If there’s a single, central objective of most estate plans, it’s to transfer property to younger family members while minimizing estate and gift tax liability. Among the many strategies and structures designed to accomplish that goal, one less well-known vehicle—a self-canceling installment note, or SCIN (pronounced “skin”)—may work particularly well with today’s depressed asset values and low interest rates.
With a SCIN, you sell real estate, a business interest, or other assets to one or more younger family members, such as your children, in exchange for an installment note with a term shorter than your expected life span. That aspect is required; to realize tax benefits, the note’s term must be shorter than the seller’s life expectancy, according to IRS tables. But under the “self-canceling” feature of the note, your heirs’ obligation to repay the loan automatically disappears if you die before the end of the term.
A SCIN provides several potential tax benefits. If you die early and there’s an unpaid balance on the loan, that amount won’t be considered part of your taxable estate. Yet the property still ends up in the hands of your heirs. And because the transfer is a sale for fair value, not a gift, there’s no gift or estate tax.
There’s also an advantage in using a SCIN to pass along property that has appreciated in value. Though you may owe capital gains tax on the sale, you can spread out that liability over the note’s term. (Note that if the assets’ buyers are family members, they must wait at least two years to sell the property in order for the capital gains to be prorated and deferred.) The longer term might help you avoid moving into a higher tax bracket, particularly if the term of the loan extends into your retirement years, when your income may be declining. Meanwhile, if the transferred property continues to appreciate, those gains will be outside your estate.
Because the self-canceling aspect of a SCIN is a risk to your estate, the note must include either an inflated market value for the assets or an interest rate that’s higher than the applicable federal rate, or AFR. That can be a drawback of this estate planning technique. But interest rates now are exceptionally low, and the value of most assets is well below what they may have been worth in recent years. As a result, the interest rate required for a SCIN may still be quite reasonable. And with asset values depressed, the principal of the note will be lower, and any rebound in prices will, again, occur outside your estate.
If you are interested in transferring property to your heirs, we can work with you and your attorney to consider whether a SCIN could help.
This article was written by a professional financial journalist for Preferred NY Financial Group,LLC and is not intended as legal or investment advice.