Shielding your assets from estate taxes


As part of the American Taxpayer Relief Act passed in January, Congress has permanently set the federal estate tax exclusion amount at $5 million, indexed each year for inflation. In 2013, the amount each individual can exclude from estate taxes is $5.25 million. In addition, "portability" became a permanent part of the estate tax, so when one spouse dies, the other can take the unused portion of the exemption and apply it to his or her own estate.

The high exclusion amount means only the very rich will need to worry about saving estate taxes. But among those with wealth primarily concentrated in their home or investment portfolio, there are two types of trusts designed to transfer wealth to heirs and save taxes by removing the assets from the estate. In effect, this reduces the amount of the decedent's taxable wealth.

One is a grantor retained annuity trust, or GRAT, typically used to shelter future appreciation of stocks. The other is a qualified personal residence trust, or QPRT, that will shelter current and future appreciation on the value of your home. Both are set up for a predetermined term of years, and in both cases, the creator of the trust must outlive the term, or the assets go back into the estate.

An important factor for both of these techniques is the interest that will be charged on the value of the assets transferred to the trust. The 7520 rate, also known as the hurdle rate, is set by the Internal Revenue Service every month and is based on recent sales of three- to nine-year Treasury notes. When it's low, as it is now, it's beneficial to set up a GRAT. If the trust can beat the hurdle rate, the remainder of the appreciation passes to heirs tax-free. Once the trust is set up, the hurdle rate won't change for the life of the trust. The rate has been hovering just above 1 percent: The June rate is 1.2 percent. Compare that with a double-digit rate in the late 1980s.

According to Thornton "Tim" Henry, tax attorney at Jones, Foster, Johnston & Stubbs, P.A. in West Palm Beach, Fla., the low hurdle rate won't help the QPRT. But, reduced home values make it an attractive technique to consider right now.

Following is a closer look at the two types of trusts.

Putting your home in a QPRT

This type of trust allows a person to still live in a home for the term of the trust, deduct mortgage interest and real estate taxes, and then when the term of the trust expires, the home passes to the heirs and out of the owner's estate. The owners can retain the right to live in the home for the rest of their lives by paying fair market rent to the heirs.

Henry says there are three factors to take into consideration when setting up a QPRT:

Life expectancy. The owner has to outlive the term of the trust, or it comes back into the estate as if the trust never existed. "In that case, you haven't lost anything, but you haven't won," says Henry. So it's a best-guess scenario. Typically for a healthy 70-year-old, 10 years would be a reasonable term.


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