Private Annuity Not Subject to OID Provisions

R is an individual who owns a real estate investment organization; it provides a full range of services, including acquisitions, planning, development leasing and property and project management.

R proposes to transfer his interest in partnership P to Trust E in exchange for a private annuity that will provide fixed annual payments for his life. Rs grandchildren are Es beneficiaries. Es assets consist of publicly traded stocks and real estate holdings; its only liability is a note. P owns a percentage of outstanding stock in a company that owns interests in entities that own real estate.

Pursuant to the agreement, R will irrevocably transfer his interest in P to E for Es obligation to pay R an annual annuity on 60 days demand. The annuity payment amount will be calculated under applicable IRS tables to equal the value of the interest in P on the transfer date. Also, the annuity payments will terminate with the last payment immediately preceding Rs death, or at Rs death if no payments were made before that. Es obligation will not be secured by any of its assets and it will not establish any security or any fixed or other specific chargeable source for the annuity payment. However, the trustee is authorized to invade or dispose of Es principal to meet the annuity obligations.

Annuity vs. Debt Instrument

An annuity is a periodic amount paid at a regular interval under a contract that provides a determinable amount of payments in consideration for a fixed sum or transfer of property; see Regs. Sec. 1.72-2. A private annuity is an arrangement under which an individual or entity promises to make periodic payments to the transferor for the transferors remaining life.

For purposes of the original issue discount (OID) provisions, debt instrument does not include any annuity contract to which Sec. 72 applies which depends (in whole or in substantial part) on the life expectancy of one or more individuals; see Sec. 1275(a)(1)(B). Under Regs. Sec. 1.1275-1(j)(2)(i), an annuity contract depends (in whole or in substantial part) on the life expectancy of one or more individuals only if (1) the contract provides for periodic distributions made not less frequently than annually for the life (or joint lives) of an individual (or a reasonable number of individuals) and (2) the contract does not contain any terms or provisions that can significantly reduce the probability that total distributions under the contract will in-crease commensurately with the longevity of the annuitant(s).

Regs. Sec. 1.1275-1(j)(3) through (7) describe the terms and conditions that can significantly reduce the probability that total distributions under the contract will increase commensurately with the longevity of the annuitant(s), including (1) availability of a cash surrender op-tion; (2) availability of a loan secured by the contract; (3) a minimum payout provision; (4) a maximum payout provision and (5) a decreasing payout provision.

The agreement does not contain any terms that will significantly reduce the probability that the total annuity payments to R will increase commensurately with longevity. At the time the agreement becomes effective, the parties intend that R will receive annuity payments over his life beginning on an agreed starting date within the period of his life expectancy (determined under the applicable tables). In addition, the annuity payments will be made at least annually. Thus, because the private annuity obligation is excepted from the definition of debt instrument, the Sec. 1275 OID provisions do not apply.

IRS Letter Ruling 200352001 (12/24/03)