Getting a client into a qualified personal residence trust (QPRT) to reduce estate-tax exposure in this down real estate market sounds like a no-brainer. Yet, like deciding to ask your doctor for the purple pill, recommending this trust to a client simply because house values are down would be a move based on facile logic.

A QPRT is a device through which taxpayers (grantors) can gift their home to their children in a highly tax-advantaged manner. The parents transfer the title of their principal residence or vacation home to the trust and retain the right to live in the house for a fixed number of years.

At the end of this term, if the parents are still living, the children, as the remainder beneficiaries, receive the house. The result is a dramatic reduction of gift tax, achieved by leveraging the parents' $1 million gift exclusion, as well as the removal of future appreciation on the house from the taxable estate.

As with many other estate planning techniques, these trusts take advantage of the time value of money. The children have to wait for the QPRT to end before they can claim the asset the parents gave them-the house. If they gift a child $500,000 today, it's worth the full $500,000. But if they gift the child a house worth $500,000 today and the child has to wait 10 years-until a QPRT ends-to get it, the gift is deemed to be worth much less than the original value of $500,000. Of course, the actual value of the house at the time the child takes ownership is determined by the real estate market at the time, which in all likelihood will have risen.

Like all estate planning strategies, these trusts are great under the right circumstances. To get their clients the desired benefits, planners must carefully gauge the client's situation and numbers against QPRT rules and dynamics.

Every taxpayer is entitled to give away up to $12,000 per year per recipient without limit. Over this level, every taxpayer is entitled to give away $1 million during his or her lifetime without triggering any gift tax. Under current law, which most experts believe is likely to change, every taxpayer is entitled to bequeath up to $2 million without incurring any federal estate tax.

However, if a client uses up any of the $1 million gift exclusion while still alive, this reduces the $2 million he or she can bequeath at death. QPRTs don't qualify for the $12,000 annual gift exclusion, so the gift of a house to a QPRT eats into both the $1 million gift exclusion and the $2 million estate exclusion.

Meet the Cleavers

Significant declines in the housing markets might make a QPRT seem attractive to clients concerned about the potential impact of a housing price rebound on taxes triggered by gifting homes to children, or on the taxable value of the estate. However, broader analysis is necessary to determine whether this is the right step for a given client's particular circumstances.

Let's look at the example of Ward Cleaver, 70, and June, age 68. They own a home worth $1.75 million. The home is part of the taxable estate from which they plan to bequeath assets to their children, Wally and Beaver, with minimal estate-tax exposure.

Ward and June, already concerned about preserving estate value, are wary that current economic conditions may lead to new legislation increasing estate tax rates. So they set up a QPRT for the kids to last for 12 years. Because Ward and June have reserved the right to live in the house for 12 years rent free, the value of the house for gift-tax purposes is reduced from its current value of $1.75 million to about $900,000. This is because the children have to wait 12 years to obtain ownership of the house given to them through the QPRT.

This rent-free use of the house—and the delay in the children's receiving ownership—ultimately reduce its value. At the end of the 12 years, the kids will own the house, and they will then have the option to rent the home to the parents.

If the house appreciates at 4% per year over the next 12 years, it will be worth $2.8 million. That means Ward and June will have removed $2.8 million from their estate, using up only $900,000 of their two $1 million lifetime gift-tax exclusions. Not a bad deal. If Ward or June is worried about outliving the term of the trust (a requirement for the QPRT to succeed), they could take some comfort in knowing that their life expectancies are 17 and 18.6 more years, respectively. So 12 years doesn't seem to be long odds.