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E-DIRT
Fall 2000
(Volume I, Issue 4)
Newsletter
of the Real Property Probate and Trust Law Section
of the American Bar Association
Back
to Table of Contents
Family Limited Partnerships----One
Answer to Reducing Estate Taxes
by Arthur H. Kroll*
Chairman and CEO
KST Consulting Group, Inc.
250 East Hartsdale Avenue
Suite 30
Hartsdale New York 10530
Telephone: 212-754-2710
Facsimile: 914-722-6341
Email: kstconsultinggroup@worldnet.att.net
For the individual who is willing to give up value but
not control, the family limited partnership (FLP) is a possible solution.
A limited partnership, which has a
general partner and limited partners, allows taxable income and losses
to flow directly to the partners. The general partner makes all management
decisions and bears the liability for partnership debt, while the limited
partners' liability is generally restricted to their capital commitments.
When establishing the partnership, it's important to meet all the requirements,
otherwise the Internal Revenue Service may consider it an association
instead, which would cause it to be treated as a corporation for tax purposes.
The liability of the general partner can be restricted by using a corporation
owned by the grantor to be the general partner.
The following example illustrates
how a family limited partnership operates. Let's say a husband (H) and
wife (W), who own real estate worth $2 million, form a family limited
partnership consisting of a 1 percent general partnership (GP) interest
and a 99 percent limited partnership (LP) interest. The general partner
is a newly-formed corporation, which is controlled by H and W, who also
hold the limited partnership interests as well. Secondly, they contribute
the real estate to the partnership. (An FLP can hold other types of assets
as well, such as publicly traded securities and stock in a family-owned
business - except for shares of S corporations.) Let's assume that the
FLP's $2 million of real estate holdings are then divided into 200 units,
each worth $10,000. Federal law allows each person to make lifetime transfers
of $675,000 plus present gifts of $10,000 per year, per donee, free of
gift taxes. These amounts are doubled if both spouses join in the gifts.
The value of making lifetime gifts is that any future appreciation and
income generated from the gifted property are removed from the donor's
estate. The gift itself will also be removed from the donor's estate to
the extent of $10,000 per year, per donee. Now, H and W can each give
away one unit of the FLP ($10,000 worth) per year to each of their children
free of gift taxes and without using up any of their $675,000 lifetime
exemption amount. In fact, they could probably give away more than one
unit because each unit may be valued at significantly less than $10,000
- since the courts have allowed substantial discounts when valuing minority
LP interests. Keep in mind though, the fair market value of the partnership
interest should be reviewed each year that gifts are made. Indeed if a
child is married and the parents join in the gift they can gift up to
$40,000 ($20,000 to the child and $20,000) to the spouse).
As an alternative, H and W could transfer
up to $1,350,000 without triggering any current federal gift tax, although
they would be using their lifetime exemption amounts. Through a series
of planned gifts over a period of years, H and W might transfer up to
their entire 99 percent LP interests to other family members. Thus at
death, they will have transferred future income and appreciation in value
attributable to their partnership interests out of their estates. Even
though the couple may have given away as much as 99 percent of the value
of the real estate, they still maintained lifetime control of the property.
Through their GP interest, H and W continue to manage the partnership's
assets. In addition, they can draw management fees, as long as they're
reasonable for the work involved, and they can also decide how much cash
flow to distribute to the limited partners. And finally, if a minor child
is involved, transfers of partnership interests can be made in trust for
the benefit of the child, provided certain requirements of the Code are
satisfied. This trust is commonly know as a Section 2503 (c) trust.
All in all, family limited partnerships could be a
viable alternative for individuals concerned with reducing their estates,
while maintaining control of their assets.
*Mr. Kroll wishes
to express his appreciation to Scott Ditman, a CPA with David Berdon &
Co in New York City, for his review of this article and verification of
certain factual matters stated therein. Other topics including this one
are covered in Arthur’s newsletter the Family Business Professional published
by Harcourt Brace.
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E-DIRT
Fall 2000
(Volume 1, Issue 4)
Newsletter of the Real Property Probate and Trust Law Section
of the American Bar Association
Back
to Table of Contents
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