Providing or Restructuring a Stream of Income

Providing or Restructuring a Stream of Income

The Providing or Restructuring a Stream of Income In some cases an investor has property that has been in the family for a long time. Perhaps it’s a piece of vacant land, a rental house, or some other type of investment property. Many times it is producing little or no real income in relation to its current market value if it were to be sold.

Example:
Mary is 70 years old and lives in northern California. Her mother passed away 20 years ago, leaving Mary a small house located in southern California. There is no mortgage on the house, and it is rented for $800 per month. After management fees, repairs, property taxes, and insurance, Mary’s yearly income on the property is about $7,200. The current market value of the house is $220,000, so the stream of income on this asset is only about 3.3 percent.

If Mary in the previous example were trying to provide the best stream of income, the intelligent financial decision would be to sell the house and invest the money another way. However, Mary has had the house for 20 years, so having to pay taxes on her capital gain and recapture of depreciation will reduce proceeds in her situation by about 28 percent. For Mary, a better choice would be to defer her capital gain taxes through an installment sale, defer her taxes through a private annuity trust, or eliminate the tax liability through a charitable remainder trust.

All three of these options dramatically improve Mary’s stream of income. Which one is best depends on determining Mary’s secondary goal. For example, if she is primarily interested in improving her income stream and only secondarily interested in removing the asset from her estate, a private annuity trust or charitable remainder trust might be best. If her secondary goal is to pass the remaining asset to her children, then an installment sale or private annuity trust might be best. And a charitable remainder trust might be best if the secondary goal was charitable giving.

Each person’s situation is going to be slightly different based on his or her own specific needs and objectives. Mary was actually a real client. What did she do? She sold the property to a long-term investor by way of an installment sale. After receiving a 10 percent down payment that covered the expenses of the sale and the capital gains tax that would become due on the down payment, Mary carried a first mortgage of $198,000 at 7.5 percent amortized over 30 years and all due in 15 years. Mary no longer has tenant problems, repairs, property taxes, management fees, or insurance expenses. Her interest income from the asset is now approximately $14,850 per year (a 106 percent improvement), and she will still be able to leave a significant portion of the asset’s value to her children when she dies.

Mary’s choice was based primarily on her desire to restructure and improve her income stream, but her secondary goal was to provide for her children, which discounted the idea of a charitable remainder trust. And the private annuity trust option would have returned more of the principal and gain to her more quickly than she wanted, so the best choice for her needs was a straight installment sale.