Tony's Tax Tips

The Tax Chess Board Part 9

This article originally appeared in the Pasadena Star News on May 27, 2006.

THE TAX CHESS BOARD – An important piece on the tax chess board is the ownership of stock and real estate. If the stock and real estate appreciate, they can increase your net worth and you do not have to pay any income tax. Some of the tax consequences of disposing of appreciated assets can be deferred by transferring them to a private annuity trust.

C. Anthony Phillips, CPA

PRIVATE ANNUITY TRUST – You can establish a private annuity trust and transfer your appreciated property into it in exchange for annuity payments for the rest of your life. The transfer to a private annuity trust and receipt of an annuity payment contract will not be considered an immediate taxable event.

WHAT IS A PRIVATE ANNUITY TRUST? – A private annuity trust is an irrevocable trust in which you retain the right to receive an annuity payment for a specified term.

HOW DOES A PRIVATE ANNUITY TRUST WORK? – Prior to the sale of an appreciated asset, you transfer it to a private annuity trust. The private annuity trust sells the appreciated asset to a buyer. The resulting funds are invested in an income producing asset that generates a rate of return sufficient to pay the required annuity to you. You pay tax on the gain portion as you receive the annuity payments. Any assets remaining in the private annuity trust go to the named beneficiary of the private annuity trust, estate and gift tax free.

WHY WOULD YOU WANT TO TRANSFER YOUR APPRECIATED PROPERTY TO A PRIVATE ANNUITY TRUST? – The principle benefit is that you can defer the tax on the gain from the sale of appreciated assets into future years as periodic payments are received.

OTHER REASONS FOR DOING A PRIVATE ANNUITY TRUST – You avoid paying the higher depreciation recapture tax; you eliminate estate taxes upon your death; the transferred appreciated assets are protected from any legal disputes. You avoid probate expenses and delays.

YOU MAY NOT WANT TO DO A PRIVATE ANNUITY TRUST – The trustee of the private annuity trust is totally independent from you and is governed by the private annuity agreement. The risk is that the trustee may misappropriate or simply squander the assets in the trust. Another reason is the trustee may not be able to generate a sufficient cash flow to pay the required annuity payments.

Tony Phillips, CPA has a certified public accounting firm, Phillips & Company in Pasadena and is President of Downstream Exchange Company which helps investors save taxes when they sell their investment property.

The above is not intended to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer.