The NY Forest Owner 33:1:6; Jan/Feb 1995
What’ll You Do With The Farm When You’re Gone?
As a practicing attorney, I am constantly asked whether the living trusts that are being propounded and sold by attorneys around the state will achieve the objectives of avoiding probate, limiting income taxes, reducing or eliminating estate taxes, as well as fulfilling the planning objectives of the grantor. While living trusts may be appropriate for some, I believe living trusts are oversold and are not appropriate for many of the individuals and family situations for which they are being created. My principal objection to living trusts is that the estate, income, and gift tax benefits (if any) of living trusts are not sufficient to justify the monumental effort in creating and maintaining the trust.
Many of my clients are forest owners with family tree farms which they have every intention of passing on to the next generation so their stewardship ideas and plans can be followed for many decades to come. They have expressed to me that they wish to continue to control the management and harvest decisions of those tree farms for the foreseeable future. They also want to pass the fruits of their labor onto their descendants. Subject to these conditions and desires, they are willing to make some present transfers to their descendants to take advantage of the annual $10, 000.00 gift tax exclusion.
There is currently an estate planning tool that can achieve the multiple goals of reducing estate taxes, utilizing the annual gift tax exclusion, and transferring assets to the next generation with control retained by the present generation. This estate planning tool is known as the family limited partnership. As with a business partnership, ownership of an asset, in this case a tree farm, is transferred from the current owners to a limited partnership. A small fraction of the ownership, usually, is transferred to the “general partner”, who makes all the management and operational decisions for the limited partnership. The remainder is split into multiple limited partnership “units”, similar to shares in a corporation, that evidence ownership and can be transferred individually or in blocks. Initially, all the units are owned by the original tree farm owners.
What makes the family limited partnership concept so appealing for tree farmers is that the tree farm remains intact, the management of the tree farm remains stable and under the control of the original owners, and the fractional units of the limited partnership can be transferred without breaking up the parcel into smaller parcels. The limited partnership can be created without regard to the value of the asset being transferred. However, the greater the value of the asset, the more limited partnership units that must be created to best utilize estate and gift tax exclusions.
How About: A FAMILY LIMITED PARTNERSHIP?
Since the units can be transferred each year, each owner can transfer as much as ten thousand dollars per year to each child and (or) grand child as they deem appropriate. Additionally, because the gifts of the units represent minority interests with restricted marketability, the IRS permits discounts of market values to reflect the fact that market prices of business minority interests are usually substantially reduced. Any increase in the value of the property or timber after the units are transferred will be attributable to the partners proportionate to their ownership. This further reduces estate size and tax burden. There are income tax advantages to the family limited partnership over a trust or corporate entity; because all the benefits and deductions are passed through to the partners to be taxed at their income tax rates, not the higher rates applied to trusts and the double taxation of most real estate corporations.
Eventually, the creator of a family limited partnership may want to transfer control of the partnership as “general partner” to the next generation. Since a general partner is a part owner of the equity of the asset, that fractional value can be calculated the same as the valuation of the limited partner units; but once control shifts, no discount is given for minority interests.
Family limited partnerships are currently being created for many types of investments; but they cannot be created for S corporation stock, pension funds, or the primary residence portion of real property. They are ideal for the tree farmer who wants to be the “managing general partner” in an organization which was created to transfer family wealth. The limited partnership unit owners have no liability to creditors beyond the partnership assets.
The drawbacks are that the asset will be owned by a separate entity and once the units are given away, they cannot be recovered. Also, the IRS, which has ruled favorably on family limited partnerships in the past, may change their stance in the future, in which case the partnership agreement can be amended to take new laws into account. Also, certain formalities must be observed, including a written limited partnership agreement properly filed with the State and an annual partnership income tax filing for information purposes, even though any income is “passed through” to the partners.
The creation of a limited partnership by a family wishing to transfer an asset such as a tree farm is legally permissible and it creates substantial savings of gift and estate taxes. If you would like additional information regarding family limited partnerships, the author can be reached at (716) 885-1150.
David Colligan, a member of NYFOA’s Niagara Frontier Chapter, is a practicing attorney with a Buffalo law firm (Colligan Law LLP; 600 Bank of America Building, 12 Fountain Plaza, Suite 600 Buffalo, NY 14202) and regularly provides articles on legal matters of interest to forest owners.