Author Topic: Has anyone used a structured sale to minimized the taxes on a property sale?  (Read 4512 times)

Mr. Green

  • Handlebar Stache
  • *****
  • Posts: 1974
  • Age: 36
  • Location: Wilmington, NC
A structured sale would be particularly useful to a mustachian looking to minimize the taxes paid on a property sale so I'm wondering if anyone has completed one. If you have, how did it work out and are you liking the results? I have a property to sell and I'm considering a structured sale but I don't know anyone who has ever done one.

jwright

  • Bristles
  • ***
  • Posts: 266
Do you mean an installment sale?  I've had clients do it, although mostly as a trick to preserve capital gain treatment on land held for development.  You break up the proceeds into a number of years, lowering your taxable income in the year of the sale, and including the annualized amount in income each subsequent year. 

You have to charge interest to your buyer, and you'll end up with reportable interest income as well.  Also, if it is a short term gain, you have to pay on the short term rate even if you are receiving the payments over time. 

Mr. Green

  • Handlebar Stache
  • *****
  • Posts: 1974
  • Age: 36
  • Location: Wilmington, NC
Do you mean an installment sale?
There's a bit of difference between a structured sale and an installment sale. In a structured sale, the buyer pays the whole amount at the time of sale and takes possession of the property free and clear. The seller chooses how much of that money to receive immediately, and the remainder is paid to an insurance company, where they turn that lump sum into annuity payments on your terms. The income delay from the annuity has the same tax ramifications as the buyer deferring payment over a number of years but there is no encumbrance upon the deed since the buyer has paid the full purchase price already.

soupcxan

  • Stubble
  • **
  • Posts: 181
I'm just guessing...you're going to pay a large commission to someone to set this up, then you're going to have high fees in the annuity with low-return investment options, you'll have exposure to the insurer's credit risk, then you end up paying taxes anyway so all you are saving is the time value of the deferred taxes. Maybe this would make sense if you have to sell now and are in a high tax bracket but you expect a huge decrease in your marginal tax rate in the near future.

Mr. Green

  • Handlebar Stache
  • *****
  • Posts: 1974
  • Age: 36
  • Location: Wilmington, NC
I'm just guessing...you're going to pay a large commission to someone to set this up, then you're going to have high fees in the annuity with low-return investment options, you'll have exposure to the insurer's credit risk, then you end up paying taxes anyway so all you are saving is the time value of the deferred taxes. Maybe this would make sense if you have to sell now and are in a high tax bracket but you expect a huge decrease in your marginal tax rate in the near future.
The seller doesn't pay anything beyond the sale price negotiated. There is no commission paid for the set up of the annuity; that is all taken care of in the terms of the annuity given by the insurance company. There are no fees in the annuity either, just whatever the agreed upon yearly payment is. For instance, the insurance company gets a million dollars and they pay me 50k a year for 30 years, or whatever the going terms are for annuities at that time. Deferred taxes are worthwhile here because the sale will immediately push me into the highest tax brackets across the board, and we're FIRE'ing, so a structured sale could allow me to pay no tax at all (at least at the federal level), depending on the terms.

bobechs

  • Handlebar Stache
  • *****
  • Posts: 1068
I'm just guessing...you're going to pay a large commission to someone to set this up, then you're going to have high fees in the annuity with low-return investment options, you'll have exposure to the insurer's credit risk, then you end up paying taxes anyway so all you are saving is the time value of the deferred taxes. Maybe this would make sense if you have to sell now and are in a high tax bracket but you expect a huge decrease in your marginal tax rate in the near future.
The seller doesn't pay anything beyond the sale price negotiated. There is no commission paid for the set up of the annuity; that is all taken care of in the terms of the annuity given by the insurance company. There are no fees in the annuity either, just whatever the agreed upon yearly payment is. For instance, the insurance company gets a million dollars and they pay me 50k a year for 30 years, or whatever the going terms are for annuities at that time. Deferred taxes are worthwhile here because the sale will immediately push me into the highest tax brackets across the board, and we're FIRE'ing, so a structured sale could allow me to pay no tax at all (at least at the federal level), depending on the terms.

I am not a tax person, nor do I want to be one more than mere survival requires.

BUT-- are you quite sure that the purchase price of the annuity will not be taxable income to you in the year in which it is purchased?  That is the linchpin of your scheme and if you are wrong you will see no tax benefit at all and will have that money tied up in an under-performing asset for a considerable time.

I'm skeptical because if you are right I can't imagine anyone selling a greatly appreciated asset would not defer taxation this way until after retirement, early or not.  Yet it does not seem to be the pattern.

soupcxan

  • Stubble
  • **
  • Posts: 181
There is no commission paid for the set up of the annuity; that is all taken care of in the terms of the annuity given by the insurance company. There are no fees in the annuity either, just whatever the agreed upon yearly payment is.

The insurance company is making money on this deal somehow. You would need to look at the implied interest rate between the lump sum today and the annuity payments they're offering. If the going rate is $1m for $50k/year for 30 years, then you are effectively lending money at 2.8%. The first thing is that you could buy a 30 year US treasury and get 2.7%, and that is much less risky than an insurance company obligation. The second thing is that if you had the cash today, you could invest in the stock market and perhaps earn +6% (whatever you think is reasonable over 30 years). So there is an opportunity cost of lending to the insurance company. Whether it is worth the tax savings depends on your assumptions and your tax rates.
« Last Edit: February 17, 2016, 12:20:32 PM by soupcxan »

bobechs

  • Handlebar Stache
  • *****
  • Posts: 1068
There is no commission paid for the set up of the annuity; that is all taken care of in the terms of the annuity given by the insurance company. There are no fees in the annuity either, just whatever the agreed upon yearly payment is.

The insurance company is making money on this deal somehow. You would need to look at the implied interest rate between the lump sum today and the annuity payments they're offering. If the going rate is $1m for $50k/year for 30 years, then you are effectively lending money at 2.8%. The first thing is that you could buy a 30 year US treasury and get 2.7%, and that is much less risky than an insurance company obligation. The second thing is that if you had the cash today, you could invest in the stock market and perhaps earn +6% (whatever you think is reasonable over 30 years). So there is an opportunity cost of lending to the insurance company. Whether it is worth the tax savings depends on your assumptions and your tax rates.

I think you are barking up the wrong tree.

 However much you hate annuities, if you can sidestep taxes this year at, say 15% on the part of sale price diverted to an annuity and receive the money (both principal and annuity-paid interest) in the future over a number of frugal post-retirement years at much closer to a 0% tax rate, then the difference between the annuity yield and buying the underlying bonds directly diminishes to insignificance. There is of course an as yet unknown crossover point in the future  where a big difference between stocks and bonds favors paying taxes now and waiting for the reduced principal to out-earn the annuity or its bond basis.

The nub of the matter is that I sincerely doubt one can sidestep current taxes this year using OP's proposed dodge. If he is right, losing a couple % per year to a dastardly insurance company is probably very cheap indeed.

I just don't think it works that way.

soupcxan

  • Stubble
  • **
  • Posts: 181
I think you are barking up the wrong tree.

Let's say you have to sell a house for $1m and the taxable gain is $500k. Your marginal tax rate today is 33%, your marginal rate next year and forever into the future is 0%. So if you sold today for $1M you would pay $165k in taxes ($500k @ 33%) and receive $835k after-tax.

Option 1: Invest $835k in the stock market and earn average 6%/year over 30 years. In 30 years that compounds to $4,796k.

Option 2: Receive zero cash today and $50k/year for 30 years from the insurance company. As you receive those payments you invest them in the market at 6%. In 30 years you end up with $3,953k.

So even though option 2 saves you $165,000 in taxes, you are worse off by $843,000 in 30 years by using the insurance annuity.

Now obviously the risk of investing in the market is greater than the credit risk of an insurer but you can decide whether that risk is worth $843k to you. And of course you can change these assumptions to make the annuity look better, for extremely large capital gains and tax rates it might make sense. And the annuity would look better if you can direct only the capital gains portion of the sale to the annuity and take some of the cash upfront (I have no idea, but I suspect the IRS makes you prorate it). But in general, I think these circumstances will be hard to find in reality.

Mr. Green

  • Handlebar Stache
  • *****
  • Posts: 1974
  • Age: 36
  • Location: Wilmington, NC
There is no commission paid for the set up of the annuity; that is all taken care of in the terms of the annuity given by the insurance company. There are no fees in the annuity either, just whatever the agreed upon yearly payment is.

The insurance company is making money on this deal somehow. You would need to look at the implied interest rate between the lump sum today and the annuity payments they're offering. If the going rate is $1m for $50k/year for 30 years, then you are effectively lending money at 2.8%. The first thing is that you could buy a 30 year US treasury and get 2.7%, and that is much less risky than an insurance company obligation. The second thing is that if you had the cash today, you could invest in the stock market and perhaps earn +6% (whatever you think is reasonable over 30 years). So there is an opportunity cost of lending to the insurance company. Whether it is worth the tax savings depends on your assumptions and your tax rates.

I think you are barking up the wrong tree.

 However much you hate annuities, if you can sidestep taxes this year at, say 15% on the part of sale price diverted to an annuity and receive the money (both principal and annuity-paid interest) in the future over a number of frugal post-retirement years at much closer to a 0% tax rate, then the difference between the annuity yield and buying the underlying bonds directly diminishes to insignificance. There is of course an as yet unknown crossover point in the future  where a big difference between stocks and bonds favors paying taxes now and waiting for the reduced principal to out-earn the annuity or its bond basis.

The nub of the matter is that I sincerely doubt one can sidestep current taxes this year using OP's proposed dodge. If he is right, losing a couple % per year to a dastardly insurance company is probably very cheap indeed.

I just don't think it works that way.
But it does work that way. The seller sidesteps the taxes because the seller does not buy the annuity. The buyer pays the insurance company directly and the seller is the beneficiary of an annuity. It's a legit thing.

It's not used frequently because a property sale is capital gains tax and I'm only able to save that 20% if I can get myself down into the bottom two tax brackets where the capital gains tax is 0%. Most folks who are working jobs aren't able to do that so whether you took the whole payment now vs. over the years you're still paying the same 20% capital gains tax. I figure there's a better chance of mustachians or people who have already FIRE'd doing it because if I'm living off of my investments then I can simply let those investments grow and instead use the annuity income to live off of. As married filing jointly, that gives me almost 100k in capital gains income that is tax free at the federal level.

The back of the napkin math says the tax savings will roughly equal the gains you'd get from investments (based on average return) if you took the tax hit now and invested the lump sum. If you're already got a nest egg in the market, the annuity is a nice way lessen your exposure to volatility while still getting a similar "rate of return" (in the form of paying less tax).

Mr. Green

  • Handlebar Stache
  • *****
  • Posts: 1974
  • Age: 36
  • Location: Wilmington, NC
I think you are barking up the wrong tree.

Let's say you have to sell a house for $1m and the taxable gain is $500k. Your marginal tax rate today is 33%, your marginal rate next year and forever into the future is 0%. So if you sold today for $1M you would pay $165k in taxes ($500k @ 33%) and receive $835k after-tax.

Option 1: Invest $835k in the stock market and earn average 6%/year over 30 years. In 30 years that compounds to $4,796k.

Option 2: Receive zero cash today and $50k/year for 30 years from the insurance company. As you receive those payments you invest them in the market at 6%. In 30 years you end up with $3,953k.

So even though option 2 saves you $165,000 in taxes, you are worse off by $843,000 in 30 years by using the insurance annuity.

Now obviously the risk of investing in the market is greater than the credit risk of an insurer but you can decide whether that risk is worth $843k to you. And of course you can change these assumptions to make the annuity look better, for extremely large capital gains and tax rates it might make sense. And the annuity would look better if you can direct only the capital gains portion of the sale to the annuity and take some of the cash upfront (I have no idea, but I suspect the IRS makes you prorate it). But in general, I think these circumstances will be hard to find in reality.
You were taking my $1 million/50k for 30 years example too literally. I was just throwing numbers out there to illustrate the process. You'd have to call an insurance company to find out what they'd give you yearly for 30 years based on a $1 million lump sum now.

However, in your example this is how you would do it. If your marginal tax rate next year and forever into the future is 0%, and your basis is 500k, you take the 500k today at the sale. The seller gives the 500k that would be a taxable gain to an insurance company and the seller dictates the terms of the annuity to the insurance company. As the seller you could say you wanted 75k a year. How long will the insurance company pay you that if they're getting a 500k lump sum.  It's no different than your standard annuity. It's the seller paying for the annuity that prevents it from being taxable to the buyer because the buyer doesn't "realize the gain" until each payment of the annuity is made. If that happens to be 0% that year because of the tax bracket the seller is in, then so be it! :)

soupcxan

  • Stubble
  • **
  • Posts: 181
It's no different than your standard annuity.

Does that mean if you die while receiving the annuity, the insurance company can stop paying? Or does the insurance co agree to pay for X years and if you die before then your estate still gets the remaining payments?

If this is like a regular annuity where the payment stops when you die, that is a huge downside risk to your spouse/kids (assuming you want the money to go to them).

Mr. Green

  • Handlebar Stache
  • *****
  • Posts: 1974
  • Age: 36
  • Location: Wilmington, NC
It's no different than your standard annuity.

Does that mean if you die while receiving the annuity, the insurance company can stop paying? Or does the insurance co agree to pay for X years and if you die before then your estate still gets the remaining payments?

If this is like a regular annuity where the payment stops when you die, that is a huge downside risk to your spouse/kids (assuming you want the money to go to them).
This depends on the kind of annuity you take. An annuity that pays for a specific number of years does so regardless of death. A lifetime annuity is only payable for the duration of your life. A structured sale may even dictate an annuity that is a set number of years (buyer's choosing) because the IRS rules for an installment payment require at least one payment after the year of the sale.
« Last Edit: February 18, 2016, 12:07:16 PM by Mr. Green »