In most markets, real estate has provided an exceptional return over the past decade. Many people's homes have been the primary contributor to increasing their net wealth, especially given the stock market's sharp decline from 2000 to 2002. As even modest homes in popular markets such as San Francisco, Washington, D.C., and Los Angeles approach or exceed the $1 million mark, many people probably don't realize that their homes may be creating a potential estate-tax problem for their heirs.

If you believe that your home will continue to appreciate in value, and if you have substantial assets other than your home, you may want to consider making a gift of your home to your children. By doing this, you effectively lock in the present value of your home for gift and estate-tax purposes. Any future appreciation in value generally won't be included in your estate.

There's one problem with giving your home away: If you want to keep living there, you've got to pay rent to its new recipient or face a host of potential problems. In addition, you may owe gift tax if the value of your home is high enough, and in any event, you will have used a significant amount of the tax-free gifts you're allowed to make during your lifetime.

A better solution for some people is to create a qualified personal residence trust, or QPRT. Here's how it works: You make a gift of your home to the QPRT. You define how long you would like the QPRT to last, and for that entire period, you retain the right to live in your home rent-free. At the end of the period you select, your home is transferred to the beneficiaries you name in the QPRT. Although you then must either leave the home or begin paying rent, the flexibility in choosing the period gives you the ability to pick a length of time you're comfortable with.

Because the QPRT doesn't force you to give your home away immediately, the value of the gift for tax purposes is less than the current value of your home. Depending on how lengthy a term you select, the gift value may be only a small fraction. To receive the full benefit of the QPRT, you must outlive the term you select; otherwise, the home is pulled back into your estate and taxed at its full value. However, many affluent families are willing to take this gamble to gain some big potential savings.

Read more in our series about trusts:

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