604 / How are payments received under a private annuity issued after October 18, 2006 taxed?

Proposed regulations, which are currently in effect, have dramatically altered the tax treatment of private annuities. Under the current rules, the receipt of an annuity contract for property will be treated as the receipt of property in an amount equal to the fair market value of the annuity contract.¹ The fair market value of an annuity contract is determined under the rules of IRC Section 7520 ( Q 921). Therefore, all of the gain on the property will be recognized at the time of the exchange. The private annuity’s investment in the contract will be the amount paid for the contract. Thus, where the value of the property exchanged and the value of the annuity are the same, the investment in the contract will be the fair market value of the property exchanged for the private annuity.

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Planning Point: The general outcome of these rules is that subsequent payments will still be taxable to the payee under the rules for amounts received as an annuity, but the investment in the contract will be based on the fair market value of the property received in exchange for the annuity contract.²

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These proposed regulations were intended to be effective for exchanges of property for private annuity contracts that occur after October 18, 2006. For certain transactions, however, the proposal was for a later effective date for transactions occurring after April 18, 2007. This delayed effective date was for exchanges where: (1) the issuer of the annuity is an individual; (2) the obligations under the contract are not secured; and (3) the property transferred in the exchange is not sold or otherwise disposed of during the two year period beginning on the date of the exchange. A disposition includes a transfer to a trust or any other entity, even if wholly owned by the transferor.

For tax consequences to the obligor, see Q 606.

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1.     Prop. Treas. Reg. §§ 1.1001-1(j); 1.72-6(e).