Great news, you are about to sell your home, investment real estate, closely held business or other real property at a large gain. Bad news, a large gain means a large tax liability. Since the beginning of time or the beginning of the income tax at least, taxpayers have wanted to defer their tax obligations. So how can you keep the tax man at bay?
A sellerās options
Sellers of appreciated property can choose from a variety of strategies designed to defer or cut capital-gains taxes. These include Private Annuity Trusts (PATS) which no longer pass IRS muster, Charitable Remainder Trusts(CRTS) which can help reduce capital gains but might not do much for your heirs and can be complicated and fee intensive. On the commercial real estate front, the popular 1031 Exchange may be a viable technique provided you want to stay in the like kind exchange game. Then there is the structured installment sale, a new twist on an old concept.
What is an installment sale?
Installment sales hardly represent a new concept and are merely a ādisposition of property where at least one payment is to be received after the close of the taxable year in which the disposition occursā (26 USCS Ā§ 453 (2005)). Installment sales permit the seller to defer gains on certain property dispositions to the tax year in which the related sales proceeds are received. The buyer arranges to buy assets from the seller. The installment saleās agreement obligates the buyer to make specific periodic payments for a stated number of years to the seller.
Installment sale irritant
By its very nature, an installment sale calls for the buyer to take possession of the property in question now and pay for it later. What if the buyer runs into financial problems and is unable to fulfill his promise to pay? If an installment sale fails, then the seller looks for recourse, such as reclaiming the property or cash. Even if the seller is successful in collecting, it is likely the experience was frustrating, time consuming and expensive. If the seller winds up with cash which he is entitled to after the buyer defaults, he will owe the tax right away, so the goal of tax deferral will have been lost.
The solution: the guaranteed structured sale
Borrowing from the structured settlement industry whereby plaintiffs or claimants in personal injury settlements opt for future periodic payments in lieu of one time lump sum cash payments, the structuring of an installment sale (a structured sale), involves the seller bargaining for future periodic payments instead of an immediate cash distribution.
In this transaction the buyer and seller acknowledge and agree that payment will be in the form of specific future periodic installments for a stated number of years or a lifetime. The buyer then makes a lump sum payment (representing the discounted present value of the future payments, or the agreed upon sale price) to an A+ rated life insurance company who in turn makes the scheduled periodic payments in the form of a tax deferred fixed rate annuity, thereby guaranteeing the sale.
Recent development
It is now possible for the structured sale to be used as a fallback to a failed 1031 Exchange providing bona fide intent is expressed in the agreement.
As an unprecedented wave of baby boomers begin to reach retirement, there is more concern about retirement security, income streams and tax effects than in any other time in our nationās history. The structured sale is a unique vehicle for satisfying multiple goals across a wide spectrum of personal and commercial sales and can provide a seller with a guaranteed stream of income that can never be outlived, providing a lifetime of worry free income and financial freedom.