Wednesday, July 20, 2011

The Value of a Family Limited Partnership

Let’s look at the Estate of Natale Giustina v Commissioner.
The Giustina family owned timberland in Oregon. As the generations passed on, some of the land came to Natale, who passed away in 2005. Natale was the trustee of the N.B. Giustina Revocable Trust.
         NOTE: Remember that a revocable trust would be included in Natale’s estate upon death.
The trust in turn owned 41.128 percent of the Giustina Land & Timber Co Limited Partnership (LP). The LP was formed in 1990 and owned 47,939 acres of timberland in the area around Eugene, Oregon. It employed between 12 and 15 people. There appeared to be no doubt what the timberland was worth – at least $143 million. A 41.128 percent share of that would be almost $59 million.
Here is today’s quizzer: what value did the estate put on its estate tax return and what did the IRS think the value should be?
If you guess $59 million, you are wrong. Here is what the two sides fought over:
                                Estate                   $12,678,117
                                IRS                         $ 35,710,000

What happened to the $59 million? This case is a good primer on valuation discounts. Let’s say that you own horseland in central Kentucky – a lot of it. Say that it is worth $20 million. You want to sell it to me. It’ worth $20 million, but I sense that time is of the essence to you. I offer $18,500,000. The faster you have to sell it, the less I am willing to offer. This is a discount, and a valuation person would refer to it is a “market” discount.

So even if you start with $59 million we could argue that the land was worth $54,750,000 to the estate.

Now let’s do something else. Let’s put the horseland in a “limited partnership.”  The limited partnership will have general partners and limited partners. The general partners make all the decisions, and the limited partners have little authority. I buy the land and put it into an limited partnership with my wife and me as general partners. Our children are the limited partners. My wife and I (the “generals”) have full control over the business of the partnership. We have the power to buy, raise, race and sell horses. We have the power to make distributions of cash or property to the partners in proportion to their respective interest in the partnership.  We have the power to buy or sell land. All decisions of the general partners must be unanimous.

The limited partners (“limiteds”) can force removal of a general by a two-thirds vote. If a general resigns or is removed, the limiteds can put in one of their own by a two-thirds vote. An additional general can be admitted if all the partners consent to the admission.

The partnership agreement does not allow my kids to transfer their interests willy-nilly. Oh no.  The partnership only allows an interest to be transferred to (1) another limited, (2) a trust for the benefit of a limited or (3) anyone else approved by the generals.  Unless you are our grandchild, it is very unlikely that the generals (my wife and I) will permit any transfer away from our kids.

How much are you willing to pay to buy the limited interest from my kid? It’s different now, isn’t it? My kid does not control her own fate with regard to the LP interest. My wife and I control. If we decide there are no distributions, then there are no distributions. If there is taxable income but no distributions with which to pay the tax … well, tough luck. I suspect you are revising your price downward the more I explain how much control my wife and I are keeping.

This is called a “control” discount.  The limited partnership allows you to introduce a control discount – if you play by the rules.

The court went through some interesting analysis of valuation methods, interest rates and discounts that is a bit inside-baseball for this blog post. At the end, however, the court found itself disagreeing with both the estate and IRS valuations and posited its own valuation of $27,454,115. This is much closer to the IRS value than to the estate.

Did the family gain anything from all this?  Let’s look at the following two values:
                By doing no tax planning                              $58,813,040
                The court said                                                 $27,454,115

 I would say this was good tax planning.

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