Academic journal article Journal of Accountancy

Private Annuity Defers Gain

Academic journal article Journal of Accountancy

Private Annuity Defers Gain

Article excerpt

A taxpayer was permitted to defer capital gain when he transferred appreciated capital assets in exchange for a private annuity The Tax Court held the arrangement met the requirements of Revenue Ruling 69-74, 1969-1 C.B. 43, and thus the capital gain could be deferred until the taxpayer began receiving payments under the annuity contract.

Code [section] 72(b) permits taxpayers to exclude a percentage of an annuity payment received equal to the ratio of the taxpayer's investment in the annuity to its expected return. When an appreciated capital asset is exchanged for a private life annuity, Revenue Ruling 69-74 permits the deferral of capital gain until the taxpayer begins to receive annuity payments. (However, note proposed regulations described below that, if adopted as final, generally would curtail this deferral.) As payments are received, each payment consists of three components: return of investment, capital gain and ordinary income. The basis of the capital asset becomes the investment in the annuity, which is recovered tax-free evenly over the expected life of the annuitant. The capital gain portion (measured as the difference between the asset's basis and its fair market value on the date of the exchange) is recognized evenly over the taxpayer's life expectancy Once this capital gain has been recognized, any reportable income is ordinary

Marcus Katz formed a student loan business, Educational Loan Administrative Group Inc. (ELA), in 1993. When ELA merged with UICI Acquisition Corp. in 1997, Katz exchanged his EtA shares for 470,708 shares of UICI, the parent company of UICI Acquisition. In 1998 Katz purchased 200,000 UICI common stock put options and sold 200,000 UICI common stock call options, both exercisable on Feb. 3, 2000. On Feb. 3, 2000, Katz then transferred 200,000 UICI shares and the put options to SJA Co. Ltd. in exchange for a private annuity contract. On Feb. 8, 2000, SJA exercised the put options and sold the 200,000 UICI shares to Merrill Lynch.

As a result of an assignment agreement with Katz and SJA, Merrill Lynch settled the transaction with SJA for $4,617,841, which it erroneously deposited into Katz's account. Under the terms of the annuity contract, Katz should have received $800,000; thus Merrill transferred $3,817,841 from Katz's account into RJA's. …

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