28. The Private Annuity

A Private Annuity can be a valuable estate planning tool in intra-family situations and in a closely-held corporation (e.g. younger stockholders buy out a retiring stockholder's shares). An individual transfers his assets to a second party for the unsecured promise of income payments payable for life.

Upon the death of the seller (annuitant) all annuity payments cease. The seller has transferred an asset out of his estate and has received an income for life. The annuitant's income consists of 3 parts:

1. A "recovery of basis" portion which is excluded from gross income.

2. A "capital gain" portion for the life expectancy of the annuitant
- ordinary income thereafter.

3. An "interest" portion which is taxed as ordinary income.

The purchaser of the assets makes a capital expenditure with each annuity payment. The "interest" portion to the annuitant is not an interest payment by the purchaser. The purchaser is not entitled to an income tax deduction.

Careful consideration and legal advice should be obtained before entering into the private annuity. The savings in estate taxes may not be worth the formation and administration fees, the commitment by the purchaser (heir) to life-time payments, and the ability of the asset to generate enough money after taxes to make the payment.

The purchaser will have a new basis in the property equal to the present value of the annuity payments (the purchase price) for depreciation purposes until the annuitant dies. The purchaser's cost basis at death will equal the sum of all annuity payments.

Tax reference verification 1-800-829-1040

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