Proposed regulatory changes
halt private annuity trusts.

    A proposal by the Treasury Department and Internal Revenue Service has effectively killed the private annuity trust as a way to postpone taxes on the sale of appreciated property.
    If adopted at a public hearing next month, the proposal would be retroactive to October 18, 2006, the date of the federal announcement. The change would be implemented by making private annuity trusts subject to the same tax treatment as commercial annuities.
    Federal officials have said that private annuities created prior to October 18, 2006, would be grandfathered. Also, the rule's effective date may be extended for six months for "some transactions that pose the least likelihood of abuse."
    Private annuity trusts, created via a decades-old IRS ruling, grew like wildfire with the recent real estate boom as a way to defer taxes on capital gains from the sale of property. A client can, in effect, exchange an appreciated asset-often to family members-in return for a lifetime of fixed annuity payments. They also are used to defer capital gains on the sale of businesses, artwork and securities, and help remove an appreciated asset from a taxable estate.
    The public hearing is scheduled for February 16, 2007, and written or electronic comments to the IRS may be filed on the proposal by January 16. To do this, visit or
    In the month following the IRS announcement, Renaissance, Indianapolis, a company that trains advisors in charitable tools and administers 5,100 charitable trusts, has been fielding calls on the issue from financial advisors. "Those take two forms," says Ted R. Batson Jr., senior vice president. "An advisor who has done private annuity trusts in the past and is looking for an alternative to have in the arsenal, as well as advisors who were in the middle of a transaction and needed an alternative."
    "There wasn't any warning from the Treasury," laments Paula Straub, an investment advisor, and insurance and real estate agent in San Marcos, Calif. Straub had been offering private annuity trusts through a fiduciary company, The National Private Annuity Trust (NPAT) in Kitty Hawk, N.C. She had become a "capital gains tax strategy facilitator," offering private annuity trusts and other capital gains tax shelters. With the IRS/ Treasury announcement, she stopped offering private annuities.
    NPAT, with a professional referral network of 11,000 advisors, accountants, lawyers and real estate agents, continues to administer private annuities that would be grandfathered, according to Anthony March, NPAT founder.  Foreseeing the IRS trouble, though, it had created a sister company, National Insured Structured Sale Co. (NISS), and immediately introduced a substitute product, taking advantage of installment sales provisions under Section 453 of the Internal Revenue code. Straub had six clients closing on the new product, backed by commercial annuities from Fortune 500 companies. The product was reported to be similar, but more flexible than another structured sale product pioneered by Allstate Life Insurance Co. Straub, though, shifted gears after NISS on Nov. 27 unveiled an even newer product-an installment sale through a public foundation. With it came a new company name, "National Installment Sales Service."
    Despite all this fast action, and the fact that just about everyone has stopped offering private annuities, not everyone agrees that the private annuity trust is dead. Nor are IRS installment sales rules a client's only remaining option.
    San Marcos, Calif., tax and estate planning lawyer Joseph Petrucelli says a court interpretation could trump the IRS interpretation on private annuity trusts. But, that could take time. Clients with private annuity trusts, he suggests, should have them reviewed to see if there's anything in the transaction that could cause concern based on the proposed new regulations.
    A private annuity trust still might be useful to help minimize estate taxes, he adds. Financial advisors and attorneys were scrambling to identify alternative instruments. Charitable gift annuities, the IRS confirmed, would not be affected by the proposed guidance. Self-canceling installment notes (SCINs) and installment sales programs using commercial annuities were just a few other alternatives under consideration.
    March says NISS' newest installment-sales-through-a-foundation program "blows away" most capital gains tax solutions-including private annuity trusts. It uses section 453 of the Internal Revenue code, which covers installment sales; IRC 1011(b), which outlines a bargain sale; and partners with a legitimate 501(c)(3) private foundation.
    Under the program, NISS arranges for the foundation to take over the property and liquidate it. Proceeds from the sale go to the foundation, which March declined to name but which he says is identified to clients. Clients get a large, up-front income tax deduction-as much as $500,000 on a $2 million property-along with significant forgiveness of part of the capital gains tax.
    The foundation makes payments to the client for a specific term at an agreed upon interest rate, which he says is typically 5.50% to 6%. The foundation retains whatever it earns over the contracted rate. Payments, backed by a fidelity bond held by the foundation, may be deferred, but not for longer than 20 years. Meanwhile, March says, a publicly traded trust company-SEI Private Trust in Oaks, Pa.-holds all funds. Your client, he says, can get "two to three times the amount of money he or she would get from a private annuity or charitable remainder trust." 
    The foundation pays all fees, including NISS' $2,500 set-up fee. The foundation earmarks money to a charity of your client's choice. If your client dies, a spouse or children can continue to receive payments. Children would owe taxes "at present value." Although his company gets an ongoing administrative fee, he says, "there are no money management fees or costs of any kind to the client."
"The foundation we're working with has been doing it for a long time," March says. "That was one of the things we liked about it." Clients, he says, typically were philanthropic, high-net-worth individuals. His program brings the concept to anyone who is cash-strapped in real estate or just needs to fund retirement. It would not be suitable, he notes, for someone over 85 years old.
    Seth Pearson, a fee-only CFP licensee and president of Pearson Financial Services in Dennis, Mass., is one skeptic. His concern: The added layers of risk triggered by all the intermediaries involved.
    "I don't care what kind of (fidelity) bonds there are," he says. "A lot of people might be extremely wealthy and may want to take a risk on a small part of their total estate. But I don't think, given the option, people are going to take that level of risk."
    Pearson, who had been setting up private annuity trusts since 1974, says he likes the idea of charitable remainder trusts. "A charitable remainder trust is invested just like an IRA account. They're (the clients) in control. If they want to buy low-cost index funds and treasuries, they can do that."
    A charitable remainder trust can be structured to provide for three generations, he says. Here's how:
    Take a property valued at $1 million. Two trusts are set up. Half of the property is put in the charitable remainder trust for the parents. The other half is gifted in a trust for the children, with the parents named as trustees. The property is sold inside the charitable remainder trust, so no capital gains tax is owed by anyone.
    The parents get an immediate $50,000 income tax deduction for the gift to charity, based on a complex formula. They withdraw an equal amount from their IRA and convert it to a Roth IRA, naming their grandchildren as beneficiaries. That $50,000 is left to grow in value tax-free for their grandchildren's lifetime.
    The parents' trust, which pays them periodic income, continues for 20 years or the parents' lifetime, whichever is longer. When the parents die, their proceeds from the sale of the property ultimately reverts to charity. But the $500,000 share in the children's trust continues to grow in value.
    Say the children's $500,000 share grew at 7% annually. The children's share would be worth $1 million in ten years and $2 million in 20 years, he says.
    The downside of the charitable remainder trust, Pearson admits, may be that the asset ultimately leaves the family and goes to the charity when they die. But even so, the parents' trust says that if they die, children must get income from it for at least 20 years. Plus the children's own trust is paying them income for life.
    "(Charitable remainder trusts) are specifically defined in the Internal Revenue code and are supported by a large body of authoritative rulings and pronouncements," Renaissance's Batson says. "It provides sales of an appreciated asset with no immediate capital gain recognition, an income stream to the donor and removal of the asset from the donor's taxable estate."
    Tax attorney Charles Rubin, of Tescher Gutter Chaves Josepher Rubin Ruffin & Forman, P.A., in Boca Raton, Fla., says a sale to a defective grantor trust is attractive for rapidly appreciating property. Unlike many structured sales arrangements, this involves no commercial annuities.
    "It's similar to a 453 sale, except you don't pay any tax on the gain at all," he says. The owner of the property sets up the trust for family members, so that everything the trust owns is treated for income tax purposes as being owned by the person who created it. "If I sell the property to the trust for tax purposes, I'm really selling it to myself. That doesn't  create a tax event. The trust is still effective for estate and gift tax purposes. When I die, I don't own the property any more. Any increase in value after I sold it escapes taxation from my estate."
    The downside: A defective trust could make it tough to sell a property because the trust buying the property, for tax purposes, gets only the same basis in the property as the seller had. This means that if the property appreciates dramatically, a buyer ultimately could be saddled with significant capital gains taxes when he or she eventually sells. Also, the buyer trust pays for the property over time with a promissory note. For the IRS to respect this transaction, the buying trust should have other assets-typically equal to at least 10% of what it's buying, Rubin says.
    The National Association of Financial & Estate Planning (NAFEP), a for-profit Salt Lake City-based company that owns the Certified Estate Advisor registered service mark, suspended its private annuity trust. Proclaiming the private annuity trust "dead," NAFEP was reported to be finalizing a substitute program, using IRS installment sales rules.