A private annuity is an arrangement in which one person transfers property to another in exchange for the recipient’s unsecured promise to make regular payments for the rest of the transferor’s life. The person handing over the property is the annuitant; the person receiving it and promising to pay is the obligor. When the annuitant dies, the payments stop, no matter how much or how little has been paid, and the obligor keeps the property outright. These deals are used almost exclusively between family members, most often as an estate-planning move to shift a high-value asset out of a parent’s taxable estate while converting it into predictable income.
Before going further, one piece of context matters: a 2006 IRS rule change stripped away the income tax deferral that once made private annuities popular. The structure still exists and still has estate-planning uses, but the tax picture today looks nothing like the one described in older planning guides.
How the Arrangement Actually Works
The annuitant owns something valuable and wants to move it. The obligor takes ownership of the property and, in return, agrees in writing to pay the annuitant a fixed amount on a regular schedule for as long as the annuitant lives. Payments end at death. If the annuitant dies a year in, the obligor is done paying. If the annuitant lives another 30 years, the obligor keeps paying for 30 years.
The feature that separates this from a normal installment sale is that the obligor’s promise is completely unsecured. No collateral. No lien on the property. Nothing pledged. If the obligor puts up the transferred property, or any other asset, as security for the payments, the IRS treats the whole thing as a closed sale and taxes the entire gain immediately.1Internal Revenue Service. Proposed Regulations REG-141901-05 The unsecured status is what preserves the intended tax treatment, and it is also what makes the annuitant vulnerable if the obligor stops paying.
What Kind of Property Goes Into One
Private annuities fit illiquid assets. Rental houses, commercial buildings, undeveloped land, and closely held family business interests are the usual candidates because these are things the owner wants to move without forcing a sale. A family business is a common example: transferring the ownership stake through a private annuity lets the next generation take over without the business being liquidated to pay estate settlement costs. The general logic is to take something hard to divide or sell and turn it into a stream of cash payments.
How the Payment Amount Is Set
Three inputs drive the calculation. An independent appraiser establishes the fair market value of the property on the transfer date; that figure is the effective purchase price the obligor is repaying through the annuity. The IRS actuarial tables in Publication 1457 supply the annuitant’s life expectancy, which sets the expected length of the payment stream.2Internal Revenue Service. Actuarial Tables The interest rate comes from Section 7520 of the Internal Revenue Code, which equals 120 percent of the federal midterm rate for the transfer month, rounded to the nearest two-tenths of a percent, and the IRS publishes an updated rate each month.3Office of the Law Revision Counsel. 26 USC 7520 – Valuation Tables
Getting the arithmetic right matters. If the present value of the promised payments falls below the property’s fair market value, the shortfall is treated as a taxable gift from the annuitant to the obligor.
The 2006 Rule Change
Before October 18, 2006, an annuitant could spread capital gains recognition across the expected payment period, paying tax on only a portion of the gain each year. That installment-style deferral was the main reason families chose private annuities over outright sales.
The IRS proposed regulations in October 2006 that ended this treatment. Under the current rules, when you exchange property for a private annuity contract, the full gain is recognized in the year of the exchange. The amount realized equals the fair market value of the annuity contract determined under Section 7520, and capital gains tax is owed on all the appreciation right away.1Internal Revenue Service. Proposed Regulations REG-141901-05 The proposed regulations apply to any exchange of property for an annuity contract after October 18, 2006.
The estate-planning benefits survive. The income tax deferral does not. Many practitioners now look at other structures, such as self-canceling installment notes, though those come with their own tradeoffs.
How the Annuitant’s Payments Are Taxed
Once payments start, each one is taxed under Section 72 of the Internal Revenue Code. For post-2006 arrangements, where the capital gain was already recognized upfront, each payment splits into two pieces.
Part of the payment is a tax-free return of basis. Section 72 uses an exclusion ratio, which compares your investment in the contract to the total expected return over your lifetime, to determine what percentage of each payment comes back to you tax-free.4Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts The rest is ordinary income, representing the interest element that compensates you for taking the money over time instead of in a lump sum.
If you live long enough to fully recover your basis, the tax-free portion disappears. From that point on, every dollar you receive is ordinary income taxed at regular rates. A capital gains portion, ranging from 0 to 20 percent depending on total income, only appeared in pre-October 2006 transactions where gain was spread across the payment period.5Internal Revenue Service. Topic No. 409, Capital Gains and Losses
One point that surprises buyers: the obligor cannot deduct the interest portion of the payments. Unlike mortgage or business loan interest, the interest baked into private annuity payments produces no tax benefit for the obligor. The full amount paid simply increases the obligor’s basis in the property over time.
Estate and Gift Tax Effects
A properly structured private annuity keeps the transferred property out of the annuitant’s taxable estate. The annuitant traded the property for a stream of payments that ends at death, so nothing remains to include when the annuitant dies. The payments stop and the obligor owns the property free and clear.
This exclusion falls apart if the annuitant kept an interest in the property. Under Section 2036, if the transfer was not made for adequate consideration, or if the annuitant retained the right to use or enjoy the property, the full value gets pulled back into the gross estate.6eCFR. 26 CFR 20.2036-1 – Transfers With Retained Life Estate A parent who transfers a home to a child through a private annuity and then keeps living there rent-free hands the IRS a strong argument that the transfer never really happened.
Gift tax comes in when the present value of the annuity payments is less than the property’s fair market value. The difference is a gift from the annuitant to the obligor. Present value is calculated using Section 7520 rates and IRS actuarial factors to test whether the annuity represents full and adequate consideration.7eCFR. 26 CFR 25.2512-5 – Valuation of Annuities, Unitrust Interests, Interests for Life or Term of Years, and Remainder or Reversionary Interests If a gift exists, the annuitant reports it on Form 709 with adequate disclosure, including a qualified appraisal or a detailed explanation of how fair market value was determined.8Internal Revenue Service. Instructions for Form 709 (2025)
What Happens When Someone Dies
If the Annuitant Dies Early
Payments stop right away. The obligor keeps the property and owes nothing further, which can amount to a significant financial windfall if the annuitant dies well before actuarial projections. Nothing related to the transferred property is included in the annuitant’s estate. The obligor’s basis in the property equals the total of payments actually made, so an early death leaves the obligor with a lower basis and a larger taxable gain whenever the property is eventually sold.
If the Annuitant Outlives Life Expectancy
The obligor keeps paying for as long as the annuitant lives, even if the running total goes well past the property’s original value. Once the annuitant has fully recovered basis, every payment received is ordinary income at regular rates.4Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts
If the Obligor Dies First
The obligation does not disappear. The obligor’s estate must continue the annuity payments. In practice, the annuitant becomes an unsecured creditor of that estate, which is a shaky position if the estate lacks assets. The estate may set aside property or pay the present value of the remaining promise, but nothing is guaranteed if the estate is insolvent.
The Risk Built Into an Unsecured Promise
The unsecured nature of a private annuity is both its defining legal feature and its most serious practical weakness. The annuitant has no lien, no collateral, and no priority over other creditors. If the obligor mismanages the property, takes on heavy debt, or simply stops paying, the annuitant’s only remedy is a breach-of-contract claim, standing in line with every other unsecured creditor.
There is no clean workaround. If the obligor buys a life insurance policy naming the annuitant as beneficiary and the IRS sees a link between the policy and the annuity, the arrangement can be treated as secured, which triggers immediate recognition of the full gain. A life insurance policy is not off-limits, but it has to stay entirely separate from the annuity contract.
This is why these deals live almost entirely inside families. The whole structure rests on the obligor’s willingness and ability to keep paying, possibly for decades. Any family considering one should have a candid conversation about the obligor’s finances before signing.
Private Annuity vs. Self-Canceling Installment Note
A self-canceling installment note, or SCIN, is the closest cousin to a private annuity. Both convert property into periodic payments and both cancel at the seller’s death, keeping the asset out of the seller’s estate. The tax treatment at death is where they split.
With a private annuity, income tax obligations end when the annuitant dies. Payments stop and that is the end of it. With a SCIN, the cancellation itself is a taxable event: the remaining deferred gain becomes taxable income on the decedent’s final income tax return. For a family where the seller is in poor health and unlikely to reach the note’s term, that difference can be a large tax bill a private annuity would have avoided.
The SCIN has an offsetting advantage for the buyer. The interest component of SCIN payments is generally deductible for the buyer under standard limitation rules. Private annuity payments offer the obligor no deduction at all. Which structure fits better depends on the annuitant’s health, the property’s appreciation, the obligor’s income level, and how much each side values certainty.
What It Costs to Set One Up
A private annuity needs professional help on several fronts. A qualified appraiser has to establish the property’s fair market value, and an attorney experienced in estate planning has to draft the agreement. Residential appraisals typically run from a few hundred dollars to over a thousand depending on the property; commercial appraisals and business valuations cost considerably more. Legal fees vary with the complexity of the asset, whether gift tax reporting is involved, and whether related documents like trust amendments are needed.
The annuity calculation itself calls for an actuary or tax professional comfortable with Section 7520 rates and the IRS Publication 1457 tables.2Internal Revenue Service. Actuarial Tables Errors here can create an unintended gift, pull the property back into the taxable estate, or invite an IRS challenge. Given the stakes and the finality of the transfer, this is not the place to cut costs.