San Francisco Real Estate - Residential

Private Annuity Trusts may provide enormous financial benefits - Part 3

This article is provided by our friends at Quantum Advisors.

- Mick Orton

A Private Annuity Trust Can Be A Home Seller’s Best Friend

When you sell a personal residence, as long as you meet certain requirements including living in the house as your primary residence in at least 2 out of the previous 5 years, you don’t have to pay tax on gain up to 250,000 as a single taxpayer, or $500,000 as a married couple filing jointly. Any gains above these tax-free exclusion amounts will be taxed. A Private Annuity Trust will allow you to decrease your taxes when you sell your personal residence even in the following situations:

• Many people now have taxable gains in the personal residence that exceed these amounts.
• If you do not occupy the property as your primary residence for at least 24 months, the entire gain will be taxed at capital gain tax rates (if you’ve held the asset for at least 12 months.)
• If you “Flip” the property, selling it in less than 12 months, you will be faced with paying tax on the entire gain at ordinary income tax rates.
• The law requires that if you do move into a property that was previously a rental property and was obtained in a 1031 tax-free exchange, you can’t use the tax-free home gain exclusion unless you have held the new property for 5 years.

Real Life Example:

Barb, age 60, wants to sell her home and buy a condo. She lives alone and does not want to take care of her big house any longer. In addition, she would like more monthly income because most of her net worth is tied up in the equity in her home. Her children agree that it would be a great idea to sell the house and buy a nice condo for $500,000. Barb purchased her home 30 years ago for $50,000, has made $150,000 in capital improvements, and now wants to sell it for $1.5 million.

Barb went to her CPA to find out the tax implications of selling her home. He explained that as a single individual, she could exclude $250,000 of taxable gain from the sale of her home, but that she would still have to pay $255,150 in taxes calculated as follows:

Taxed Sale Calculation:

• Original Purchase Price - $ 50,000
• Plus Improvements - ($150,000)
• Cost Basis - $200,000
• Sales Price - $1,500,000
• Less Net Cost Basis - ($200,000)
• Equals Gross Taxable Gain - $1,300,000
• Less Tax Free Exclusion - ($250,000)
• Equals Taxable Gain - $1,050,000
• Federal Taxes Due - $157,500
• State Taxes Due - $97,650
• Total Taxes Due - $255,150

Barb was stunned when she heard that she would have to pay $255,150 in taxes if she sold her home. She told her CPA that she would not pay this ridiculous amount of taxes because it was five times more than she paid for the home when she originally bought it!

The Answer To Barb’s Problems -- $255,150 In Current Taxes Can Be Avoided!

The great news is that Barb can sell her home and buy the new smaller condo and avoid paying the $255,150 in taxes this year! If Barb places her home into a Private Annuity Trust before she sells it, she will not have to recognize the $1,050,000 in taxable gain this year. The Private Annuity Trust structure will allow her to pay tax on the $1,050,000 gain over her entire lifetime as follows:

Private Annuity Trust Transaction:

• Sales Price - $1,500,000
• Current Taxable Gain - $0
• Current Taxes Due - $0
• Annual PAT Payments - $93,750 - New Income for Barb!
• Tax-Free - $18,000
• Capital Gain - $42,000
• Ordinary Income - $33,750
• Annual Taxable Capital Gain - $42,000
• Paid Over Life Expectancy - Years X 25
• Total Gain To Pay Tax On - $1,050,000

While it is true that $1,050,000 of current gain will be avoided, Barb will pay tax on $1,050,000, over 25 years. Each year for the next 25 years, Barb will pay tax on just $42,000 of capital gain - much better than paying the tax on $1,050,000 of capital gain this year!

Now Barb Needs To Buy Her Condo

Barb will receive $7,812 in monthly payments from the Private Annuity Trust. If she takes out a 100% loan for $500,000 to buy her condo, her monthly payment will be approximately $3,200. She will easily qualify for this loan even her Trust income is her only source of income. By making payments on her condo, Barb will receive income tax deductions for the mortgage interest as well as her real estate taxes. Her mortgage interest and real estate tax deduction will be $36,000, which is more than enough to offset 100% of the ordinary income portion of her Private Annuity Trust payments!

This means that after Barb makes a condo payment of $3,200 and after she pays the taxes on her Trust income, she will have $4,000 more to spend every month than she has now.

Eventual Wealth Transfer to the Kids

If the Private Annuity Trust assets earn a net annual return rate of 8%, and if Barb receives her $93,750 of annual income for 25 years, then passes away in 25 years at her life expectancy, the assets in the Private Annuity Trust would be valued at $3,598,803. This value is AFTER Barb has received her 25 years of payments. The $3,598,803 passes to her beneficiaries free of estate taxes.

For more information, or for a FREE, 10 page Tax Savings Analysis on your property, contact Gary Katz at QFN – 800-224-1053 – or email Gary@QAplan.com.

- Betsy Hartwell - Quantum Advisors

*This is the third in a series of articles - to be continued...

Part 1 may be read here.
Part 2 may be read here.

posted by SFResidence.com @ 9:03 AM