What Is a Private Annuity?

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What Is a Private Annuity?

A private annuity is an estate planning strategy in which you can transfer property from your estate to your children prior to your demise. Provided that the private annuity is correctly established, you can avoid estate and gift taxes while realizing income for the remainder of your life.

It involves the sale of an asset to your children or other beneficiaries in return for an unsecured promise to compensate you with yearly payments for the rest of your life. Since the asset is transferred to another party, it is, therefore, removed from your estate. However, the annual payments that you receive in exchange for the asset will be included in your estate.

How to Structure a Private Annuity

Every annuity payment that you receive is a return of your basis that is partially tax-free. Each payment also represents an amount that is partly made up of capital gain and interest. Your beneficiaries will receive a basis in the property that is the equivalent of the annuity payments that they make to you. When the annuity’s value is equal to the property’s value, your beneficiaries can immediately sell the property without having to pay capital gains taxes. They can then reinvest the proceeds from the sale.

When to Use a Private Annuity

It is very beneficial to use a private annuity when you are in possession of property with a low basis.  Capital gains are recognized over the course of several years in lieu of all in one year. In addition, if the property is one to which the rules of depreciation recapture apply, the recapture is drawn out over the course of years while you receive payments. Thus, a private annuity is often used for such assets as real estate, securities, business interests, and cash. It is especially advantageous when applied to property that is likely to yield large capital gains.

Establishing Your Annuity Payments

At the time at which you set up your annuity payments, you will need to find out the fair market value of your property. The actual amounts of the annuity payments are then determined by consulting the IRS annuity tables under Internal Revenue Code (IRC) §7520.

According to the tables, if you live as long as your life expectancy, then you will get all of the value and interest from the property. However, if you do not live as long as your life expectancy, the beneficiary will no longer have to make any annuity payments after your demise. But if you live beyond your life expectancy, you will receive an amount in excess of the property’s value plus interest.

How Important Is My Life Expectancy?

The amounts of the annuity payments are determined by your life expectancy. The payments are likely to be higher if you are older. According to the IRS, the tables cannot be used in the event that you are terminally ill or unlikely to live beyond one year from the annuity date. Although the IRS has attempted to forbid the use of the tables in cases where the annuitant is not in good health, though not necessarily terminally ill, it has been unsuccessful.

Seeking Legal Advice

If you would like to learn more about private annuities, and whether they are appropriate for you, then you should consult an estate attorney, who can help you determine whether they are the right vehicle for you to use in avoiding estate and gift taxes.

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Last Modified: 06-23-2015 03:47 PM PDT

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