Annuity How To Calculate A Private Annuity Tip! One benefit of annuity over other investments is annuity offer is tax deferral benefit. You only pay taxes on annuity payments that are considered earnings, you are not taxed on the portion that is principal. A private annuity is an increasingly popular "exit strategy" option. Investors often wonder how to calculate a private annuity to understand its appropriateness to their situation. Basically, a private annuity is the sale of an appreciated asset in exchange for a promise to pay income for the rest of your life. A private annuity can be arranged using almost any type of asset (e.g., a home, real estate, stocks, or a business interest). However, the best type of property to use is probably income-producing, highly appreciated, or rapidly appreciating property. These types of assets let you take the most advantage of the tax-saving benefits of the private annuity. If you want to know how to calculate a private annuity, the first thing you must do is determine the fair market value (FMV) of the property you are selling. This is important, because you need an accurate value to know that you are getting a fair price for your property. In addition, the IRS may challenge the value if it is not reasonable. If the IRS is successful, (1) the transfer may be deemed a gift (or partial gift) and therefore subject to generation-skipping tranfer tax (GSTT) and/or estate and gift tax, and/or (2) you may have to report a larger gain on the transaction. FMV means the price at which would sell on the open market. To prevent a dispute with the IRS and to keep the court from becoming involved in the valuation question, you should use care and thoroughness in arriving at a reasonable value. Use published references (newspapers, or valuation tables issued by IRS) when possible. Refer to IRS regulations and rulings concerning how property is to be valued for tax purposes. You may need or want to use qualified experts and appraisers for certain property and create documentation to back up the values you establish, especially for hard-to-value assets (e.g., real estate and stock in closely held companies). An expert appraiser can be found in the yellow pages or by seeking referrals from banks, financial planners, or real estate brokers. Be sure to check the appraiser's credentials for experience in valuing property for income and estate tax purposes. The second thing to do, if you want to know how to calculate a private annuity, is to become familiar with the IRS annuities for life actuarial table. Once the FMV has been established, you need to look up the applicable annuity factor on the annuities for life tables issued by the IRS. These tables are based on your life expectancy and are classified by single life or two life and by the federal discount rate. The third thing to do, if you want to know how to calculate a private annuity, is ascertaining ability of purchaser to make payments. If the purchaser has sufficient independent income, then any of your assets can be sold with relative confidence that the purchaser can make the payments. But if the purchaser has little or no income, be sure that the property you are selling produces sufficient income to make the annuity payments. If this is not possible, at least be sure that the property is of a type that can be easily sold or borrowed against. The purchaser should not be a person who regularly engages in issuing private annuities. This may cause the IRS to classify the annuity as a commercial annuity, and the benefits of the private annuity will be lost. The purchaser should be someone who is the natural object of your bounty (e.g., your children or other family members). Tip! With a variable annuity, you can decide to a limited extent how to invest your money. But it will have to be placed in what amounts to as an in-house mutual funds. The fourth thing to do is to draft a written agreement. Once the details of the arrangement are agreed upon, put it in writing. It is recommended that you hire an attorney to draft the agreement. This is especially important because your interest must be unsecured. The terms of the agreement should be clear and easy to prove in case the purchaser defaults and you wind up in court. The fifth step is to transfer complete and absolute ownership of the property to the purchaser. It is extremely important that the purchaser's promise be unsecured; otherwise, a taxable event will occur immediately upon the signing of the agreement. This means that you cannot retain a pledge, mortgage, lien, or any security interest in the property. Make sure the agreement clearly states that the promise is unsecured and ensure that a security agreement (a UCC form) is not executed or filed. Tip! Unlike deferred annuity which is required relatively longer accumulation period. Immediate annuity has only little or no accumulation period. Finally, you will have to file an annual income tax return for each year you receive the annuity payment. The annuity is treated as part return of capital, part gain, and part ordinary income until your entire basis has been recovered. These amounts are calculated by a formula. After your basis has been recovered, the annuity payment must be reported as part gain and part ordinary income until the expiration of the life expectancy period. Annuity payments after that are reported as ordinary income only. A private annuity offers lots of potential advantages. If you are trying to determine if its an appropriate strategy for your situation, it is important for you to know how to calculate a private annuity.