The Skinny on the SCIN (Self-Canceling Installment Note)
By: Randall A. Denha, Esq.
These times of historically low interest rates have made Self-Canceling Installment Notes (SCIN) an attractive estate-planning tool. As we know, real property is one asset that, as we know, has declined in value during recent months and may be a prime candidate for an intra-family transfer. This particular asset can be given or sold at its seemingly depressed value allowing its post-transfer appreciation to escape any and all gift and estate tax. The SCIN is a technique that deserves attention.
A SCIN involves the sale of a business interest, stock, or an interest in real estate or other asset, typically to one or more family members of the owner/seller, or to an entity that represents them, in exchange for an installment note with a term shorter than the seller’s life expectancy.
In essence, the seller (usually a senior family member) serves as a “friendly banker” by financing the sale of a family business or other asset through a loan payable by a junior family member or a trust in installments (annual, semiannual, quarterly, or monthly) over a specified period of years.
However, unlike the classic installment sale, the note in a SCIN includes provisions for automatic cancellation of the unpaid balance at the death of the seller. In other words the SCIN is a promissory note (evidence of debt), given by a buyer to a seller, with a provision under which the obligation to make any future payments ends at the seller’s death. Therefore, there is nothing included in the estate of the deceased. If the seller lives beyond the period over which installment payments are to be made, the “cancel at death” provision is ignored. If the seller dies during the term of the note, the buyer’s obligation to make payments ends on the date of death. It can be advantageous to utilize a SCIN when one family member, such as a parent or grandparent, desires to transfer property to another family member, such as a child or grandchild, with minimal gift and estate tax consequences. In the appropriate circumstances, SCINs offer your designated heirs considerable tax savings.
In order to have a properly designed self-cancellation provision, the cancellation provision must be bargained for as part of the consideration for the sale. In addition, the purchase price must reflect this bargain with either a principal risk premium that is above the market sales price or an interest rate premium that is above the market interest rate. Finally, the seller may not retain any control over the property being sold once the sale has taken place.
The ideal candidate for a SCIN has a shorter actual life span than would be indicated by his/her actuarially projected life expectancy. The earlier into the specified term the seller dies, the more advantageous the SCIN is. This is because the property transferred plus all the appreciation and any income it has produced is removed from the transferor’s estate.
WHY SET UP A SCIN?
Prorate capital gains. You can sell an asset with a low tax basis and spread the gain over the term of the note rather than bunching that gain all into one year. Prorating the taxable gain over the payment period may enable a shift of income from high bracket to lower bracket (or higher deduction) years so that you net more of the income.
Estate tax savings on asset appreciation. If the stock or asset purchased by the younger family member(s) appreciates more rapidly than the investment purchased by senior family members (with the annual after-tax proceeds of the installment sale, or if you consume or give away the after-income tax proceeds), the effect you have created an “estate freeze” since your estate will either remain the same or decrease.
So the SCIN enables an asset to be retained within the family unit while its value is frozen for death tax purposes. This is particularly appealing during economic conditions in which asset values are depressed at the same time interest rates are relatively low.
Estate tax savings on principal. The SCIN will remove the unpaid balance from the seller’s estate since there is a risk premium (or mortality charge) built into the agreement, therefore, the present value of any remaining payments should be excluded from the seller’s estate.
Create cash flow. If you own non-income -producing assets (such as undeveloped land, by selling it to a family member, the asset (such as a family vacation home) can be kept within the family unit yet the seller’s income can be increased significantly. Children who currently (or anticipate to) support aging parents may want to consider this “graceful and dignified” approach to provide income for their parents who might otherwise be financially handicapped. A fixed stream of income for the term of the note is secured (assuming the buyer-child remains both financially able and willing to make payments).
The SCIN, of course, also has downsides and costs which must be understood. So when planning, it is always essential to weigh the pros and cons of all your viable alternatives.