SECTION 5. ANNOTATIONS

REGARDING SAMPLE QUALIFIED PERSONAL RESIDENCE TRUST

.01 Annotations for Introductory Para- graph and Article I, Retained Interest and Irrevocability .

(1) Qualification as a QPRT . In order to qualify as a QPRT, the governing instrument must contain all the provisions required under the regulations, and these provisions must by their terms continue in effect during the existence of any term interest in the trust. Section 25.2702–5(c)(1).

(2) Appointment of Trustee . Alternative or successor trustees may be designated in the trust instrument.

(3) Limited Power of Amendment . A QPRT must be irrevocable. However, modification of a trust by judicial reformation (or nonjudicial reformation if effective under state law) to comply with the requirements of § 25.2702–5(c) will be effective for purposes of § 2702, provided the reformation is commenced within 90 days after the due date (including extension) for the filing of the gift tax return reporting the transfer of the residence under § 6075 and is completed within a reasonable time after commencement. Section 25.2702– 5(a)(2). .02 Annotations for Article II, Quali- fied Personal Residence Trust.

(1) Requirement that QPRT Must be Funded With a Personal Residence (Ar- ticle II, Paragraph A(1)) . The QPRT must be funded with a residence that qualifies as a personal residence of the term holder during the term of the QPRT. A personal residence of a term holder is: (A) the principal

year beginning on the cessation date (as defined below), the Trustee shall pay to the Transferor an annuity, the amount of which shall be determined in accordance with Paragraph D of this Article III. The right of the Transferor to receive the annuity amount begins on the cessation date.

B. Cessation Date . The cessation date is the date on which the Residence ceases to be used or held for use as a personal residence of the Transferor, the date of sale of the Residence, or the date of damage to or destruction of the Residence that renders the Residence unusable as a residence, as the case may be.

C. Payment of Annuity . The annuity amount shall be paid in equal [ insert monthly, quarterly, semi-annual or an- nual ] installments. The annuity amount shall be paid first from the net income of the GRAT and, to the extent net income is not sufficient, from principal. The Trustee may defer payment of any annuity amount otherwise payable after the cessation date until the date that is 30 days after the date that the assets are converted to a GRAT as provided in this trust instrument. Any deferred payment of the annuity amount shall bear interest for the period of deferral, compounded annually, at a rate not less than the rate prescribed in § 7520 of the Code in effect on the cessation date. The Trustee shall reduce the aggregate deferred annuity payments by the amount of income actually distributed to the Transferor during the deferral period.

D. Computation of Annuity Amount . The amount of the annuity payable to the Transferor shall be determined as follows.

(1) If, on the date that any property of the trust is converted from the QPRT to a GRAT (hereinafter the “conversion date”), the assets of the trust do not include a Residence used or held for use as a personal residence of the Transferor, the annuity shall be the amount determined by dividing the lesser of (a) the value of the interest retained by the Transferor (as of the date of the original transfer) or (b) the value of all the trust assets (as of the conversion date) by the annuity factor determined (i) for the original term of the Transferor’s interest and (ii) at the rate used in valuing the retained interest at the time of the original transfer to the QPRT.

(2) If, on the conversion date, the assets of the trust include a Residence used or held for use as a personal residence of

the Transferor, the annuity shall be the amount determined under subparagraph (1) of this Paragraph D multiplied by a fraction. The numerator of the fraction is the excess of the fair market value of the assets of the trust on the conversion date over the fair market value of the assets as to which the trust continues as a QPRT, and the denominator of the fraction is the fair market value of the trust assets on the conversion date.

(3) In computing the annuity amount for any second or subsequent GRAT to be administered under this Article III, the Trustee shall make appropriate adjustments to the formulas above in this paragraph D that are consistent with the applicable provisions of the Code and the regulations thereunder and with the Transferor’s intent to maintain qualification of each of the trust shares hereunder as a QPRT or a GRAT.

(4) If there is an error in the determination of the annuity amount, then, within a reasonable period after the error is discovered, the difference between the annuity amount payable and the amounts actually paid shall be paid to or for the use of the Transferor by the Trustee in the event of an underpayment, or shall be repaid by the Transferor to the Trustee in the event of an overpayment.

E. Proration . Notwithstanding the preceding paragraphs of this Article III, in determining the annuity amount for a short taxable year, the Trustee shall prorate the annuity amount on a daily basis. In determining the annuity amount for the taxable year of the termination of the GRAT, the Trustee shall prorate the annuity amount for the final period of the annuity interest on a daily basis.

F. Additional Contributions Prohibited . No additional contributions shall be made to the GRAT after its creation.

G. Termination of GRAT . The GRAT shall continue through the date of termination of the QPRT, as defined in Paragraph C of Article II, and shall then terminate. Upon termination of the GRAT, the Trustee shall distribute all of the trust property in the manner described in Paragraph C of Article II as if the GRAT property had been part of the QPRT disposed of under that provision.

H. No Commutation . The Transferor’s interest in the annuity amount may not be sold, commuted, or prepaid by any person.

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(b) Generation-Skipping Transfer Tax . Consideration also should be given to potential generation-skipping transfer (GST) tax consequences under § 2601 upon termination of the trust by reason of the death of the transferor during the QPRT term. The transferor may prefer to design the dispositive provisions to avoid any generationskipping transfer in the event of the transferor’s death during the term because, pursuant to § 2642(f), no allocation of GST exemption can be made until the end of the term of the QPRT (the transferor’s death).

(6) Cessation of Use As a Personal Resi- dence (Article II, Paragraph D).

The governing instrument must provide that a trust ceases to be a QPRT if the residence ceases to be used or held for use as a personal residence of the term holder. Under § 25.2702–5(c)(7)(i), a residence is held for use as a personal residence of the term holder so long as the residence is not occupied by any other person (other than the spouse or a dependent of the term holder) and is available at all times for use by the term holder as a personal residence.

.03 Annotation for Article III, Grantor Retained Annuity Trust (GRAT) .

(1) Payment of Annuity (Article III, Paragraph C) . Allowing deferral of the annuity payment is an optional provision and is not required in order to qualify as a QPRT. If the trustee is given the power to defer payment of any annuity amount, then the trust may (but is not required to) provide that the aggregate deferred annuity payments must be reduced by the amount of income actually distributed to the transferor during the deferral period. Section 25.2702–5(c)(8)(ii)(B). (2) Computation of Annuity Amount (Ar- ticle III, Paragraph D) . The annuity amount may be greater than the amount identified in the sample trust, but may not be less than that amount. See Example 6 in § 25.2702–5(d) for a numerical example of how the annuity formulas operate.

.04 Annotation for Article IV, General Provisions .

Trustee Powers . The trust instrument may contain administrative provisions relating to the trustee’s duties and powers, as long as the provisions do not conflict with the rules governing QPRTs under § 2702(a)(3)(A) and § 25.2702–5(c), or the rules governing qualified annuity interests under § 25.2702–3. A clause may be included that provides: “Except to the ex

residence of the term holder (as that term is defined in § 25.2702–5(c)(2)(i)(A)); (B) one other residence of the term holder (within the meaning of § 25.2702– 5(c)(2)(i)(B)); or (C) an undivided fractional interest in a residence described in either (A) or (B). Section 25.2702–5(c)(2)(i). A personal residence may include appurtenant structures used by the term holder for residential purposes and adjacent land not in excess of that which is reasonably appropriate for residential purposes, taking into account the residence’s size and location. The fact that a residence is subject to a mortgage does not affect its status as a personal residence. The term “personal residence” does not include any personal property, for example, household furnishings. Section 25.2702–5(c)(2)(ii). A residence is a personal residence only if its primary use is as a residence of the term holder when occupied by the term holder. The principal residence of the term holder will not fail to meet the requirements of the preceding sentence merely because a portion of the residence is used in an activity meeting the requirements of § 280A(c)(1) or (4) (relating to deductibility of expenses related to certain uses), provided that such use is secondary to use of the residence as a residence. A residence is not used primarily as a residence if it is used to provide transient lodging and substantial services are provided in connection with the provision of lodging, for example, a hotel or a bed and breakfast. A residence is not a personal residence if, during any period not occupied by the term holder, its primary use is other than as a residence. Section 25.2702–5(c)(2)(iii).

(2) Assets other than personal residence (Article II, Paragraph A(3)) . This is an optional provision that, if included in the trust instrument, permits the trustee to accept additions of cash to the trust for the purposes set forth in Paragraph A(3) of Article II. A provision in the trust instrument that permits these additions is not required in order to qualify the trust as a QPRT. Section 25.2702–5(c)(5)(ii)(A). In addition, the trust instrument may permit improvements to the residence to be added to the trust and may permit the trust to hold such improvements, provided the residence, as improved, meets the requirements of a personal residence. Section 25.2702–5(c)(5)(ii)(B).

(3) Authority to Sell or Repair Resi- dence (Article II, Paragraph B(4)) . The pro

visions of Paragraph B(4) are optional. If the trustee is given the authority to sell the personal residence but not to reinvest the proceeds in a replacement personal residence, the trust ceases to be a QPRT upon the sale of the residence.

(4) Prohibition on Sale of Residence to Transferor or Related Person (Article II, Paragraph B(5)) . The governing instrument must prohibit the trust from selling or transferring the residence directly or indirectly to the transferor, the transferor’s spouse, or an entity controlled by the transferor or the transferor’s spouse during the retained term interest in the trust or at any time after the expiration of that interest when the trust is a grantor trust. For these purposes: (A) a sale or transfer to another grantor trust of the transferor or the transferor’s spouse is considered a sale or transfer to the transferor or the transferor’s spouse; and (B) a “grantor trust” is a trust that is treated as owned in whole or in part by the transferor or the transferor’s spouse pursuant to §§ 671 through 678, and “control” is as defined in § 25.2701–2(b)(5)(ii) and (iii).

This prohibition, however, does not apply to a distribution for no consideration either to: (i) another grantor trust of the transferor or the transferor’s spouse, if the distributee-grantor trust includes the same prohibition against a sale or transfer; (ii) the transferor’s spouse after the term of the QPRT; or (iii) any person pursuant to the trust instrument or the exercise of the transferor’s retained power of appointment, if any, if the transferor dies prior to the expiration of the retained term interest. Section 25.2702–5(c)(9).

(5) Termination of Trust (Article II, Para- graph C) .

(a) Termination on Death of Trans- feror . If the trust terminates by reason of the death of the transferor, and therefore terminates prior to the end of the term interest, the trust property will be includible in the transferor’s gross estate for federal estate tax purposes because the transferor will have retained an interest in the trust for a period that did not in fact end before the transferor’s death. Section 2036(a)(1). Therefore, consideration should be given to designing the dispositive provisions to take advantage of marital or charitable deductions that may be available for estate tax purposes.

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trust has ceased to qualify as a QPRT in one of two ways, as the Trustee may select in the Trustee’s sole discretion. Specifically, the Trustee shall distribute the assets with respect to which the trust no longer qualifies as a QPRT either: (i) to the Transferor, outright; or (ii) to a separate share of this trust to be referred to and administered as a GRAT in accordance with Article III below. That GRAT shall continue until the date of termination as defined in Paragraph C above.

DRAFTING INFORMATION

The principal author of this revenue procedure is Mary Berman of the Office of Associate Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue procedure, contact Mary Berman at (202) 622–3090 (not a toll-free call).

26 CFR 601.105: Examination of returns and claims for refund, credit or abatement; determina- tion of correct tax liability. (Also Part I, §§ 1361, 1362; 1.1361–1, 1.1361–3, 1.1362–4, 1.1362–6, 301.9100–1, 301.9100–3.)

Rev. Proc. 2003–43