Family Limited Partnerships, an estate planning technique.
Imagine transferring one or more of your properties to a partnership or Limited Liability Company (LLC) and then gifting your children, grandchildren or trusts for their benefit, an interest in this newly formed entity. Further imagine valuing that gift for less than the value of its proportionate interest in the underlying real estate.
This is possible since the value of a partnership interest is deemed to be less than the value of the underlying assets of the partnership due to lack of marketability.
As a result, the gift, which is a gift of a partnership interest, can be discounted. In addition, if this interest is a minority interest, it may be further discounted.
This method of estate planning can even be coupled with the use of a Defective Grantor Trust or often referred to as an Intentionally Defective Grantor Trust (IDGT). By using an IDGT, the grantor (transferor of the assets) is taxed on the income earned by the trust, without incurring a gift tax on the payment of the beneficiary's income taxes.
By paying the tax, the grantor is effectively transferring even more assets without gift tax.
The reason this is possible, is that the IRS has separate sets of rules that relate to the income tax treatment of trusts versus the estate tax treatment.
What does this all mean? Let's say for example you transfer a building worth $5 million, having a cash flow and income of $400,000 per year, to a partnership and gift a 60% interest in the partnership to an IDGT for the benefit of your children. Using a 35% discount, your gift would be valued at $1,950,000 ($5 million x 60% x 65%). If neither you nor your spouse has used your lifetime exclusions for estate taxes, this gift would result in NO gift taxes (the exempt amount each spouse can gift is $1,000,000).
Since the gift was made to an IDGT, the income earned by the trust each year would be reported by you on your income tax return, and you would pay the tax on this income.
Therefore, the $240,000 of income the trust will earn ($400,000 x 60%), will be reported on your tax return costing you approximately $100,000 in income taxes, further reducing your estate with no gift tax implications. The trust would receive the $240,000 each year (tax free) which it can invest.
If the partnership is a "real" entity, i.e., has a separate bank account, books and records, and files a tax return, the entity will generally not be disregarded by the IRS. In addition if the partnership does not include all of your assets and you do not control the entity, there is less for the IRS to dispute.
The following are certain steps to be sure to take and some to avoid:
Be sure to do or consider the following:
1. Have other family members contribute assets to the FLP.
2. Distribute income pro-rata in accordance with each partner's interest.
3. Transfer legal title to the assets being transferred to the FLP.
4. Establish a business and non-tax purpose for the FLP.
5. Keep a separate bank account for the FLP.
6. Maintain separate books and records for the FLP.
7. If possible, transfer control. Avoid:
1. Transferring all of your assets to the FLP.
2. Commingling personal and FLP funds.
3. Transferring personal, nonbusiness or non-investment assets i.e. your home, to the FLP.
In order for these techniques to work and sustain any challenge, there are various steps that should be adhered to.
Therefore, it is strongly recommended that you consult with your tax advisor before proceeding.
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|Title Annotation:||Insiders Outlook|
|Publication:||Real Estate Weekly|
|Date:||Mar 2, 2005|
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