Transfer of a Cooperative Apartment to the Right Trust Requires
                                         Careful Planning

Cooperative Corporations have been and remain a popular way in which to own an apartment in New York.  For a young couple, it provides the benefit of equity ownership of their residence, including hopefully an increase in that equity as the value of the property increases over the years of ownership.  For an older couple, it provides a simpler way to own a residence, perhaps after years of maintaining a home.  In either case, the Boards of Directors of Cooperative Corporations are receiving more and more requests for the transfer of cooperative apartments into trust ownership.  

Owners thinking about transferring ownership from individual or joint ownership into a trust have basically two choices.  The apartment can be transferred into either a “grantor” trust or a QTIP Trust.  Which one is best in a particular case will depend on tax and non-tax circumstances.  Some traditional considerations will be the person’s age, state of health, available gift tax exemption, anticipated estate tax exemption, projected taxable estate, the cost basis in the apartment and a consideration of the owner’s comfort level in parting with ownership.  After the 2001 Tax Law changes and the pending repeal of the estate tax, a good crystal ball wouldn’t hurt, either, since whether the estate tax will actually be repealed in 2010 or be resurrected in 2011 is currently a question without a good answer.

The Basics: A Qualified Personal Residence Trust (“QPRT”) is an irrevocable trust funded with a primary or secondary residence.  On the transfer of the residence to the trust, a present interest is created for the benefit of the grantor and a future interest is created in favor of the remaindermen.  In practical and basic terms, a parent or parents fund a QPRT, reserving a right to reside in the house for a period of years, after which the house is given to the children and the trust terminates.   An immediate gift is made to the children measured by the value of the right to receive the house at the end of the term of the trust.  The longer the term, the less the value of the remainder interest and the more the value of the retained right to live in the house.  The greater the value of the gift of the remainder interest.  

A Grantor Trust is usually (but not always) a revocable trust created during the lifetime of the grantor.  No gift is made on the funding of the trust.  Any income earned by the trust is taxed to the grantor if the grantor retains any one or more powers defined in the tax code.  (For purposes of this discussion, it is not necessary to itemize them, but in future articles the Grantor Trust will be discussed  in detail, since there are so many ways this kind of trust is used in the estate planning process.)  For now, it is the distinction of the Grantor Trust from the QPRT that is the important factor.  

The current tax structure is the other external factor.  The estate tax rates will be reducing from 2002 through 2009 and then repealed in 2010.  The credit shelter deduction is $2 million in 2007 and 2008 and rises to $3.5 million in 2009.  In 2010 the estate tax is eliminated but, if no other legislation becomes law before then, it comes back to life in 2011 at the 55% rate and only a $1,000,000 exemption.  The gift tax exemption is $1 million for this year through 2009, and remains at $1 million even after 2009.  Assuming repeal of the estate tax in 2010,  in the place of the estate tax, carryover basis rules are put in place to capture the increase in value of inherited assets by way of an income tax on gain recognized as the assets are sold by the decedent’s heirs.  If the estate tax is reinstated in 2011, then the carryover rules will disappear as well and the estate tax returns to the way it was in 2001.

How the considerations work together.  For the next 2 years, that is, until the repeal of the estate tax, it is likely that older and very high net worth individuals will continue to find the QPRT an attractive way to leverage the use of their $1,000,000 gift tax exemption.  Individuals with more modest estates may not find as much benefit in putting their apartments in a QPRT.  An individual with a life expectancy beyond 2009 and an anticipated taxable estates below $3.5 million may find little benefit in transferring his coop to a QPRT. Why?  A married couple with a properly drawn will and a well-planned estate can have a combined estate of $7 million by 2009 and have no estate tax exposure. In 2010, there would be none.  So, they may feel that the QPRT adds little to their estate planning goals.  Another couple with the same assets this year may anticipate that their combined estate will grow to greater than $7 million by 2009.  Or, they may believe that either may die prematurely before 2010 or may doubt the full phase in of estate tax reduction and ultimate repeal of the estate tax.  In either of the foregoing cases, the estate tax savings from the QPRT must be offset against the loss of the step up basis rules that would apply to testamentary transfers until 2010.  

On the other hand, an individual with a high cost basis in the apartment would not be as concerned about the loss of stepped-up basis in the apartment if he survives passed repeal of the estate tax.  Contrast this with the situation where a low cost basis apartment is transferred into a QPRT.  In this case, the remainderman of the trust received the future interest with a carryover basis equal to the lesser of the donor’s basis or the fair market value of the residence on the date of the gift.  As a result, the built in gain is passed along to the remainderman who will be taxed on it when the apartment is sold.

In our next and future articles, we will continue with the evaluation of factors that would go into a decision to fund either a Grantor Trust or a QPRT . For now, you should take away the idea that this relatively simple estate planning strategy has become a bit more complex and in need of more thought and planning than before the 2001 Tax Law changes.  As with so many other decisions, this one should not be made or executed upon without prior consultation with a competent estate planning professional.

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