One of the key factors in planning your financial legacy is potential exposure to the federal estate tax. This tax can have a huge effect on your loved ones. Currently, the estate tax rate is 35%, and the exclusion amount stands at $5 million. For those who are very wealthy, this tax seems punitive; but even individuals with more modest estates should beware because change is coming in 2013.

Under the current law, the estate tax relief enacted in December 2010 sunsets at the end of next year. If Congress does not come to agreement on extending relief, the estate tax rate will return to the 2001 level of 55%. And, a lot more people will be exposed to the tax because the exclusion will be slashed all the way down to just $1 million, which is where it was in 2002.

If you’re like many people your home may be your single biggest asset and may push your estate above the exclusion amount. If you are in this position, you may want to consider the creation of a qualified personal residence trust or QPRT.

With these trusts you name a beneficiary and fund the trust with your home. When you are creating the trust, you set a period of time during which you will remain living in the home rent-free. So your day-to-day life is really not affected, but your home is no longer part of your estate for tax purposes. After the rent-free period, you can pass more assets to your beneficiary without paying estate tax by paying “rent” on the home.

The funding of the trust is considered to be a taxable gift. But the taxable value of the home is reduced by the interest that you retained in it by keeping the right to live there. This taxable value will be considerably less than the fair market value, and this is where the primary tax savings come from.