- Private annuity trust
A private annuity trust (PAT) enables the value of highly appreciated assets, such as real estate, collectables or an investment portfolio, to be realized without directly selling them and incurring substantial taxes from their sale.
A PAT can defer 100% of the United States federal
capital gains taxdue on the sale of an asset, provide a stream of income, and effectively remove the asset from the owner's estate, thus reducing or eliminating estate taxes. With these advantages, a PAT provides an alternative to other methods of deferring capital gains taxes, such as the charitable remainder trust (CRT), installment sale, or tax-deferred 1031 exchange.
As of October 2006 the IRS ruled that the PAT is no longer a valid capital gains tax deferral method. Those who utilized the PAT before the IRS ruling are grandfathered in and will continue to recognize its tax deferral benefits.
Prior to October 2006, PAT's were very attractive to sellers of highly appreciated real estate. A PAT will allow the owner of investment property to defer up to 100% of the taxes without ever having to buy another property. This is very important because good quality investment properties are difficult to locate. The PAT will also allow the seller of a highly appreciated
primary residenceto defer up to 100% of the taxes as well. This is important because all gains on primary residences over $250,000 for a single person, and $500,000 for a married couple will be taxed if a PAT is not used.
A properly structured PAT involves first transferring the asset to the PAT in return for a lifetime income stream in the form of an annuity. The transfer of the asset is not a taxable transaction. It is important to understand that a PAT is not issued by a commercial insurance company. Anytime after the asset is placed into the PAT the asset can be sold without taxation to the trust. There is no tax on the sale to the PAT because the PAT has actually purchased the asset from the owner for the fair market value of the asset. The PAT pays the owner for the asset with a lifetime income stream. The PAT has a basis equal to the fair market value so the PAT can sell the asset for fair market value and not be subject to taxation. The original owner of the asset pays taxes only on the PAT payments received, not on the transfer of the asset to the PAT.
PAT payment amounts are based on IRS Life expectancy tables for a single individual or for the joint lives of the asset owner and his or her spouse. The lifetime annuity payments are then made from the PAT assets and/or investment earnings from asset or, alternately, the asset is sold and the proceeds are reinvested by the trustee to fund the payments. PAT payments are calculated using an IRS formula based on the age of the asset owner(s), the value of the asset, and the current IRS interest rate called the Applicable Federal Rate -AFR. PAT payments can be made monthly, quarterly, or annually.
Neither the transfer of the asset to the trust nor its later sale is subject to income taxes if, as is usually the case, the annuity payment is established at a level that gives the annuity a present value equal to the value of the asset sold. However, each annuity payment when received will be partially taxable on the share of capital gains, depreciation recapture and
ordinary incomeincluded in the payment. The portion representing recovery of original tax basis is not taxable.
To preserve the benefits of a PAT, the trustee must be independent, the annuity cannot be secured in any way, and the annuitants cannot have any control over the trust or its investments. Informal suggestions and advice, however, are not prohibited.
The primary benefit of a PAT is that it allows the full appreciated value of the asset to be invested and to earn income before capital gains and recapture taxes are paid. This means that the taxes due can be stretched out over the owner's entire lifetime. The IRS does not charge any interest or penalties for this form of tax deferral. If the trust's earnings are greater than the annuity amounts paid, the excess value will accrue or can be paid out to the ultimate beneficiaries. The owner's heirs who will also receive any remaining investments in the PAT completely free of estate taxes after the owner has died. If the owner dies before living out his or her life expectancy, the trust might be required to pay a portion of the deferred capital gains taxes. On the other hand, in most cases if the owner lives at least 2/3 of his or her life expectancy, the trust will receive additional tax benefits.
The investment of the pre-tax proceeds potentially gives private annuity trusts the ability to generate substantially more money over the long run than a direct and taxed sale. However, partially offsetting this advantage are the compressed income tax brackets for trusts that cause the investment earnings to reach the maximum income tax bracket when income exceeds $9,000–$10,000 annually. Also, the PAT is not allowed to deduct the amount of imputed interest built into the annuity payments that it makes. Sometimes the PAT will invest in a deferred annuity in an effort to minimize trust income taxes, but at the expense of sizable commissions, fees, and taxes. Investing PAT assets in a deferred annuity issued by a commercial insurance company should be avoided at ALL costs.
Thus, potential benefits from a private annuity trust include lifetime income, deferral of capital gains and depreciation recapture, investment flexibility and diversification, enhancement of retirement income, and tax-free inheritance of the remaining trust funds by the designated beneficiaries. These benefits in many cases will enable a PAT to provide superior results as compared to a charitable remainder trust (CRT), installment sale, or tax-deferred
After October 2006 the PAT is no longer a method to defer capital gains taxes. Allstate Insurance developed the Structured Sale which utilizes a structured annuity. The Structured Sale (Ensured Installment Sale) has generally considered to be a much superior tax deferral method to the PAT. However, this is heavily debated by E. Anthony Reguero, who contends that if used properly, the Private Annuity Trust is superior to the Structured Sale both in terms of the tax benefits to the beneficiary or client AS WELL AS the number of ways the IRS can benefit by taxing the trust.
* [http://www.annuitiesinstitute.com/ Annuities Institute] National independent planning firm
* [http://www.nafep.com/ NAFEP] National Association of Financial & Estate Planning
* [http://www.napat.org/ NAPAT] National Association for Private Annuity Trust
Wikimedia Foundation. 2010.
Look at other dictionaries:
private annuity — An arrangement under which a parent transfers assets to a trust for children or grandchildren and in return gets regular lifetime payments (an annuity). Under certain circumstances, the trust assets won t be subject to estate tax when the parent… … Law dictionary
Private Annuity — An agreement between two parties in which one party (annuitant) transfers an asset to another party (obligor) in return for unsecured payments for the remainder of the annuitant s life. For the agreement to be classified as a private annuity,… … Investment dictionary
Charitable Remainder Annuity Trust — A Charitable Remainder Annuity Trust, is a Planned Giving vehicle that entails a donor placing a major gift of cash or property into a trust. The trust then pays a fixed amount of income each year to the donor or the donor s specified beneficiary … Wikipedia
trust — n 1 a: a fiduciary relationship in which one party holds legal title to another s property for the benefit of a party who holds equitable title to the property b: an entity resulting from the establishment of such a relationship see also… … Law dictionary
trust — A legal entity created by a grantor for the benefit of designated beneficiaries under the laws of the state and the valid trust instrument. The trustee holds a fiduciary responsibility to manage the trust s corpus assets and income for the… … Black's law dictionary
Annuity (European financial arrangements) — An annuity can be defined as a contract which provides an income stream in return for an initial payment.Immediate annuityAn immediate annuity is an annuity for which the income stream begins at a time after the initial payment which is less than … Wikipedia
United States trust law — Introduction Most law regulating the creation and administration of trusts in the United States is now statutory at the state level. In August 2004, the National Conference of Commissioners on Uniform State Laws created the first attempt to… … Wikipedia
Charitable trust — Wills, trusts and estates … Wikipedia
Fund for Assistance to Private Education — with the mandate of providing assistance to private education institutions in the Philippines.HistoryFAPE was established in the sixties from the confluence of two factors, namely: the recognition of the crucial role of private education in… … Wikipedia
Investment trust — Investment trusts are companies that invest in the shares of other companies for the purpose of acting as a collective investment.cite web title = Investment Trusts work = Your Money publisher = The Motley Fool date= 13 March 2006 url =… … Wikipedia