T—Installment Sale and Private Annuity

Both the installment sale and the private annuity are used to transfer future appreciation through sale of property (e.g., a business interest) from one individual to another, in our example, from parent to child. There are, however, substantial differences in both the tax implications and resulting rights and obligations.

INSTALLMENT SALE.The primary distinguishing characteristic of the installment sale, as compared to the private annuity, is thefixed scheduleof payments made by the buyer. The parent (as seller) can spread a large gain and the resulting income tax liability over a number of years, while at the same time transferring future appreciation to the child (as purchaser).

The child’s obligation to the parent may besecured, which also distinguishes the installment sale from the private annuity. With respect to the parent, each payment is divided into gain, interest income, and a nontaxable recovery of basis. If the parent dies, payments continue to the parent’s estate. Although the child’s obligation could be cancelled by the parent’s executor, or passed by will to the child, previously unreported gain would still be taxable to the estate.