Many sellers have a capital gain that exceeds their allowable tax free capital gain
on primary residences or are faced with huge capital gain liabilities on second properties. There are several deferral mechanisms that all real estate professionals should have in their toolbox. Some of the most commonly used tax deferral mechanisms are, 1031 Exchanges, TIC's and Private Annuity Trusts. These three devices allow clients to dispose of property without triggering a taxable event. Each of these devices has its inherent benefits and drawbacks, but another method has seen a recent spike in achieving this goal is the Structured Sale.
The insurance industry has created a product using IRC Section 453, to allow clients to sell highly appreciated assets in the form of an installment sale. The seller of property has an unlimited source of capital gain deferral. The structured sale is built on the chasis of the conservative structured settlement product used in legal settlements. The structured sale is typically underwritten by companies with A+ ratings or higher. This product completely eliminates any risk associated with the real estate market.
The basic process is the buyer and seller settle on a sale price. The seller works with a structured sale planner to set a periodic payment schedule that meets their future and short term needs. At closing, the buyer pays the full amount with the amount being deferred distributed directly to a third party. The third party uses the funds to purchase an annuity that will pay the periodic payment. By following this process the seller is able to defer all or a portion of the capital gains on the property. The seller has disposed of the real estate and moved their assets into a guaranteed investment vehicle. Unlike a typical installment sale, the seller no longer has the added concern of the buyer's creditworthiness to make the periodic payment stream.
Example 1: John and Jane Beach, both age 55
John and Jane bought an ocean front condo in 1979 for $195,000. The condo has always been the second home for the Beach's. The Beach's have negotiated the sale of the property for $950,000. The Beach's recently sold their primary residence and were able to realize the full $500,000 capital gain exception.
Their current income needs are fixed and they would like to sell the condo but not pay the taxes. The Beach's, with the help of their real estate agent and structured sale planner, have decided to use the structured sale product. They have paid the mortgage off and have no loans against the property. The following will take place at closing.
The Beach's will receive $195,000 at closing. This represents their basis in the property. The remaining capital gain of $755,000 will be placed into the structured sale.
The Beach's have set up a periodic monthly payment of $4,000 for 120 months. On the 121 month the remainder of the funds will be distributed in a lump sum of $520,800. Each installment payment received by the seller may consist of any or all of the following, non-taxable recovery of basis, taxable gain and/or interest.
The Beach's were able to sell the property at it's highest value and defer the capital gains taxes. They set up a payment stream to cover their fixed costs for the next ten years. They no longer have the hassle of the second home and have eliminated the high costs of maintaining the property.