Court Allows the Use of a SCIN
November 21, 2011
How can you transfer valuable real estate property to relatives without incurring a substantial estate or gift tax bill? One possibility is to sell the property to one or more family members on the installment basis and take back a note. As one court case points out, a self-canceling installment note (SCIN) may be used to avoid some tax on sales between related parties.
This case is being viewed as a significant victory for taxpayers in light of a recent string of contradictory court decisions. (Estate of Durilio Costanza, CA-6, 2/4/2003).
Key facts: Mr. Costanza owned two real estate parcels in Michigan that he sold to his son, Michael, in 1992 for a SCIN in the amount of $830,000. The note was fully secured by a mortgage on the properties, which consisted of a restaurant and an retail office plaza. Under the terms of the note, the son was required to make monthly payments over the course of 11 years.
"Intrafamily transactions are subject to rigid scrutiny, and transfers between family members are presumed to be gifts. A sale of property from a parent to a child in exchange for an installment obligation will not be 'bona fide' absent an affirmative showing that there existed at the time of the transaction a real expectation of repayment and intent to enforce the collection of the indebtedness."
- The U.S. Tax Court,
Estate of Durilio Costanza, TC Memo 2001-128
The SCIN provided for the payment of interest at a rate that increased by one half percent every 24 months. The initial interest rate was 6.25 percent and the final rate for the last 12 months was 8.75 percent.
The note also included a provision canceling the obligation in the event of Costanza's death.
Although Costanza had a history of heart disease, he was not known to be ill when the SCIN was signed. Just five months later, he died after undergoing bypass surgery. The note was identified as an asset of the estate, but it was assigned no value under the cancellation-upon death provision.
Initial result: The IRS contended that the SCIN did not represent a bona fide transaction between the parties and the Tax Court agreed. One factor that affected the decision was the fact that Michael did not make the first few payments on time. Thus, gift tax was assessed on the transfer of the real estate properties.
Final result: Now the Sixth Circuit Court of Appeals has reversed the Tax Court's decision. Despite having a history of heart problems, there was no evidence that either party presumed the father would die shortly after signing the SCIN. At the trial, medical experts testified that before he died, Costanza's life expectancy was between 5 and 14 years. In addition, the properties were fully secured by a mortgage, giving credibility to the transaction. Finally, the Court dismissed the suspicions of the IRS concerning the timing of the first few payments as being inconsequential.
Keep this in mind: Over the last few decades, courts have issued conflicting decisions on the validity of SCINs between family members. These are extremely complex transactions. Consult with your tax adviser about the best way to proceed.