Feature

Deferring Capital Gains Taxes Without a 1031 Exchange

by Larry Weiss

Many people have profited from our fabulous real estate market over the past several years. As property owners age, the burdens of acting as landlords and working with tenants often outweigh the benefits of real estate ownership. Many property owners want to know the best way to sell a highly appreciated property. For example, a recent client owned a small apartment building with four units. He had purchased the building over 25 years ago, and it was now worth over $1,500,000. He wanted to sell his property and get out of the landlord/tenant business.

There are numerous options for owners who wish to sell their properties. Some of the more common sales transactions include an outright sale, an installment sale or a 1031 exchange. A Private Annuity Trust (PAT) is a less frequently used but effective technique for selling appreciated property. With a PAT, you have the ability to defer the capital gains tax from the sale of your property. PATs provide tax-advantaged lifetime income and provide assets that are free of estate taxes for your heirs.

A PAT has some features that are similar to installment sales except that they are more tax friendly. Installment sale payments are made for a fixed number of years, with a PAT. You receive annual income from the trust for the remainder of your life. If you are married, you can elect to receive payments over the lifetime of both you and your spouse. In addition, you can defer any payments until you are reach the age of 70.

Your annual payments are based on three factors that include (1) your life expectancy or the joint life expectancy of you and your spouse, (2) the Applicable Federal Mid-term Rate (AFMR) published monthly by the IRS and (3) the fair market value of the property granted to the trust. Each tax-advantaged payment includes portions of capital gain, ordinary income and return of basis.

The PAT Steps Are

find a buyer for the property;
transfer the property to the PAT;
the PAT sells the property to the buyer for cash; and
the PAT pays you, the annuitant, an annual income for your lifetime.

There are several additional PAT benefits you might consider as well. The first is estate tax avoidance, which involves the transfer of the property to the trust and removes the assets from the estate immediately. When you pass on, the annual payment stream is cancelled without any value included in your estate. All remaining assets held by the trust are transferred to your beneficiaries free of estate taxes.

The second is probate avoidance. The property is removed from your estate by the buy-sell annuity contract.

The third is investment control. Family members retain the control of the investment of funds in the trust. At your death, all remaining assets are transferred to beneficiaries free of estate taxes.

The fourth is gift tax avoidance. The transfer of the property to the trust is free of gift taxes. A PAT is treated as an arm's length transaction by the IRS. The trust receives the property while the annuitant receives the annual annuity payments.

A PAT is a very attractive method for selling highly appreciated property. A PAT can be used to provide lifetime income, to defer capital gains on the sale of property and to help transfer assets to children free of estate taxes.

	1031 Exchange	Sale of Property	Private Annuity Trust
Capital Gains Tax	Indefinitely Deferred	Pay Immediately	Pay Over Seller’s Lifetime
Assets Subject to Estate Tax	Yes	Yes	No
Annual Income	Depends on New Property	Depends on How Sales Proceeds are Reinvested	For Lifetime of the Seller of the Property

The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of the SFAA or the San Francisco Apartment Magazine. The information contained in this article is general in nature and is not to be construed as advice. Consult the advice of an attorney or accountant for any specific problem. Larry Weiss, CPA, CSA is a tax and investment planner with Lau Financial Services and can be reached at 415-665-0100. He is a Registered Representative with Linsco Private Ledger, member NASD/SIPC. Tax services provided by LFS are not Linsco Private Ledger (LPL). Copyright © 2004 by the San Francisco Apartment Magazine. All Rights Reserved.