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A recent decision from the United States District Court for the Southern District of Florida offers a cautionary tale for estate planners who rely on Qualified Personal Residence Trusts (QPRTs) and the interplay between state homestead protections and federal estate tax inclusion rules. In Palermo v. United States, No. 24-22514-Civ-BECERRA/TORRES (S.D. Fla. Aug. 17, 2026), the court addressed whether a residence held in a QPRT was includable in the decedent’s gross estate, and in doing so, clarified important limits on the use of state homestead law to secure a stepped-up basis under I.R.C. § 1014.
The decedent in Palermo created a QPRT in 2002 and transferred his residence into the trust. After the trust term expired, he continued living in the home under lease agreements with the trust, paying rent below the property’s appraised fair rental value. Following the eventual sale of the property, the trust claimed a stepped-up basis under Section 1014, arguing that the residence should have been included in the decedent’s gross estate. The IRS disagreed, assessing additional tax and penalties, which prompted the litigation.
The trust first argued that the property’s homestead exemption status under Florida law created an interest includable in the gross estate under I.R.C. § 2033. The court rejected this theory on partial summary judgment, holding that state homestead provisions exist to provide limited protections, primarily against creditors, and do not operate to determine property ownership for federal estate tax purposes. This holding reinforces a familiar principle: state law characterizations of property rights do not automatically translate into federal tax consequences, and taxpayers cannot bootstrap a homestead classification into estate tax inclusion simply because it may be advantageous for basis purposes.
The court reached a different result, however, on the government’s alternative argument under I.R.C. § 2036(a)(1), which addresses transfers where the decedent retains possession or enjoyment of transferred property. Because the decedent continued to occupy the residence after the QPRT term ended, under a lease arrangement priced below market and lacking arm’s length characteristics, the court found genuine issues of material fact as to whether he had retained the kind of beneficial enjoyment that would trigger inclusion under Section 2036(a)(1). Summary judgment on this issue was therefore denied, leaving the question for further proceedings.
Finally, the court held that the taxpayer could not pursue two additional theories, cessation of qualified use and a reasonable cause defense to the penalties, because neither had been raised in the administrative refund claim. This aspect of the ruling underscores the importance of comprehensively identifying and preserving all arguments when submitting a claim for refund, since failure to do so can foreclose those arguments in subsequent litigation.
Palermo serves as an important reminder for practitioners administering QPRTs. Post-term lease arrangements with the grantor must be carefully structured at fair market rental value and on genuine arm’s length terms to avoid inadvertent estate tax inclusion exposure, and taxpayers should ensure that every potential theory of recovery is clearly articulated in administrative refund claims before proceeding to litigation.
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