An annuity (a contractual promise to make periodic payments for life or
a term of years) issued by a private individual (versus a company which
issues commercial annuities and spreads actuarial risk), in exchange for
an asset. A private annuity can be issued between family members.
A private annuity may be issued to transfer ownership of a family business
such as a farm or closely held corporate stock without incurring gift tax
and ensuring the annuitant a steady stream of income for life.
Gift tax consequences
If the annuity is for full and adequate consideration, there should be
no gift. However, there are certain circumstances, such as when the income
from the property is the only source of annuity payments, when the transfer
may be considered a gift. Careful structuring
of the transaction is necessary.
Estate tax consequences
If the annuity is for the life of the annuitant alone, there should be
no inclusion in the annuitantís estate since his/her interest ends at the
moment of death. The annuity payments received between the time the annuity
is issued and death to the extent not consumed
will be in the annuitantís estate.
Income tax consequences
The annuitant receives two components in each payment. One component is
a proportionate share of principal (the original purchase price of the
annuity). This component is broken down into the original basis of the
property, which is treated as return of capital to the annuitant, and into
gain, which is the difference between the purchase price of the annuity
and the original basis. The second component is income. Therefore, the
annuitant reports the gain from the ďsaleĒ of the property over his/her
life expectancy. If the annuity extends beyond the original life expectancy,
the payments become wholly taxable as income.
The appreciation of the property is taken out of the annuitantís estate.
The annuitant receives an income for life.
If the annuitant lives much longer than his/her life expectancy, the annuity
payer may end up paying substantially more than he/she would have in an
installment or outright sale of the property.
Certain structuring of the transaction could result in gift/estate tax
inclusion in the estate of the annuitant such as if the annuity is secured
by the transferred property. Thus, the annuitant risks default on an unsecured
annuity or inclusion for gift/estate tax purposes.
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