When selling a business, professional practice or personal property, you may wish to defer all or a portion of the capital gains tax realized from the transaction. A structured sale annuity can be advantageous as it allows you to spread the tax liability over several years through periodic annuity payments.
Rather than reporting a lump sum profit in the year of the sale, the annuity would disperse the taxable gains over a desired number of years. There are some protocols that must be followed, but when setup correctly structured sales can help to reduce taxes while providing a fixed income stream.
Also known as an installment sale, a structured sale is the disbursement of a qualified asset where you receive at least one payment after the year of the transaction. Each installment or payment consists of a portion of the following:
- The nontaxable recovery of your original investment (cost basis)
- The taxable gain from the sale (profit)
- Earned interest
In some cases, annuity contracts underwritten by well capitalized, highly rated insurance companies are used to guarantee future payments. In other instances, treasuries are used to create and guarantee payments.
You and the buyer agree on a purchase price of the asset. You both enter into an installment sale agreement where the buyer promises to make periodic payments for a set period of years. Next, the buyer assigns the periodic payments in a lump sum (agreed upon purchase price or portion thereof) to an assignment company.
The assignment company immediately uses the lump sum to purchase an annuity contract that guarantees future payments. The insurance (or treasury) company underwriting the annuity then makes regular future payments to you the seller.
The installment sale agreement must be established before the sale of the asset takes place. It cannot be established if all funds have already been exchanged between you and the buyer.
It is important to note that the buyer does not make periodic payments to you, rather they assign the agreed upon amount of the sale in a lump sum to the annuity. This way, the buyer has no future obligations and you need not worry about their ability to make future payments.
Additionally, you (the seller) are not obligated to receive all funds by way of periodic annuity payments. In some cases, you may wish to receive only a portion of the sale through future payments and the remaining amount in a lump sum – or by any other agreed upon arrangement with the buyer.
Annuities are used to fund a structured sale because of their safe track-record and long history of meeting future financial obligations. Few other investments can safely provide periodic payments as well as a tax-deferred annuity contract. The insurance companies providing the annuity payments are highly regulated and have strict reserve requirements designed to prevent insolvency.
Annuities will also credit fixed interest on the funds in deferral. Your future payments earn interest until they are withdrawn in subsequent years. The longer the payments, the better your overall returns.
Using periodic payments, you can defer the recognition of a significant portion of your taxable gains over several years.
The capital gains that would otherwise be owed to the government in one year will instead be spread over many years while earning fixed interest in a safe and insured account. The longer your payment stream, the more time your deferred payments can benefit from compounding interest gains.
Should you have capital losses from future transactions, you could write those losses off against the gains associated with your future annuity payments. This would also be ideal for mitigating carried capital losses year over year. All of these advantages are possible with a structured annuity or treasury account.
You can also alleviate any concerns about the buyer’s ability to make future payments. The buyer’s role is complete once they assign the agreed upon purchase price (or portion thereof) to the assignment company.
The monthly payments will provide a steady source of reliable income to you or your estate. Should you pass away before all funds are distributed, then your named beneficiaries will continue to receive your future payments.
There is very little investment risk associated with a tax deferred annuity or treasury account. The investment provides predictable growth and long term financial security that can be difficult to find elsewhere.
The overall markets have been very volatile over the last decade – and during uncertain economic cycles, depreciated stocks and bonds can quickly reduce your principal and earning power. Conversely, fixed annuities and treasuries have no direct exposure to downside market risk and are therefore much more stable investments.
