In our July Newsletter, we shared what’s happening in the agriculture space and the special tax-advantaged programs that Congress put in place for the ag industry. (Click here to read “Selling the Farm? How About a 30-Year Tax Deferral?”)
We had no idea how popular that article was going to be! There are a whole lotta folks out there either in the agriculture space or know folks in that space completely unaware of the special programs we shared about!
That makes us feel great! But what if you are NOT in the ag space? What then?
What if I told you that it is possible to sell appreciated real estate or a business and defer the recognition of tax for up to 40 years? And, at the same time, defer the recognition of tax on any growth of assets as well?
Holy cow! A 40-year tax deferral!
For those of you not living in super high-taxed states, like California, New York, New Jersey, or Oregon, you miiiiight be OK with paying 25% or 30% all-in between Federal, State, and the Medicare tax.
But, in states like those named above, such as California, you’re looking at 37.1% in taxes going to what we to refer to as “involuntary philanthropy.”
Most of you know … we love philanthropy. We believe it’s an integral part of leaving the world a better place than when you came into it. But it’s better if it’s voluntary … right?
To that end, this month, let’s look at an idea that will be new to most of you. It allows sellers NOT in the agricultural sector to defer taxes on the sale of a business or real estate for up to 40 years…Imagine That!™
Non-Ag Structured Installment Sale
OK … so just how do you sell appreciated assets and not pay taxes for 40 years? (Technically, you could potentially go longer, but we don’t advise it.) The IRS calls it a “structured installment sale.”
Forty years is enough time, especially with the current inflation rates, to take out much of the tax sting. The taxable gain will remain the same, but imagine the difference between paying $100,000 in taxes 40 years ago versus today. Okay, it may still sting a little, but I’ll bet it’s a more manageable sting, even if tax rates might be a tad bit higher on that gain amount!
Let’s start unpacking the structured installment sale from a 30,000-foot view.
- The sale is structured as an installment sale with an assignment provision
- You (the seller) transfer the asset and title into escrow
- The buyer places the cash into escrow
- The asset and title are transferred to the buyer
- Escrow transfers the installment sale to the assignment company (some special juju there …)
Even though it is structured as an installment sale, 100% of the net cash (the sale proceeds after closing costs) goes from the buyer into the escrow to a third-party assignment company simultaneously.
And now for more special juju … the cash goes to something else you might never have seen before … a “private placement variable annuity.” It’s an annuity that is stripped out of costs and allows your investment advisor to buy & sell just about anything inside the non-taxable “wrapper” of the annuity.
Anything? Anything! (Well, almost anything. You cannot buy that Picasso you have been drooling over and put it on the wall in your chateau … but most anything else!)
And, with the money safely ensconced into the private placement annuity, you can not only defer the payment of taxes on the sale but you could also defer the tax on the earnings of the assets you have in the annuity! Warning: reports of sightings of spontaneous happy dances!
You can take income out of the annuity at any point in time. If it’s earnings on the assets, that will be taxable as ordinary income. If you have stripped out all of the earnings, then the distributable income will be taxable as long-term capital gains.
What Else Do We Need To Know?
Private Placement Annuities allow us to add cash, stocks, mutual funds, ETFs, real estate, and other types of assets that traditional annuities would refuse to accept as contributions.
Note: Be aware, however, that if you add assets to the annuity that have themselves appreciated, that is a taxable event. So, it’s better to just add cash, or if assets have a loss, sell the assets to claim the tax-deductible loss and place the net cash into the annuity to be reinvested.
There are special diversification rules as well. We get approximately one year to allocate investments with specific diversification rules:
- A single asset must be less than 55% of the overall value of the annuity assets
- Two assets must be less than 70%
- Four assets must be less than 90%
Once again, using this technique allows us to completely defer the recognition of the taxable gain on the sale of our appreciated assets, but also potentially defer all the gains on the growth of those assets along the way! And, if you need to or decide you want to sell assets inside the annuity, that is all tax-deferred as well.
So … does this change your thinking a bit on that upcoming sale?
Asset Protection
There are more advantages to using annuities or life insurance, such as asset protection.
Many states protect the policy’s cash value from creditors and lawsuits, unlike California, which has very limited asset protection.
The private placement annuity we are discussing is purchased from an insurance company in South Dakota, where the “premium tax” is just a tiny bit more than zero! And even though you may not be a resident of the Mount Rushmore State, there are ways that you can obtain that creditor protection on those assets even if you live in the litigation capital of the US – California – or other such states! (That, however, is major tax juju and outside the scope of today’s newsletter!)
Oh, and the millions of dollars growing in your private placement annuity protected from creditors and lawsuits are also not subject to garnishment if something goes sideways.
Which reminds me … there are minimum requirements to purchase a private placement annuity. It’s a cool $1,000,000 or more. But, since this is for the sale of real estate or a business, a million is a relatively easy target to hit.
But What About Private Placement Life Insurance?
Are we still together? Eyes still on the screen and not rolled into the back of your head yet?
Hope so, because there is another strategy in the private placement “wrapper” space I want to briefly touch on … a private placement variable life insurance contract.
The minimum amount of assets required for this strategy is $2,000,000 with our preferred South Dakota-based life insurance company. In practice, we recommend this be accomplished by making contributions of $500,000 a year for four years. This is for special tax reasons that we will explore in a future newsletter. For now, just go with it! LOL.
The other consideration is there is obviously a death benefit involved. With an annuity, you’re just focused on the contribution and growth. Life insurance, however, adds an expense we don’t have in the annuity, which will erode some of the returns.
But, as an alternative benefit over the annuity, you can take money out of the private placement variable life insurance via a policy loan. That’s potentially non-taxable when you take the money out … but again, this must be properly structured.
What Are The Tripping Hazards?
Surely, if anyone could do this, anyone would, right?
Right! So why isn’t this super common?
First, the steps must be done exactly right, in the right order. The flowchart above? You cannot “get creative” with it. The IRS says this one way is acceptable, and that’s it. “You can have any color as long as it’s black.” – Henry Ford
Second, on non-agricultural sales – like your business or real estate – there is a $5 million per person per year cap. If your business gets valued at $17 million, you’re out of luck after the first $5 million of that … at least, for the year, unless you are married. That’s $5 million more. Do you have children? That could potentially be $5 million more per child if you are willing to make gifts into a trust for their benefit. Anyway, you see the theme here. There is a cap that may or may not be able to be worked around … but at least we can defer taxes on $5 million of the sale at the very least.
Third, to purchase a private placement contract you must be an “accredited investor.”
This means:
- At least $1 million net worth not counting your primary residence; or
- Over $200,000 of income a year if single, $300,000 if married.
Normally, however, this requirement is pretty easy to meet since the sale of the business or real estate is usually multiple millions of dollars!
And … not to be forgotten, this is just a tax deferral strategy. It allows you to time when you will report the sale … a little bit each year over 40 years, or all at once 40 years hence, or something in between. Whatever you choose, we’re not avoiding taxes … just pushing them out to pay with, usually, a much less expensive dollar.
Selling The Business Or Property?
Call or email us for a free 20-minute complimentary discussion to see if this strategy might work for your situation or if there are other options to reduce, defer, or even eliminate taxes on the sale of your business or real estate.
Selling your appreciated asset(s) and not having to pay taxes for as long as 40 years into the future! Imagine That!™
Imagine That!™ is a complimentary monthly newsletter provided by Wealth Legacy Group®, Inc. that addresses various topics of interest for high-net-worth and high-income business owners, professionals, executives and their families. Sign up to receive our monthly newsletter here.
R. J. Kelly, Wealth Legacy Group®, Inc. – September 2023
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