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A SCIN will avoid adverse gift and estate tax treatment only if the self-cancellation provision is properly designed. The courts have held that:
The cancellation provision must be bargained for as part of the consideration for the sale. The purchase price must reflect this bargain either with a principal risk premium (above market sales price) or an interest rate premium (above market interest rate), and the seller may not retain any control over the property being sold after the sale.
If the self-cancellation provision is not properly designed, the seller may be deemed to have made a part-sale part-gift. If any of the transfer of the remainder interest (the canceled payments) is considered a gift, the entire value of theproperty sold, less the consideration actually paid, will be included in the decedent’s gross estate.
This problem can be avoided by structuring the note as much like a market note as possible, except for the principal or interest rate premium. Although not all issues of valuation and proper design have been resolved by regulation or by the courts, most authorities feel the debt instrument and the sales contract should both include the self-cancellation clause. To avoid retained controls, the sales contract and/or note cannot place any restrictions on the use of the property by the buyer, including any restrictions on subsequent sales. (In general, a subsequent sale of the property by the buyer within 2 years of the original sale will trigger recognition of any remaining deferred gain by the original seller, even if the note has not been fully repaid.) Furthermore, it is advisable to avoid using the property sold as collateral for the note so the seller has no right to reacquire the property sold under any circumstances.