You've enjoyed your lifelong passion of acquiring extraordinary collectables. You've gathered rare pieces over the years such as an antique grandfather clock, a bat autographed by Babe Ruth, an original Ford Model T, a one-of-a-kind Persian rug or maybe even a priceless Picasso painting. This hobby has been fun and exciting but now, in order to take advantage of the appreciation you've enjoyed, you want to liquidate your collection.

Upon liquidation, you find out that your collectables are worth much more than you had ever dreamed. But with the new valuations come huge and hefty tax bills. Sellers are now routinely facing large gains of $500,000, $1,000,000 or more, resulting in tax bills in the hundreds of thousands, and even millions, of dollars.

There are many reasons collectors are selling their rare possessions. They may finally want to turn their collectable into an income-producing asset. Maybe they just appraised that Model T or autographed bat and would like to take a profit on it. Perhaps they just moved and the antique grandfather clock doesn't fit with the look of their new home. Whatever the reason is it always comes back to….

HOW DO I SELL MY COLLECTABLE AND NOT PAY ALL OF THOSE TAXES???

Investors have traditionally used a variety of methods to try to limit or defer their tax consequences. Tenants In Common (TICs), 1031s, Installment Sales, Self Canceling Notes and Charitable Remainder Trusts (CRTs) have been the more publicized methods in the past. However, since the 1980s, tax and estate planning professionals have increasingly turned to a little known strategy called a Private Annuity Trust (PAT).

PATs are appealing because they may provide significant estate tax relief along with other benefits including:

· NO estate tax imposed upon the taxpayer's death for assets inside the PAT.

· The creation of an income stream for life or joint lives.

How a Private Annuity Trust Is Structured

A PAT is a contractual agreement between private parties. Usually the transferor (the annuitant or the parent) transfers ownership of an asset (real estate, stock, a business or a collectible, etc.) to the transferee (the obligor or the child or other beneficiary) in exchange for the unsecured promise to provide a stream of payments for life (an annuity contract). The PAT is simply a specific trust set up and designed to give structure, formality and a legal conduit to the private annuity contract.

The Private Annuity Trust Alternative

A Private Annuity Trust (PAT) exchanges an asset for an income stream for life.  This income stream may be deferred until the age 70 1/2.  If the annuitant dies, his/her spouse may continue to receive payment for the rest of his/her life.

But that's not all. In 2006 - 2008, $2,000,000 of a decedent's estate is sheltered from the estate tax ($4,000,000 for a couple if titled correctly). Any amount over this is subject to estate taxes (otherwise known as the "death tax"). This tax can quickly reach up to 50 percent of your taxable estate. Because a PAT removes this asset from your estate…there is no estate tax or probate costs!

Assume your net worth is $10,000,000, you are married and have a marital deduction bypass living trust. If you both passed away in 2008, anything over $4,000,000 might be taxed up to 50%. Your estate (your children and your beneficiaries) might owe up to $3,000,000 in estate taxes!! This tax can be avoided on the assets in a PAT.

There are many other advantages of PATs but the last one we'll speak of is the income feature.

The PAT is funded with the proceeds from the sale of your property. The trust issues a private annuity contract that is required to pay out an income for life based on interest rates and actuarial tables published by the government. As the annuitant, you will receive the federally determined amount for the rest of your life. This income can start immediately or it may be deferred. It must begin, however, by age 70 ½.

The Competing Alternatives

A PAT has become increasingly popular because it has advantages over other competing strategies. If a person was selling his 2nd home - a beach house, for instance - he could consider options such as an installment sale or a CRT.

There are pros and cons with each alternative, however.

In a PAT the biggest drawback is that the trust is irrevocable and generally only the income payments can be taken out. In an installment sale there are different risks. What if the buyer defaults on his contract? You might have to take back a neglected property and sell it in a depressed market, possibly turning a profit into a loss. And if you were to pass away before the installments were completed then the value of the remaining portion is included back into your estate for the dreaded estate tax.

A CRT is another planning strategy used to defer capital gains and income taxes on the sale of an appreciated asset. However, unless you have a significant charitable intent, the PAT often provides more benefit to the family because in a CRT the assets eventually will be left to charity as opposed to your heirs.

It's easy to see why a PAT has become increasingly popular, however, most tax professionals have little or no knowledge on the structure of a PAT. Others have looked at it and found it to be too technical to be part of their everyday practice. For this reason, it is extremely important to use professionals who are familiar with and well versed in the language of Private Annuity Trusts.

When set up, funded and executed properly, a Private Annuity Trust can be a versatile and valuable tool for your estate and tax planning needs.

This article is for discussion and information purposes only and is not intended to replace competent legal, tax or financial planning advice. NAPAT is based in California and this information may be specific to that state. Please contact the appropriate tax and legal professionals in your state. This information is provided from sources believed to be reliable, but should be used in conjunction with professional advice that is consistent with your personal situation.