Private Annuity Trusts As Alternative To A IRS § 1031 Exchange

From PalmBeachRealEstateSource.com

Alternative to 1031 Exchg.
Private Annuity Trusts As Alternative To A IRS § 1031 Exchange
By John Kavazanjian

Private Annuity Trusts

A Way Out

     Those of us who own highly appreciated commercial and residential investment real estate assets are often reluctant to sell because of capital gains and depreciation recapture costs associated with the sale. But what other choice do we have? Is there another way to deal with the capital gains tax deficits that so many experience when they sell their real estate assets? The answer may lie in the Private Annuity Trust.

“ I am going to get killed with capital gains when I sell my property”

“ Because of the capital gains tax, we are not going to sell our property”

“After all, If I own a commercial building that is generating cash flow and I do not need a lump sum of money immediately, why would I just hand it over to the government?” Why not let my kids take it over so that they have an income after I pass away.

     This IRS-accepted capital gains tax deferral program could save you thousands of dollars and at the same time make a profit on the money you would have paid to Uncle Sam in the year of the sale. Obviously, this strategy is gaining popularity among those who have highly appreciated assets that are marked for sale. You, too, can take advantage of this program once you understand how it works.

The process starts with a property owner, transferring ownership of the property to a dedicated family trust. Next, the trust "pays" the property owner (annuitant) for the property. The payment isn't in cash, but with a special payment contract called a "private annuity." The private annuity promises to make payments to the annuitant for the rest of his or her life. The trust then sells the property. There are zero taxes to the trust on the sale since the trust "purchased" the property in the form of a private annuity contract.

    Often annuitants will choose deferral of annuity payments because they have other income and don't need the payments right away. The tax code doesn't require payment of the capital gains until the annuity payments begin and the capital gains tax is paid to the IRS with an "easy installment plan" since only that portion of capital gains is due in proportion the number of years the annuitant is actuarially stated to live. For example, if the annuitant begins to receive annuity payments at age 65 and the actuarial tables state that they will live until they are 85 years of age, then the capital gains are broken up into 20 payments (one per year). There is no interest or penalty on these deferred payments of the tax. On top of that, the tax payments will be made with depreciated dollars. Yet the investment money in the trust could grow at a greater rate than that of inflation.

    Here's an example of how well this works. We start with a $1,000,000 property value. The annuitant's basis is $200,000, leaving a profit of $800,000. We are estimating combined federal and state capital gains taxes at $160,000, which is 20% of the profit. This leaves net cash of $840,000 in the direct sale vs. $1,000,000 in the annuity deferral sale. We are assuming the investment cash earns a conservative 6% before income taxes for the next 20 years. The age of the annuitant is 45 and he chooses to start his annuity payments at 65. Under the direct and taxed sale, the property owner receives annual payments of $277,300 vs. $330,119 under the annuity plan. This yields an estimated life payout of $5,546,000 under the taxed plan vs. $6,602,380 with the annuity strategy. That is an advantage of $1,056,380 to the annuitant! This advantage is due to the larger amount of net cash that was initially available to invest for the annuitant.

    As illustrated above, the Premier VI Private Annuity Trust has the ability to generate substantially more money over the long run than a direct and taxed sale. It is also superior to the charitable remainder trust and installment sales in many respects.

FAQs

Q. How can I know the amount of my payments?

A. Your payments are based on: 1) The annuitant(s) age; 2) The selling price of the property minus any mortgages, fees or commissions that must be paid off; 3) The length of deferral, if any, until payments begin. A payment scenario will be provided by asking for your FREE illustration (above).

Q. What happens if I live longer or less than life expectancy?

A. Your annuity payments go on until you (or the surviving spouse) die, no matter whether that is sooner or later than life expectancy. Life expectancy is just the number used to calculate the size of the payments. After your death (or the surviving spouse's) the annuity becomes null and void.

Q. Are there any flexibilities or variability's in the annuity payment stream, such as increasing the payments over time?

A. The trust may issue more than one annuity contract to the annuitant at the outset. One would be immediate and the other (or multiples) would be deferred.

Q. Can I cancel the whole deal after a few years and get my money?

A. If the trustee agrees, you may terminate the trust and get the cash out. However, you would owe all the taxes, plus penalty and interest, on the full amount of cash you received.

Q. What happens if capital gains tax rates are lowered after I set up the private annuity?

A. Politicians frequently advocate lowering capital gains rates, so this could happen. In that case, you would get the benefit of the lowered rate on the capital gains portion of your annuity payments.

Q. Can the trust buy property at a later date?

A. Yes, the investments of the trust are extremely flexible. The main focus of the trust is to be able to make payments as agreed to by the annuitants. The annuitant can even borrow from the trust.

Q. What happens if the trust goes broke before I die?

A. With bad luck or poor investment that could happen. In that case there are no further taxes, nor penalty or interest owed by either the trust or the annuitant to the IRS. You cannot be taxed on money you don't have or will not earn.

Q. When the property is sold, may I keep some of the cash from the sale?

A. Yes, in that case you would pay taxes only on the portion of money that you kept for yourself.

Q. How can I have my tax advisor or attorney analyze the private annuity idea?

A. We will gladly provide your tax advisor with the technical and legal information he/she needs to properly advise you. For a quick answer have your tax advisor review IRS Revenue Rulings 55-119 and 69-74, plus the IRS' GCM39503 of 5/19/86 and Treasury Decision TD-8754 issued in 1998, and the Ninth Circuit U.S. Court of Appeals decision "LaFargue v. Commissioner, 689 F. 2d 845 (1982)".

Q. I'm interested in having one of these plans put together, what should I do next?

A. Your next step is to contact us directly. We will communicate with your tax advisors if necessary. We will also provide an illustration of your annuity payments. To get the program put together we will help you fill out an application. Then our attorneys, who are experts with the private annuity, will review the information.