Situation:

Isadore and Isabel Business Owner, both 55 years old, own a successful construction business and real estate and would like to sell it and invest the proceeds without incurring immediate capital gain taxes. The value of their business and real estate is $4,000,000 and they have a tax basis of $1,000,000 and depreciation of $250,000.   Therefore, they have a total capital gain of $3,250,000. The capital gain tax (federal and state) associated with the gain is approximately $666,875.  They have additional non-business assets consisting of their residence, vacation home and retirement accounts totaling $3,000,000.

Goals:

Their goals are to accomplish the following:

1. Defer and spread out some of the capital gain taxes of $395,000 for their business and $271,875 for their real estate.
2. Remove the value of the business and real estate from both of their estates.
3. Pay minimum gift taxes, if any.
4. Not to have to give the monies to charity to accomplish their objectives.
5. The interest free loan interest from the IRS earned by the trust is to fund a life insurance policy.

Options & Comments on Each Option:

Option.1  1031 Exchange: No, because they have no desire to purchase    more real estate.

Option.2  Charitable Remainder Trust: No, because they want their

Family members to be the beneficiaries. However, a charity can still be designated as a beneficiary of the Private Annuity Trust.

Option.3  Private Annuity Sale: Yes, because it achieves all their goals.

(IRS Revenue Rulings 55-119 and 69-74)

Private Annuity Sale:  IRS Revenue Rulings 55-119 and 69-74

1. • The Private Annuity will enable them to defer the capital gain tax

   of $666,875 (See Exhibit A & B). They can begin receiving income or defer receiving payments from the Trust up until they’re 75 years old.          In this case they are taking joint life expectancy income from proceeds of the sale of their business and deferring payments on the real estate until age 71.  According to the IRS, they have a 33-year combined life expectancy, so they would receive joint and survivor payments of $169,655 per year for 33 years, and $251,603 per year for 15 years (beginning at age 71 ) if they live that long, resulting in an estimated life payout of $9,919,408. After the second of their deaths, the remaining funds in the Non Grantor Trust will pass directly to their beneficiaries without probate or estate taxes of approximately $7,142,885 (based on  the trust earning an after tax return of 8.8%)*

2. The capital gain asset (their business and real estate) is sold to the Trust; therefore, it is not part of either of their estates. The annuity is a life annuity — the payment obligation ceases at their second death.
3. If supplemental gifts are not made to the Trust, representing its “equity”, only 7% of the value of the Trust will be allocated to the gift category.
4. Life insurance can be included as an additional estate tax-free benefit, although it is not required to make this technique work.
5. The 5.8% rate used in Exhibit A and B is an assumed IRS’s applicable federal rate (AFR), which is determined when the trust is funded from the asset sale.
6. The Trust assets should be invested in a tax-efficient manner allocated between ; municipals, managed growth stocks and variable or Index annuities would be ideal, but almost any capital growth asset with nominal income is acceptable.

Result:

All goals are achieved!  (Exhibits A, B & C)

Mechanics:

The annuity payments that will be received (deferred as late as age 70 ½) will consist of three components:

• The first component represents a tax-free return of basis.The second component represents dollars assigned to the capital
• gain portion, subject to capital gain taxation at a  20% rate.
• The third component represents ordinary income and is taxed at the same rates as dividend and interest income on their tax return.

The annuity payments to the Owners are the result of a mathematical formula that is based on their life expectancies as specified by the IRS. There are no estate taxes related to this asset because the asset had been sold at full market value and is not part of their estate. Upon their deaths, the beneficiaries will receive all that remains in the Trust, either in a lump sum or “sprinkled”.

* This is acknowledging that the trust will have to earn 1-2% more than 8.8% to pay taxes incurred by the trust.

ANNUITANT

Tax Free Build Up

No Capital Gains Taxes Owed By Annuitant from Sale to Trust

Annuity Payment Amount Remains the Same for Both Spouses

(payment continues until the second death– “Last to Die”)

BENEFITS TO ANNUITY PROPERTY

No Estate Taxes

No Gift Taxes

No Probate

THE OWNER “GRANTOR” OF THE TRUST

The Heirs— Your Family— are Beneficiaries

ANNUITANT

Tax Free Build Up

No Current Capital GainsTax Owed By Annuitant from Sale to Trust

Annuity Payment Amount Remains the Same for Both Spouses

(payment continues until the second death– “Last to Die”)

BENEFITS TO ANNUITY PROPERTY

No Estate Taxes

No Gift Taxes

No Probate

THE GRANTOR OWNERS OF THE TRUST

The Heirs— Your Family— are Beneficiaries