In the last article, we learned a little bit about how the limited partnership can shelter your assets from the negative effects of litigation. In this article, we are going to discuss the estate planning benefits of the limited partnerships.

Let me say that while I am writing about limited partnerships, many practitioners, including me, think the same holds true as for the limited liability company, both in the matters of asset protection and in estate planning.

As we have already discussed, each American can gift away an annual amount of their wealth ($12,000) without the IRS even recognizing such a gift. For many people, this is simply not enough to be able to give. Their estate has swelled through hard work or in many cases of the landowner, simply through mere appreciation. I had a client in suburban Birmingham who had a piece of farm property that just happened to end up being one of the last pieces of a very chic real estate development. Needless to say, the new value greatly exceeded his basis in the property over the 70 years his family owned the land. Therefore, he wanted to begin making annual gifts of the property to his kids to get it out of his estate as the value continued to swell in his estate.

The desired effect of using the limited partnership is to employ “discounting techniques” in order to effectively get more than the genuine $12,000 worth of gifting in one year. Consider the following example:

You place your property into the partnership and subsequently begin transferring interests to your kids and grandkids. Because of discounts, the value of those interests for estate and gift tax purposes will be less than if you transferred a percentage of the real estate outright to the kids. What this means is that a percentage of the partnership will be worth less than the same percentage of the land itself. Also, at your death, your interest in the land will be valued less for tax purposes than if you owned the land outright.

We are deliberately messing up the ownership of the property in order to take advantage of the discounting techniques.

The federal court system has long given credence to the three major factors of discounts that the IRS has begrudgingly had to acquiesce to. They are as follows:

  1. Lack of Control: The theory here is that a non-controlling interest in an enterprise is not as valuable as an otherwise controlling interest. Therefore, the children who are minority percentage owners are to receive a discount on the principle that they have these non-controlling interests. The courts look at the following factors associated with the lack of control: a) election of management; b) the right to set and maintain business policy and direction; c) the ability of the minority partner to acquire or sell partnership assets; and d) the right to liquidate assets and a whole host of other factors. The analogy is like that of a silent partner in a large investment portfolio. The silent partner seldom if ever has any right to the operation of the business.

  2. Lack of marketability: This discount is based on the economic fact that a lower value will be given to an asset as to which there is no established market. This can mean big savings when the transferred interest cannot compel the dissolution of the partnership. The theory is predicated on the thought that the ability of the new owner to convert his or her shares to cash is greatly diminished. If you give your kids shares of Microsoft, they can go and immediately sell them. Not so with the shares of your family partnership. They can not be so readily sold.

  3. Lack of Liquidity: This means the limited partner does not have the right under state law to force liquidation of the business operation. They cannot seek the right to have the business shut down and thereby seek a distribution of the underlying principal assets of the partnership. The limited partners' sole rights are to the present value of the partnership distributions, if and when received.

Many fine estate practitioners don't like to use limited partnerships for the reason they are cumbersome and detail heavy. Many matters have to be attended to for the IRS to give them any respect. Partnership assets should be appraised by a qualified valuation consultant in accordance with certain professional standards. The value of real estate holdings is harder to determine than it is to value marketable securities.

A house or an apartment building cannot be easily divided and sold. Therefore, real estate holdings in a family partnership are often awarded a deeper discount, in appropriate cases ranging from 35 percent to 40 percent.

It can be even harder to value a closely held business. A minority interest in a closely held business may be valued by reference to trading prices of publicly held stocks (also minority interests) or by another approach such as using capitalization rates.

In conclusion, the family limited partnership, when established for valid business purposes, may provide significant transfer tax savings while allowing the donor, as general partner, to retain control over the partnership assets.

The main transfer tax benefit lies in the ability to apply that discount to the limited partnership interests transferred. This is a complex area that should be reserved to experienced estate planning and tax practitioners. Let me know what you think. I look forward to hearing from you all. God bless you and America.

Mark Tippins is an Auburn, Ala., attorney licensed in Alabama and Florida. For questions or comments, he can be contacted at MTIPPINS@BELLSOUTH.NET or (334) 821-3670.