Installment Sales and SCIN’s
Chapter 35
Tools & Techniques of
Estate Planning
What Are Installment Sales & Self-Cancelling
Installment Notes (SCIN)?
• The installment sale is a device for spreading out the
taxable gain and thereby deferring the income tax on
gain from the sale of property
– Key: At least one payment will be received by the seller
after the taxable year in which the sale occurs
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Installment Sales and SCIN’s
Chapter 35
Tools & Techniques of
Estate Planning
What Are Installment Sales & SCINs?
• The self-canceling installment note or SCIN is a
hybrid between an installment note and a private
annuity
– The note contains a provision under which the balance of
payments due at the date of death are automatically
canceled
– The term of the SCIN must be less than the life expectancy
of the seller, otherwise it will be taxed as a private annuity
– Typically the note interest rate will contain a premium for the
self-canceling feature
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Installment Sales and SCIN’s
Chapter 35
Tools & Techniques of
Estate Planning
When Is The Use Of An Installment Sale
Appropriate?
• When a taxpayer wants to sell property to another
individual who may not have enough capital to
purchase the property outright
• Where an individual in a high income tax bracket
holds substantially appreciated real estate or nonmarketable securities and wishes to spread all or a
portion of the tax due on the sale of such property
over the period of installments
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Installment Sales and SCIN’s
Chapter 35
Tools & Techniques of
Estate Planning
When Is The Use Of An Installment Sales
Appropriate?
• The installment sale can begin and end when the
parties agree, unlike the rigid schedule that must be
followed for a private annuity
• This is an estate tax freeze device, shifting future
appreciation to the purchaser
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Installment Sales and SCIN’s
Chapter 35
Tools & Techniques of
Estate Planning
When Is The Use Of A SCIN Appropriate?
• Where the seller desires to retain a payment stream
that will not continue beyond his or her death
• The SCIN allows the buyer to depreciate assets
based on the purchase price paid and to deduct the
portion of payments attributable to interest expense
• Where the tax benefits attributable to excluding the
unpaid principal from a taxable estate exceed the
income tax cost that results from the buyer paying a
premium for the cancellation at death feature
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Installment Sales and SCIN’s
Chapter 35
Tools & Techniques of
Estate Planning
What Are The Requirements?
• No minimum sale price is required
• Seller of property can defer as much or as little as
desired under the installment sale, and the amount
of the payment received in a year is irrelevant
• Payments can be set to fit the seller’s business or
financial needs
Note: With a SCIN the term cannot extend beyond the seller’s
life expectancy, if it does it will be taxed as a private annuity
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Installment Sales and SCIN’s
Chapter 35
Tools & Techniques of
Estate Planning
What Are The Requirements?
• No payment has to be made in the year of the sale
• At least one payment must be made in a taxable year
after the year of the sale
• Installment sale treatment is automatic, unless the
taxpayer elects not to have installment treatment apply
• A sale can be made on an installment basis even
though the selling price is contingent
• Installment reporting is not available for sales of
marketable securities
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Installment Sales and SCIN’s
Chapter 35
Tools & Techniques of
Estate Planning
How Is It Done?
• Property title passes immediately from seller to buyer
• Seller does not receive a lump sum payment outright
Example:
• Mrs. Murphy sold land that cost her $50,000 for $100,000,
resulting in a $50,000 gain all reportable in the year of sale
• If instead Mrs. Murphy agrees to receive $10,000 plus
appropriate interest for 10 years, she will not have to report a
$50,000 gain all in the year of the sale
• Ignoring interest, Mrs. Murphy’s ration of gross profit ($50,000)
to contract price ($100,000) is 50%
• Mrs. Murphy will report 50% of each $10,000 payment she
receives or $5,000 as capital gain
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Installment Sales and SCIN’s
Chapter 35
Tools & Techniques of
Estate Planning
How Is It Done?
• SCIN’s require a premium to reflect the possibility that
the seller will die during the term of note
• The buyer may be allowed an interest deduction if the
debt was not personal and properly allocable to:
– Investment purposes
– Conduct of a trade or business
– Part of the computation of income or loss from a passive
investment activity
– Estate or GST taxes in installments under IRC Sections 6166
or 6161
– A debt secured by a qualified residence at the time the
interest is paid or accrued up to prescribed limits
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Installment Sales and SCIN’s
Chapter 35
Tools & Techniques of
Estate Planning
How Is It Done?
• If the agreement does not specify an interest charge or
the amount is too low, the IRS will impute interest,
unless the parties agreed to a safe harbor rate of return
on the unpaid balance
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Installment Sales and SCIN’s
Chapter 35
Tools & Techniques of
Estate Planning
How Is It Done?
• Rules of thumb for planning the interest rates that
should be built into an installment sale:
– There will be no imputed interest problem unless the
installment sale contract
• Does not state any interest on the unpaid balance, or
• The specified interest rate is less than the “applicable federal rate”
AFR
• For intra family land sales the AFR is applied to amounts over
$500,000
– If the selling price is under $3,653,600 (2010) indexed, interest
will be imputed at the lower of
• 9% compounded semiannually, or the AFR rate
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Installment Sales and SCIN’s
Chapter 35
Tools & Techniques of
Estate Planning
Taxation Computation
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Installment Sales and SCIN’s
Chapter 35
Tools & Techniques of
Estate Planning
Tax Implications Of An Installment Sale
• Depreciation recapture and any investment tax credit
recapture is reportable in full in the year of the sale,
even if no proceeds are received in that year
• Installment treatment is generally not allowed for
sales of depreciable property to a controlled entity or
sales of marketable securities
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Installment Sales and SCIN’s
Chapter 35
Tools & Techniques of
Estate Planning
Tax Implications Of An Installment Sale
• The installment sale will remove the property from
the seller’s estate, but the PV of any installments due
at the seller’s death must be included
– Remember that the future appreciation of the sale property
is removed from the seller’s estate without any gift tax
consequences, and
– After receiving payments, the seller using annual exclusion
gifting could gift back all or part of the proceeds further
reducing potential estate taxes
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Installment Sales and SCIN’s
Chapter 35
Tools & Techniques of
Estate Planning
Tax Implications Of An Installment Sale
• Which interest rate to use when?
– Tax Courts are split on whether to use prevailing market
rates, AFR, or special rates on sales of farmland
– Adoption of AFR rates should eliminate the gift tax problem,
but it is unclear in the case where the AFR rates are lower
than prevailing market rates
• If seller dies, remaining payments are reported as
IRD, with no step-up in basis at death
• Under an installment sale, buyer’s new income tax
basis is its FMV at date of the sale (purchase price)
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Installment Sales and SCIN’s
Chapter 35
Tools & Techniques of
Estate Planning
Tax Implications Of An Installment Sale
• Advantages of step-up in basis upon sale
– A lower bracket family member purchasing the property can
sell it and probably pay much less tax than the seller would
otherwise have to pay
– Proceeds can be reinvested in more liquid and higher
yielding assets
• Generally interest paid by the purchaser on the
unpaid balance will be deductible in full only if it is
allocable to investment or business purposes
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Installment Sales and SCIN’s
Chapter 35
Tools & Techniques of
Estate Planning
Special Rules for Disposition of Property
Between Related Parties
• Second Disposition Rule
– Certain resales (secondary dispositions) by a related party
purchaser trigger recognition of gain by the initial seller
– Original seller’s gain will be accelerated if a trustee or other
related purchaser resells the asset within 2 years of the
installment sale
– Where a second disposition results in recognition of gain to
the first seller, subsequent payments received by the first
seller will be tax-free until they have equaled the amount
realized as a result of the second disposition
– This rule does not apply where the second disposition
results from death of either party or involuntary conversion
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Installment Sales and SCIN’s
Chapter 35
Tools & Techniques of
Estate Planning
Special Rules for Disposition of Property
Between Related Parties
• Rule for Cancellation of Debt
– If an installment sale between related parties is canceled or
payment is forgiven
– Seller must recognize gain to the extent FMV on the date of
cancellation exceeds the seller’s basis in the obligation
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Installment Sales and SCIN’s
Chapter 35
Tools & Techniques of
Estate Planning
Special Rules for Disposition of Property
Between Related Parties
• Special Depreciable Property Sale Rule
– Applies only to related entities such as a corporation and an
individual that owns more than 50% of its outstanding stock
– Sale of depreciable property between related entities may
not be reported on the installment method
– Depreciation recapture must be reported by the seller in the
year of the sale up to the amount of the seller’s gain, and
can be added to the seller’s basis
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Installment Sales and SCIN’s
Chapter 35
Tools & Techniques of
Estate Planning
Tax Implications Of A SCIN
• All of the tax rules that apply to the installment sale
apply to the SCIN, along with some additional factors:
– Upon death, gain will be fully taxable to the decedent’s estate
as IRD, not as income on the decedent’s final income tax
return, where the sale was between decedent and his children
– For gift tax purposes, the actual value of the SCIN received by
the seller is not equal to its face value because of the risk of
seller’s death, otherwise the transaction would be treated as a
bargain sale
– Since the balance of the SCIN is canceled at the seller’s death,
there is nothing to include in seller’s estate for estate tax
purposes
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Installment Sales and SCIN’s
Chapter 35
Tools & Techniques of
Estate Planning
When Does It Make Sense To Forgo
Installment Method Of Reporting?
• If a taxpayer has unrelated losses, he or she might
wish to offset those losses with the gain from the
installment sale
• If taxpayer has unusually low income or high
deductions for the year
– He or she would elect to report the full gain in the year of
the sale, even though the sale was on an installment basis
to afford the buyer time to raise capital to make the
payments
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Installment Sales and SCIN’s
Chapter 35
Tools & Techniques of
Estate Planning
Use Of Life Insurance
• Where an individual transfers property to someone
else in return for installment payments:
– Seller will often purchase insurance on the life of the
purchaser to protect against potential cessation of payments
at the death of the purchaser
– The agreed upon amount of payments made by the
purchaser of the property could be increased to provide
enough cash to make premium payments
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Installment Sales and SCIN’s
Chapter 35
Tools & Techniques of
Estate Planning
Use Of Life Insurance
• Spouse or adult children of purchaser, or a trustee of
an irrevocable trust for their benefit, will purchase a
policy to:
– Ensure liquid funds to pay taxes and other death expenses
on the purchaser’s increased estate value from the
purchase of the installment sale property
– Provide liquid funds to continue to pay installment payments
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Installment Sales and SCIN’s
Chapter 35
Tools & Techniques of
Estate Planning
Issues In Community Property States
•
•
•
Both spouses should join in any conveyances of real
property, otherwise the non transferor spouse may be able
to void the sale for a specified period
If undivided interests are sold at a discount, the amount of
capital gains will be less, thereby creating estate tax
savings and lower installment payments
Possibly consider a separate sale of each spouse’s
interest, where one spouse recognizes all the gain
immediately and the other uses the installment method
– Result: Reduce capital gains tax while effectively allowing a
greater amount of sale price to be received in the year of sale
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