The Secret to Selling High
And Deferring High Taxes

Installment sales let you sell properties at high prices and defer capital-gains taxes. So do private annuity trusts. Here's another way: Combine the two.

In an installment sale, the owner sells the property on a long-term payment plan, providing some of the financing to the buyer, who pays for the property in regular installments, plus interest. The seller, in turn, gets to stretch out the capital-gains taxes they owe on the property, typically over a five-year period, and so avoid a huge upfront tax bill.

In a private annuity trust, the owner transfers the property to a trustee -- often his or her children -- before the sale. The members of the trust and the owner then enter a special payment contract called a private annuity that makes payments to the owner for the rest of their life. Using this method, the capital-gains tax for the original owner can be spread out over many years. And used in combination with an installment sale, the trust protects the original owner from having to pay a hefty capital-gains tax right away on whatever down payment the buyer makes, or if the buyer should decide to pay off the rest of the installments early.

But pairing up the strategies not only helps the owner defer their capital-gains taxes on the sale. It helps their children or relatives avoid capital-gains taxes when the sale is completed. That's because the price the trust paid for the property -- the value of the annuity contract -- is the same as the sale price to the end buyer, says Richard T. Williamson, an attorney in Long Beach, Calif.

"No triggering of capital gains will ensue because no gain is attributable to the sale by the trust," says Mr. Williamson. The trust can use the proceeds to make other investments that earn taxable income.

Another benefit of combining the two strategies is that the recipients of the transfer can earn monthly income from the installment-sale payments.

There are risks to consider. For example, the borrower could have difficulty making payments, or even default, which could in turn jeopardize the trust's ability to pay the annuity holder. What's more, the property may end up back in the hands of the trust if the borrower stops paying. Not only would the trust not get paid, but there's also the opportunity cost in terms of what other potential buyers might have paid for the property, as well as the cost of putting the property up for sale again. And if the property was neglected, or if market conditions had since changed so as to be more unfavorable for sellers, the property could prove harder to sell or fetch less money.

Kevin McKinley, a certified financial planner in Eau Claire, Wis., notes that there's also the risk that taxes could rise in the future, meaning that the original owner of the property may end up paying more in taxes on the extended annuity payments than he or she would have paid from the start in an ordinary sale.

"Some [investors] might be better off taking the hit now rather than delaying it and paying a higher rate in the future," Mr. McKinley says.

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