Private Annuity Trusts


The Private Annuity Trust, (which is made possible under Section 72 of the Internal Revenue code) is both an alternative and compliment to 1031 Exchanges and allow the seller to defer capital gains taxes at the time of sale. 

Property is sold to an irrevocable trust in exchange for a stream of payments over their lifetime, or an annuity contract.  The trust may then sell the asset to an intended buyer.  Since the asset is transferred to the trust as fair market value, capital gain is not recognized at the time of sale. Rather capital gain and recapture taxes are paid as the income is received by the property's seller (the ones receiving the annuity payments.)  

From an estate planning standpoint, the use of a Private Annuity Trust transfers the asset out of the seller's taxable estate, thereby eliminating any estate tax that might be incurred upon the seller's death.  Additionally, since the property is sold from the seller to the irrevocable trust, no gift taxes are incurred. 
The Private Annuity Trust is very flexible and can be used to:
  • Exchange down (when using a 1031 exchange, loan value of the replacement property must be equal to or greater than what is being sold)
  • facilitate one partner cashing out of a project while the others may want to participate in a 1031 exchange
  • Sell multiple properties whereby each sale would generate its own separate private annuity contract within the original trust.
  • Act as a safety net should time limits in a 1031 exchange be exceeded

  1. To take advantage of capital gain deferral benefits, the property should be placed in the trust before opening escrow to sell the property to a third party

    1. The trust buys the asset by paying the seller (or grantor) with an annuity contract which is a private arrangement between the Trust and the Grantor and not to be confused with an annuity that may be purchased from an insurance company.  

    2. Often the first payment is deferred until the grantor has reached retirement age, however payments may begin immediately

    3. When grantor begins to receive annuity payments, some of each payment is subject to the capital gains and recapture taxes that would have been payable were the property sold in a traditional way.

      1. The taxable amount is spread over the grantor's actuary life expectancy

      2. If grantor dies before actuary life expectancy, all taxes are due.  

  2. The trust must have as its trustee a party other than the property owner -- usually an adult child or other relative of the property owner.  Trust Beneficiaries are usually the grandchildren of the property owner. 

  3. When the Trust sells the property, the proceeds, including any deferred unpaid taxes, may be invested in other real estate or virtually any other investment.  

  4. Once the irrevocable trust has been created, the trust may be used as a vehicle to sell other properties whereby each sale would generate its own separate private annuity contract. 

As a Safety Net for 1031 Exchange

Requirements for a successful 1031 Exchange require 45 days to identify potential properties to purchase and 180 days to close the transaction.  

  1. Prior to opening escrow, establish a Private Annuity Trust
  2. Proceed with the standard 1031 Exchange with 100% of the cash going to the 1031 Qualified Intermediary
  3. If the 1031 exchange is successfully completed, the Trust has a mechanism to uncouple the property from the Trust; and the Trust can be used another day.
  4. If any of the deadlines expire, the proceeds go to the Trust

Source: Commercial Investment Real Estate, Nov-Dec 2006 McCready, Coley, Gorak, p36-38

 

 Uncover the Characteristics of these other Developments:

Commercial Mortgage Backed Securities Market Alert updated weekly

Additional Information Can be Found by Clicking: