DO PRIVATE ANNUITY SALES MAKE SENSE?

In the past, a common estate planning technique to shift future appreciation on a sale of property would be to sell the property for a private annuity. This provided an income stream to the seller, and also allowed the seller to defer taxes on any gain until payments were received.

In 2006, the IRS  issued proposed regulations that disallow any deferral of tax on gains – instead, all gain on sale is taxed in the year of sale. For many, this is perceived as a death blow to the planning technique.

However, even with a current income tax bite, there are still advantages to the technique and justify its use in appropriate circumstances:

a. The benefit of shifting future appreciation out of the seller’s gross estate for estate tax purpose still fully applies (although this can backfire if a seller substantially outlives his or her life expectancy, since the total annuity payments may then exceed the value of the property plus appreciation).

b. Income taxes may not be a major issue. For example, there may not be much current appreciation (i.e., little or no gain) in the property. Or perhaps the seller has other losses they can use to offset the gain.

c. For 2012, recognizing long-term capital gain may be a good thing since maximum rates are only 15%, and are scheduled to increase next year.

d. In the past, a seller of property for an annuity could not secure the annuity obligation with a pledge or mortgage on property, because that would prevent income tax deferral. Thus, sellers had to take on increased risk of loss as to a default by the buyer. Now that deferral of tax is off the table, sellers can secure the payment obligation without giving up anything.

TEMPORARY VISA DID NOT BAR HOMESTEAD STATUS [FLORIDA]

Favio came to the U.S. in 2005 after a kidnapping attempt against his son in Venezuela. He rented an apartment, and lived there with his son (a U.S. citizen), and his wife. He then purchased an apartment in 2006 and lived there with his family until his death in 2009.

Favio had borrowed $500,000 from Eric and Carla. When Favio died, they filed a claim against Favio’s estate to be repaid. Favio’s estate claimed the apartment was homestead property, and thus could not be reached by Eric and Carla to repay the debt. Presumably, Favio did not have other assets to fully satisfy the debt.

The probate court reviewed numerous cases that provided that an individual in Florida on a temporary visa could not form the requisite intent to make a residence a “permanent residence” so as to qualify for homestead protection against creditors. The court found that since Favio did not have the right to stay here on a permanent basis (he did not have a green card admitting him as a lawful permanent residence nor was he a U.S. citizen), the property was not homestead property.

The 3rd DCA reversed, and held the property was protected homestead. In doing so, they made a number of interesting observations and statements:

     a. That the son was a U.S. citizen was an important fact. The court noted that the Florida Constitution does not require the owner to reside on the property – it is enough that the owner’s family reside on the property. Thus, the father could in effect piggyback on the son’s permanent status.

     b. The intent question is to be answered based on the intent of the homesteader and not that of the U.S. Citizenship and Immigration Services. Thus, while Favio did not have the right to remain in the U.S. permanently, that was not controlling.

     c. Precedent and rules in the ad valorem tax homestead exemption area do not control in regard to the exemption from forced sale. There is strong precedent in the tax area that temporary immigration status is not sufficient to obtain the ad valorem homestead exemption. That precedent is not controlling because for tax exemption purposes, the statute is to be strictly construed against the taxpayers. However, in the forced sale arena, the rules are to be liberally construed for the benefit of those that the rules are designed to protect.

     d. That Favio and has wife had applied for permanent residence status before Favio’s death was an important fact that supported homestead status.

In the end, the court noted that based on (a) continued residence at the property since its purchase, (b) possession of a visa that permitted residence here (albeit not on a permanent basis), and (c) the application that had been made for permanent resident status, homestead protection against forced sale was appropriate.

WHERE’S THE VALUE HERE? The court opens the door to homestead protection against forced sale, even when the owner does not have the right to permanently reside in Florida. However, the special facts discussed above in (a)-(c) were key – absent similar compelling facts in other situations, the lack of the ability to permanently reside is still likely to be a significant bar to forced sale homestead protection based on the other cases in this area.

Estate of Favio Jose Grisolia Sanchez v. Pfeffer, 36 Fla.L.Weekly D2554 (3rd DCA (November 23, 2011))

PURCHASE PRICE ALLOCATIONS ARE BINDING ON THE BUYER

Purchasers and sellers of businesses will often allocate the purchase price among the assets sold. Under Code §1060, the buyer and seller must make an allocation with their tax returns.

When the allocation is made in a written agreement, the parties are bound by it for tax purposes, except under the Danielson rule. Code §1060(a).  That rule allows a party to contradict an unambiguous contractual term by offering proof that would alter that construction or to show its unenforceability because of mistake, undue influence, fraud, or duress.

Peco Foods purchased two processing plants. Portions of the purchase price were allocated to “Processing Plant Building” and “Real Property: Improvements.” Instead of capitalizing the purchase price into real property only (Code §1250 property), Peco conducted a post-closing study that broke these allocations into component parts, including allocations to specialized mechanical systems and other personal property assets (Code §1245 property). By doing this, Peco was able to increase its depreciation deductions through the use of faster write-off methods that are allowable under Code §1245.

The IRS objected, and the matter ended up in the Tax Court. The Tax Court sided with the government, and determined that a subdivision of the allocations to real property assets between real property and nonreal tangible personal property rule was an impermissible modification of the allocation in the purchase agreement.

WHERE’S THE VALUE HERE? Buyers of businesses should conduct their cost segregation analysis before the closing and conduct any refinements in the allocation in the purchase agreement, instead of doing these things after the agreement is finalized.

Peco Foods Inc. et al., TC Memo 2012-18