Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 69-74

1969-1 C.B. 43

Sec. 72

Sec. 101

IRS Headnote

Principles to be applied in determining the tax consequences of the transfer of appreciated property for a private annuity contract in an intra-family exchange.

Full Text

Rev. Rul. 69-74

Advice has been requested relative to the treatment for Federal income and gift tax purposes of monthly payments received under the circumstances outlined below.

In the instant case, the taxpayer, age 74, transferred property (a capital asset) having an adjusted basis of $20,000, and a fair market value of $60,000, to his son in 1966, in exchange for the legally enforceable promise of the latter to pay him a life annuity of $7,200 per annum payable in equal monthly installments of $600.

Section 72(b) of the Internal Revenue Code of 1954 provides that gross income does not include that part of any amount received as an annuity which bears the same ratio to such amount as the investment in the contract bears to the expected return under the contract. Further, section 1.72-3 of the Income Tax Regulations states that amounts received under annuity contracts are not to be included in the income of the recipient to the extent that such amounts are excludable from gross income as the result of the application of section 72 of the 1954 Code and the regulations thereunder.

Accordingly, the tax consequences of the private annuity transaction in this case are determined by applying the following principles:

(1) The gain realized on the transaction is determined by comparing the transferor's basis in the property with the present value of the annuity. Section 1.101-2(e)(1)(iii)(b)(3) of the regulations prescribes the appropriate table to be used for valuing a private annuity contract. (U.S. Life Table 38 contained in paragraph (f) of section 20.2031-7 of the Estate Tax Regulations.) The gain realized will be capital gain if the transferred property constitutes a capital asset.

(2) The excess of the fair market value of the property transferred over the present value of the annuity acquired constitutes a gift for Federal gift tax purposes where the transaction is not an ordinary business transaction within the meaning of sections 25.2511-1(g)(1) and 25.2512-8 of the Gift Tax Regulations.

(3) The gain should be reported ratably over the period of years measured by the annuitant's life expectancy and only from that portion of the annual proceeds which is includible in gross income by virtue of the application of section 72 of the 1954 Code. This will enable the annuitant to realize his gain on the same basis that he realizes the return of his capital investment.

(4) The investment in the contract for purposes of section 72 of the 1954 Code is the transferor's basis in the property transferred. Since the amount of the gain is not taxed in full at the time of the transaction, such amount does not represent a part of the "premiums or other consideration paid" for the annuity contract. Applying the foregoing principles, the transaction in the instant case is taxable as follows:

(1) Based on U.S. Life Table 38, with interest at 31/2 percent, the present value of the right of a person age 74 to recieve a life annuity of $7,200 per annum is $47,713.08.

(2) The excess of the fair market value of the property transferred over the value of the annuity received as a gift to the son from the father. ($60,000 minus $47,713.08 is $12,286.92, the gift made by the father to his son.)

(3) The basis of the property is $20,000.

(4) The excess of the value of the annuity received over the basis in the property transferred represents the gain realized. ($47,713.08 minus $20,000 is $27,713.08 the gain realized.) See section 1.1001-1(e)(1) of the Income Tax Regulations.

(5) The computation and application of the exclusion ratio, the gain, and the ordinary annuity income is as follows:

$72,720 expected return (annual proceeds multiplied by 10.1, the life expectancy).

$20,000 (investment in the contract) divided by $72,720 (expected return) results in an exclusion ratio of 27.5 percent.

(a) Annual proceeds, $7,200.

(b) Exclusion (27.5 percent of $7,200), $1,980.

(c) Capital gain income ($27,713.08) divided by 10.1 years (the life expectancy), $2,743.87.

(d) Ordinary annuity income: (a), minus the total of (b) plus (c), $2,476.13.

The exclusion ratio of 27.5 percent is applicable throughout the life of the contract. After the capital gain of $27,713.08 has been fully reported, subsequent amounts received (after applying the exclusion ratio) are to be reported as ordinary income.

Revenue Ruling 239, C.B. 1953-2, 53, which was issued under different provisions of prior law, is not determinative under section 72(b) of the Code.