Cottage Planning: Dealing with Estate Taxes, Part 1
Over the years, the need for estate tax planning has changed as federal law has decreased the number of individuals who will actually pay any estate tax liability. However, due to the uncertainty in this planning and the fact that absent a change in the law many more individuals will be subject to the estate tax in 2013, estate tax planning is still a valid issue for many couples.
A common estate tax-minimization to use technique with cottages is the qualified personal residence trust ("QPRT"). In this planning, an owner creates a QPRT, then gifts the cottage to the trust. The owner retains the use of the property for a set term of years, after which the property then passes directly to the beneficiaries (usually the owner's children). Because the owner only retains a partial interest in the property, he or she is treated as making a gift of less than the full value of the property. At the end of the term, however, the full value of the property passes to the beneficiaries without being included in the owner's estate. This planning has allowed many families to pass a family cottage to the next generation for a significantly reduced transfer tax cost.
However, although a QPRT can be a good tax planning device, it doesn't solve the management problems associated with family cottages. In addition, if the owner doesn't survive the term of the trust, the tax planning goals won't be realized. Perhaps most importantly, if the owner does survive the term, she then finds herself in the position of having to lease back the property from her children if she wants to be able to continue to use the property. Thus, although a powerful tax planning tool, an owner must carefully decide whether a QPRT is appropriate for her family cottage.