Friday, June 3, 2011

QPRT Planning Works, Despite Failure to Pay Rent

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A recent Tax Court decision, Estate of Sylvia Riese v. Comr., T.C. Memo 2011-60 (3/15/11), points out the potential hazards of failing to comply with the terms of a qualified personal residence trust (QPRT).

On the advice of her estate planning attorney, Mrs. Riese in April 2000 established a QPRT for her primary residence in New York. The QPRT had a three-year term and provided that, at termination, the residence would be divided between two trusts, one for each of the decedent's daughters. The decedent intended to remain in the residence after the QPRT terminated, and she and her daughters seem to have been aware that she would be obligated to pay rent to the trusts. But no planning was done for the QPRT termination until one of the daughters contacted the estate planning attorney in April 2003 to ask how to determine the rent. The attorney told the daughter that the rent could be dealt with before the end of the year, and entered a note in his diary to address it in December.

Mrs. Riese died unexpectedly in October 2003 at age 83. During the six months following the QPRT termination, she continued to live in the residence and pay all costs of its operation. She never paid rent to the new owners of the property.

When her daughters, as executors of the estate, filed her estate tax return, they excluded the value of the residence. They also deducted, as a debt of the decedent, the six months of rent ($46,498) that the decedent should have paid to the trusts. The IRS issued a $3,114,357 notice of estate tax deficiency, claiming that the residence was included in the estate under §2036(a) and denying the deduction for the unpaid rent.

The Tax Court, showing considerable sympathy for the estate, determined that the property was not includible in the estate and that it was entitled to a deduction for the unpaid rent. The court said that the estate had demonstrated that there was an agreement between the decedent and her daughters that she pay the rent and that the amount be determined before the end of the year. In light of the IRS's failure to issue any guidance describing how and when post-termination rent should be paid, the court concluded that payment by the end of the calendar year in which the QPRT terminated was reasonable.

The estate was fortunate in drawing a sympathetic judge who interpreted most of the facts in its favor. The decision points out, however, the need for the parties to a QPRT transaction and their advisors to plan for the post-termination lease well in advance of the termination date.

Harold W. Pskowski, Managing Editor for Estates, Gifts and Trusts 

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