DEFERRING CAPITAL GAINS TAXES WITH THE PREMIER VI PRIVATE ANNUITY TRUST©
FEQUENTLY ASKED QUESTIONS AND ANSWERS:
HOW CAN I KNOW THE AMOUNT OF MY PAYMENTS?
WHAT HAPPENS IF I LIVE LONGER OR LESS THAN LIFE EXPECTANCY?
WHAT IF I WANT TO CHANGE THE PAYMENT AMOUNTS?
WHAT IF I NEED SOME MONEY BEFORE ANNUITY PAYMENTS BEGIN, OR WHAT IF I NEED MORE THAN THE PAYMENTS?
ARE THERE ANY FLEXIBILITIES OR VARIABILITY’S IN THE ANNUITY PAYMENT STREAM, SUCH AS INCREASING THE PAYMENTS OVER TIME?
COULD I CANCEL THE WHOLE DEAL AFTER A FEW YEARS AND GET MY MONEY?
HOW MUCH INTEREST WILL I EARN ON THE UNPAID BALANCE?
WHAT HAPPENS IF CAPITAL GAINS TAX RATES ARE LOWERED AFTER I SET UP THE PRIVATE ANNUITY?
HOW LONG CAN THE DEFERRAL PERIOD BE?
CAN THE DEFERRAL PERIOD BE SHORTENED ONCE THE PRIVATE ANNUITY IS SETUP?
WHAT GUARANTEE DO I HAVE THAT THE ANNUITY PAYMENTS WILL BE MADE?
WHAT HAPPENS IF THE TRUST GOES BROKE BEFORE I DIE?
HOW DOES THIS COMPARE TO AN INSTALLMENT SALE?
WHO SERVES AS TRUSTEE?
CAN MY SPOUSE BE EITHER TRUSTEE OR THE BENEFICIARY OF THE TRUST?
HOW DO I MANAGE THE TRUST’S INVESTMENTS?
DO I SELL THE PROPERTY AND PUT THE CASH IN THE TRUST? MAY I KEEP SOME OF THE CASH FROM THE SALE?
HOW CAN I HAVE MY TAX ADVISOR OR ATTORNEY ANALYZE THE PRIVATE ANNUITY IDEA?
MY ATTORNEY (OR CPA) HAS NEVER HEARD OF A PRIVATE ANNUITY, OR DOESN'T THINK IT IS LEGAL. WHAT "PROOF" IS THERE THAT THIS STRATEGY IS LEGITIMATE?
WHAT RISKS OR OTHER NEGATIVE FACTORS ARE THERE?
I AM INTERESTED IN HAVING ONE OF THESE PLANS PUT TOGETHER, WHAT SHOULD I DO NEXT?
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How can I know the amount of my payments?
A. NAFEP or one of its Associates can provide that answer quickly from three facts: (1) Annuitant(s) age, (2) 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. There is no charge or obligation for an illustration of your private annuity interest.
What happens if I live longer or less than life expectancy?
A. Payments go on until you (or the surviving spouse with a married couple) 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.
What if I want to change the payment amounts?
A. The payments are locked in to a fixed amount and paid either monthly, quarterly or annually for the rest of your life. The payment will not increase or decrease. The amount is based on IRS dictated interest rates at the time the annuity is created, your age and the fair market value of the exchange property. The amount cannot be changed after the contract is issued, however read the questions below for other possibilities.
What if I need some money before annuity payments begin, or what if I need more than the payments?
A. The trust can lend money to the annuitant, but the loan should not be substantially all the trust’s assets, probably no more than 10% of its assets. The loan should be structured the same way a bank would: Fully secured, market interest rates, formal loan documents with a realistic repayment schedule, and repayments are enforced.
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 to the annuitant at the outset. For example, maybe the annuitant needs an extra $1,000 a month until retirement, and then needs more. In that case the trust could issue two annuities. The first would be immediate and would be based on just enough exchange property value to pay $1,000 per month. The second annuity would be deferred to retirement age, and would be based on the balance of the value of the exchange property. Another flexibility is that the annuitant might go to a bank or other lender, and pledge his annuity payment stream to receive a loan in the needed amount.
Could 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, this invalidates the deferral you received up to that point, so you would owe all the taxes, plus penalty and interest, on the full amount of cash you received. Also, the trustee should seek legal counsel or NAFEP assistance before agreeing to the liquidation.
How much interest will I earn on the unpaid balance?
A. Every month the IRS issues the "Annual Federal Mid Term Rate" (AFMR). This rate is calculated from an arbitrary formula created by the IRS. It fluctuates each month with the normal ups and downs of the credit markets. Your annuity will use the AFMR rate that was current in the month the annuity was created. That rate is fixed for the life of your annuity payments and won't change.
What happens if capital gains tax rates are lowered after I set up the private annuity?
A. Politicians frequently advocate lowering capital gains rates further, as they did in 1997, 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.
How long can the deferral period be?
A. Deferral can be for any amount of time up to age 70-1/2 years old. If you are already older than that a deferral of one year can be arranged by setting up annual payments for the annuity with the first payment scheduled to begin in one year.
Can the deferral period be shortened once the private annuity is setup?
A. Prior to 1998 the answer was yes. But a 1998 U.S. Treasury Decision (TD-8754) seems to have eliminated this type provision, though that result is not certain. TD-8754 also identified other provisions which were no longer allowable. However, the Decision did reaffirm that deferrals of private annuities are legal.
What guarantee do I have that the annuity payments will be made?
A. One important feature of the private annuity is that it must be unsecured. That means that the trust cannot pledge its assets to the annuitant as a guarantee of the annuity. If the annuity is secured the tax strategy is not allowed by the IRS. This is not actually a problem though. The trustee's only role is to make sure your payments are made and that the beneficiaries get whatever is left. The trustee has no legal way to personally benefit from the property. That makes the annuity as secure as the investment of the trust funds. Part of the trustee's job is to make sure that the investments are prudent and reasonable. If the investment is in mutual funds the annuity payments are as safe as the stocks held in that fund. There really is no other variable that affects the security of your payments.
What happens if the trust goes broke before I die?
A. With bad luck or poor investment guidance that could happen. In that case there would be 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 have not and will not earn.
How does this compare to an installment sale?
A. An installment sale will spread the capital gains tax over the life of the note. But, there are three problems: First, an installment sale won't defer depreciation recapture. Second, when you make the sale to an outsider there is always a chance the deal will go bad, that the payments won't be made, or that the property will be allowed to degrade in value. With the annuity you can get tax deferral without the trust being forced to make an installment sale. The trust can sell for cash if it chooses. Third, with an installment sale the unpaid balance of the note will be included in your estate when you die, which makes that balance subject to estate taxes. But when the annuitant dies there is nothing left in his taxable estate from the entire annuity transaction. The beneficiaries own whatever is left.
Who serves as trustee?
A. Annuitants cannot be the trustee nor have direct control of any kind over the trust. The trustee may be any adult trust beneficiary or any person who is independent of the annuitants. For example, an adult child who is also a beneficiary may be the trustee. The annuitants' accountant, attorney, financial advisor, family friend or a relative who is not in the immediate family are all possible choices. Another option is a NAFEP corporate trustee furnished by a NAFEP Associate member. No matter who the trustee is a co-trustee can be appointed as an extra measure of security or comfort to the annuitants and beneficiaries. When a co-trustee is used all trust transactions require the signature of both the trustee and co-trustee. In all cases the beneficiaries have the ability to fire and replace the trustee.
Can my spouse be either trustee or the beneficiary of the trust?
A. No in both cases. But, your spouse can be a joint annuitant, even though he/she is not a co or joint owner of the exchange property. With joint annuitants, payments would be made until the death of the second spouse.
How do I manage the trust’s investments?
A. The annuitant(s) absolutely cannot manage the investments or any other aspect of the trust. Only the trustee can do that, though the annuitant can make recommendations. Most trustees would go along with those recommendations as long as they were generally prudent investments.
Do I sell the property and put the cash in the trust? May I keep some of the cash from the sale?
A. It is imperative that the property be placed in trust before it is sold. The annuitant may be paid some of the cash when the trust liquidates the property. In that case the annuitant must pay, by the end of the tax quarter, a proportionate share of capital gains taxes on the cash he/she received.
How can I have my tax advisor or attorney analyze the private annuity idea?
A. NAFEP or one of its Associates will gladly work with you or your tax advisor by providing you with the technical and legal information needed to properly advise you. This is done routinely by using a NAFEP publication entitled Private Annuity Legal Package. Most CPAs and tax advisors are enthusiastic about the strategy after they understand it. Please contact a NAFEP Associate in order to get the proper advice and guidance, or contact NAFEP directly for the name of a NAFEP associate that can assist you.
My attorney (or CPA) has never heard of a private annuity, or doesn't think it is legal. What "proof" is there that this strategy is legitimate?
A. For the best and most complete information refer to the previous answer. 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)”. (These rulings and decisions are included or summarized in the above mentioned Legal Package ).
What risks or other negative factors are there?
A. The only risk to your money is from the stability of the investment. But you have that same concern even if you make a cash, taxed sale because you still need to invest the money. Prudent investment strategies make that risk negligible, though. There is an unrelated negative factor. The annuity face amount should be something less than the fair market value of your property, by 5% to 10%. This provides the trust with some backup or reserve capital. Without a reserve in the trust the value of the property that went into it and the obligation to make the annuity payments are theoretically equal. The net worth of the trust would be zero, its assets and liabilities would be equal. That could lead to a disallowance of the transaction by the IRS on the grounds that the trust lacks economic substance. Reserve capital needs may be handled by a gift of some additional property to the trust (from either the annuitant or beneficiaries). But the most common way to provide the reserve is by decreasing the face value of the annuity by some amount. NAFEP recommends writing the private annuity for 93% of the fair market value of the property.
I am interested in having one of these plans put together, what should I do next?
A. Your next step is to contact NAFEP or one of its members directly. They will communicate with your tax advisors if necessary. They will also provide an illustration of your annuity payments. To get the program put together they will help you fill out an application. Then an attorney who is an expert with the private annuity will review the information and put the documentation together. Finally, NAFEP or one of its Associate members will assist you and your advisor with implementation.
>THE C.G. TAX PROBLEM
>TAXATION
>DEFERAL OF PAYMENTS
>COMPARE A TAXED SALE
>ANNUITY PAYMENTS
>DEPRECIATION RECAPTURE
>BENEFITS
>PRIVATE ANNUITY vs. CHARITABLE REMAINDER TRUST
>PRIVATE ANNUITY AS A TAX STRATEGY
>QUESTIONS AND ANSWERS
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