his father a term interest in the residence, while paying no gift tax and using a relatively small fraction of his $5.12 million gift tax exemption.
The Private Letter Rulings
1. Outright Distribution at End of Original QPRT Term
In the first Private Letter Rulings in which the IRS considered Reverse QPRTs, issued in 2008, the facts were the same as those in our Don and Ben example. 
In these PLRS, the Settlor of the first QPRT had survived the term, the residence had been distributed outright to his children, and the Settlor had begun paying rent. The children proposed to create a new irrevocable trust, the terms of which granted their father a right to live in the residence for one year, after which the trust would terminate and the residence would be distributed back to them. The children were to be the Trustees of the Reverse QPRT. They also retained reversionary rights; if any child died before the term ended, his interest in the residence would be distributed to his estate. 
The taxpayers requested a ruling that this proposed trust would qualify as a personal residence trust under the QPRT regulations. The IRS noted that, pursuant to Rev. Proc. 2007-3, it ordinarily will not issue rulings regarding whether a particular trust qualifies as a QPRT. The IRS found it appropriate to issue rulings in these cases, however, “because of the unusual facts presented.” It ruled that, assuming the residence was a personal residence, as defined in the regulations, the trust did qualify as a QPRT, and the children’s transfer to the trust would be exempt from the special valuation rules.
Prior to these rulings, some practitioners may have assumed that the QPRT Donor must hold the term interest in the trust. The regulations, however, require that the property held by a QPRT must be limited (with a few exceptions) to “one residence to be used… as a personal residence of the term holder.”  A personal residence may be either the term holder’s principal residence or other residence.  Thus, a Reverse QPRT meets these requirements; the regulations do not require that “term holder” be synonymous with “Donor.”
2. Continuing Trust for Beneficiaries After Expiration of Original QPRT Term
In the earliest PLRs described above, the original QPRT provided for an outright distribution to the Donor’s children when the Donor’s term expired. Subsequent PLRs considered situations in which the original QPRTs provided that the residence would remain in trust for the children’s benefit, postponing outright distribution typically until the death of the original Donor or until the second death of the Donor and his spouse.
In those rulings, the Donor (individually and as Trustee) and children jointly executed trust modifications to allow the children to create a Reverse QPRT. In some cases, this modification was executed before the expiration of the original QPRT term; in others, it was executed after the term expired. The modifications generally provided that at the end of the term, the children could direct the trustee to liquidate the trust or to make a gift of a term interest to whomever they chose. In all but the most recent PLRs, it was proposed that the children would convey their interest in the residence, by warranty deed, to a new Reverse QPRT, which provided a term interest to their parent.
Beginning with the PLRs issued in 2010, the trust modifications proposed by the taxpayers took a different tack. The modifications provided that: (i) the children were granted a power to appoint the trust property to themselves upon expiration of their parent’s term interest, and (ii) could, instead of appointing the property, direct the trustee to amend and restate the original QPRT to grant their parent the right to occupy the residence for a stated term. Under this fact pattern, the children’s release of their general power of appointment constituted the gift to their parent, and there was no need to re-title the property in another trust.
In all of the above rulings, the IRS agreed that I.R.C. § 2702 was inapplicable to the proposed transfer to a Reverse QPRT, or to the proposed trust modifications, or amendments and restatements, described in each ruling.
3. The Caveat: Potential Inclusion Under I.R.C. § 2036
In every ruling in which the IRS blessed a Reverse QPRT, it also explicitly stated that, “no opinion is expressed or implied concerning whether…” the proposed technique would result in the residence being included in the parent’s gross estate under I.R.C. § 2036.
Although the IRS has not yet ruled on the issue of whether, and under what circumstances, a Reverse QPRT will cause the residence to be included in the gross estate of the original Donor, it also did not conclude in any of the PLRs that such inclusion is required under I.R.C. § 2036. This implies that any such inclusion will depend on the facts of each situation, with existing cases and rulings serving as guideposts.
Certainly, in most cases if the beneficiary of a Reverse QPRT survives beyond the term, I.R.C. § 2036 inclusion should become a non-issue, just as with a “standard” QPRT.
Beyond that, that the risk of estate inclusion can be minimized by steering clear of circumstances suggestive that the original QPRT Donor never intended to relinquish possession and enjoyment of the residence during his lifetime, or that the Donor and beneficiaries agreed at the outset that the QPRT would be followed by a Reverse QPRT. In other words, the facts should support a conclusion that there was a bona fide transfer of the remainder interest to the children after the QPRT term ended, and that their gift of a term interest to their parent was not pre-arranged. In order to accomplish this, the parties could:
· Allow the QPRT term to expire prior to executing any trust modification that relates to granting another term interest to the original QPRT Donor
· Ensure that the original Donor pays fair market rent for some period after the QPRT term ends
· If the original QPRT provided for distribution outright to beneficiaries after the term expires, ensure that a deed conveying the residence to the beneficiaries is executed and recorded
· Document any changed financial circumstances or other hardship that would provide a basis for a Reverse QTIP
· Avoid having Settlor of the original QPRT serve as Trustee of the Reverse QPRT
· Give the Settlor of the Reverse QPRT powers or interests that could extinguish the parent’s term interest. For example, have the Settlor retain a reversion in the event that he dies during the parent’s term interest
If clients are interested in a Reverse QPRT, keeping the residence out of the parent’s estate most likely remains a planning goal.  That goal will need to be balanced against the ability to pay rent and the risk of possible inclusion under § 2036. Once the original Donor has survived the QPRT term, and achieved the intended “estate freeze,” the prospect of potentially undoing that may cause some to choose to pay rent after all. But if paying rent is not a viable option, a Reverse QPRT may be able to effectively extend the original Donor’s term interest, while still sheltering the residence from inclusion in his gross estate. Even if the transaction cannot be structured to eliminate potential arguments for § 2036 inclusion, the consequences of such inclusion should be no more onerous than if the Donor had died during the first QPRT term. 
Looking Forward: Drafting Considerations
Practitioners may also want to keep Reverse QPRT techniques in mind when drafting QPRTs, in order to facilitate their potential use down the road with minimal § 2036 exposure. For example, perhaps in some situations the balance will tip in favor of outright distribution after the QPRT term ends, rather than leaving the residence in a continuing trust that would require amendments with the Donor’s involvement. The Private Letter Rulings also raise the question of whether, and to what extent, trust provisions similar to the modifications described in the rulings might be built into a QPRT at the outset, to provide flexibility while preserving the QPRT’s gift and estate tax advantages.
 See PLR 200814011 (May 4, 2008); PLR 200816025 (May 18, 2008); PLR 200848003 (Nov. 28, 2008); PLR 200848007 (Nov. 28, 2008); PLR 200848008 (Nov. 28, 2008); PLR 200901019 (Jan. 2, 2009); PLR 200904022 (Jan. 23, 2009); PLR 200904023 (Jan. 23, 2009); PLR 200920033 (May 15, 2009); PLR 201006012 (Feb. 12, 2010); PLR 201014044 (April 9, 2010); PLR 2010119006 (May 14, 2010); PLR 2010119007 (May 14, 2010); PLR 201019012 (May 14, 2010); PLR 201131006 (August 5, 2011).
 Except that two siblings were the reminder beneficiaries of the first QPRT and together created the new Reverse QPRT. See PLR 200814011, PLR 200816025.
 This reversionary interest was described in the fact patterns of only the first two rulings: PLR 200814011 and PLR 200816025.
 26 C.F.R. 25.2702-5(c)(5) (emphasis added).
 See 26 C.F.R. 25.2702-5(c)(2)(i) (emphasis added).
 Otherwise, the QPRT Donor can simply continue to live in the residence rent free after the QPRT term ends; there is no need for a Reverse QPRT.
 All a Settlor loses if he doesn’t survive the QPRT term is the benefit of the intended “estate freeze,” he will not have wasted any gift tax payment or unified credit. See Natalie Choate, The QPRT Manual §§ 1.3.09, 4.1.04 (2004); I.R.C. § 2001(b). It is not clear, however, whether the children might be worse off if the residence held in a Reverse QPRT is included in their parent’s gross estate by reason of I.R.C. § 2036. To the extent the children pay gift tax or use up their exemption, this would not be accounted for in the parent’s estate tax calculations.
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