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Family Limited Partnership - Successful Transfers
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How Do I Make a successful transfer of a Family Limited Partnership interest/share to an heir? Some related topics:
The Service has ruled that the transfer of family-limited partnership interests from a husband and wife to their children and a trust are completed gifts because the donors relinquished dominion and control over the partnership interests. SUMMARY The Service has ruled that the transfer of family-limited partnership interests from a husband and wife to their children and a trust are completed gifts because the donors relinquished dominion and control over the partnership interests. The couple and their three children formed a family-limited partnership. The husband and wife transferred most of their limited partnership interests to the children and a trust. A gift tax return was timely filed and the partnership agreement was amended. The husband and wife also propose to contribute a commercial building and property, subject to a nonrecourse mortgage, to the partnership. After the contribution, the donors' share of partnership net income will remain unchanged and the donors will receive guaranteed payments. The partnership agreement contains a buy-sell clause, in which partners have the option of purchasing a partnership interest subject to an impending transfer. The Service said the transfer of the interests was a completed gift, assuming that the transaction's form reflected the actual substance. The Service also said that section 2701 will determine the gift tax consequences of the proposed contribution of real estate and that the value of the gift would be determined using the subtraction method of reg. section 25.2701-3. The allocations of the partnership will satisfy the requirements of section 704(e)(2), the Service said, "if the donors' distributive shares of partnership income represent an equal or greater proportion of the total partnership income (computed without reduction for guaranteed payments) than the donors' capital represents of the total partnership capital." The Service declined to rule whether the partnership agreement satisfies the exceptions of section 2703(b) regarding rights or restrictions of the partnership agreement. FULL TEXT Date: November 13, 1997 In Reference to: CC:DOM:P&SI:4/PLR-100466-97 LEGEND: Dear * * * [1] This is in response to your letter dated July 14, 1997, and prior correspondence in which you request rulings concerning the income and gift tax consequences of the contribution of capital to a family limited partnership. [2] You represent that the taxpayer, his spouse, and their three children, A, B, and C (or trusts for their benefit), created a family limited partnership in August 1994. The general partner of the partnership is a revocable inter vivos trust whose trustees are the taxpayer and his spouse. The general partner holds a three percent partnership interest. The limited partners of the family limited partnership at its inception and their partnership interests were the taxpayer (47 percent), his spouse (47 percent), child A (1 percent), child B (1 percent), and a trust for the benefit of child C (1 percent). [3] The partners entered into a buy-sell agreement at the inception of the partnership. Section 11.1 of the agreement provides for restrictions on the transfer of the partnership interests. The agreement requires that, prior to either a voluntary or an involuntary transfer of a partner's interest, a partner must notify the other partners and the other partners may, within a specified time period, purchase the transferring partner's interest at the "agreement price." Section 11.6 of the instrument provide that the "agreement price" is the "fair market value of the shares of the offered interest on the date of any offer or deemed offer." [4] In 1994, after the creation of the partnership, the taxpayer and his spouse transferred a portion of their limited partnership interests to their children. A gift tax return, Form 709, was timely-filed with respect to the transfer. After the transfer, the taxpayer and his spouse (collectively, the donors) each held a one-half percent limited partnership interest and child A, child B, and the trust for the benefit of child C each held a 32 percent limited partnership interest. The partnership agreement was amended and restated in December 1996. [5] The taxpayer and his spouse propose to contribute a commercial building and the real estate on which it is situated to the partnership. The building and the real estate are subject to a non-recourse mortgage. The contribution will be credited to their capital accounts as a contribution to capital. However, the donors [sic] shares of the partnership's net income will not change. However, the partners propose to amend the partnership agreement to specify that the taxpayer and his spouse will be paid a guaranteed payment of x dollars within the meaning of section 707(c) of the Internal Revenue Code for the term of the partnership (i.e., 30 years). [6] You request that we rule as follows: 1. The transfers in 1994, of the limited partnership interests 2. Section 2701 will apply in determining the gift tax 3. The family limited partnership's allocations will satisfy the 4. The restrictions on the transfer of the partnership interest ISSUE 1 (Gift tax consequences of 1994 transfer) [7] Section 2501 imposes a tax on the transfer of property by gift by an individual. Section 2511 provides that the tax imposed by section 2501 shall apply whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible. Section 2512(b) provides that, where property is transferred for less than adequate and full consideration in money or money's worth, the amount by which the value of the property exceeds the value of the consideration is deemed a gift. [8] Section 25.2511-2(b) of the Gift Tax Regulations provides that, as to any property, or part thereof or interest therein, of which the donor has so parted with dominion and control as to leave in him no power to change its disposition, whether for his own benefit or for the benefit of another, the gift is complete. But if upon a transfer of property (whether in trust or otherwise) the donor reserves any power over its disposition, the gift may be wholly incomplete, or may be partially complete and partially incomplete, depending upon all the facts in the particular case. Accordingly, in every case of a transfer of property subject to a reserved power, the terms of the power must be examined and its scope determined. [9] Section 25.2512-1 provides that the value of property transferred by gift is the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts. The value of a particular item of property is not the price that a forced sale of the property would produce. Nor is the fair market value of an item of property the sale price in a market other than in which such item is most commonly sold to the public, taking into account the location of the item wherever appropriate. All relevant facts and elements of value as of the time of the gift shall be considered. [10] In the present case, the taxpayer and his spouse transferred a total of 93 percent of their combined limited partnership interest to child A, child B, and a trust for the benefit of child C in 1994. It is represented that a gift tax return, Form 709, was timely-filed reporting the transfer. Based on the terms of the partnership agreement, the donors relinquished dominion and control over the limited partnership interests. [11] Assuming the form of the transaction reflects the substance of the transaction, we conclude that, the transfers in 1994, of the limited partnership interests from the taxpayer and his spouse to child A, child B, and the trust for the benefit of child C were completed gifts for purposes of section 2501. We express no opinion with respect to the value of the partnership interests as set forth on the gift tax return. ISSUE 2 (Application of section 2701 to proposed contribution of [12] Section 2701 provides special rules to determine whether a transfer is a gift and the amount of the gift when an individual transfers an equity interest in a corporation or partnership to a member of the individual's family. Section 2701 applies to a transfer, the amount of the gift, if any, is determined using a subtraction method based and described in section 25.2701-3. [13] In order for section 2701 to apply, the transferor or an applicable family member must, immediately after the transfer, hold an "applicable retained interest." Section 2701(e)(5) provides that a contribution to capital or a redemption, recapitalization, or other change in the capital structure of a corporation or partnership, is treated as a transfer of an interest in the entity to which section 2701 applies if the taxpayer or an applicable family member either, 1) receives an applicable retained interest in the entity pursuant to the transaction, or 2) under regulations, otherwise holds, immediately after the transfer, an applicable retained interest in the entity. [14] Section 25.2701-1(b)(2)(i)(A) provides that, for purposes of section 2701, a transfer includes a contribution to the capital of a new or existing entity. [15] Section 25.2701-2(b)(1) provides that the term "applicable retained interest" means any equity interest in a corporation or partnership with respect to which there is either an "extraordinary payment right" or, in the case of a controlled entity, a "distribution right." Section 25.2701-2(b)(3) provides that a distribution right is the right to receive distributions with respect to an equity interest. A distribution right does not include: 1) any right to receive distributions with respect to an interest that is of the same class as, or a class that is subordinate to, the transferred interest; 2) any extraordinary payment right; or 3) mandatory payment rights, liquidation participation rights, rights to guaranteed payments of a fixed amount under section 707(c), and non-lapsing conversion rights. Section 25.2701-2(b)(4)(iii) provides that the right to a guaranteed payment of a fixed amount under section 707(c) is the right to a guaranteed payment (within the meaning of section 707(c)), the amount of which is determined at a fixed rate (including a rate that bears a fixed relationship to a specified market interest rate). A payment that is contingent as to time or amount is not a guaranteed payment of a fixed amount. [16] Section 25.2701-2(b)(5) provides that, for purposes of section 2701, a controlled entity is a corporation or partnership controlled, immediately before a transfer, by the transferor, applicable family members, and any lineal descendants of the parents of the transferor or the transferor's spouse. In the case of any partnership, control means the holding of at least 50 percent of either the capital interest or the profits interest in the partnership. In the case of a limited partnership, control means the holding of any equity interest as a general partner. [17] In the present case, the taxpayer and his spouse propose to make a capital contribution to the partnership by transferring a commercial building and the real estate on which it is situated to the family limited partnership. The capital contribution will be treated as a transfer subject to section 2701. Accordingly, the rules of section 2701, including the subtraction method contained in section 25.2701-3, apply in determining the amount of any gift resulting from the contribution to capital. [18] Under section 2701(a)(1), in applying the subtraction method to determine the amount of any gift, the value of any distribution right in a controlled entity or extraordinary payment right with respect to an applicable retained interest that is held by the transferor or an applicable family member immediately after the transfer, is to be determined under section 2701(a)(3). Section 2701(a)(3) provides that the value of any extraordinary payment right or distribution right in a controlled entity, other than a distribution right that consists of a right to receive a qualified payment, is treated as being zero. [19] Section 25.2701-2(b)(6) provides that a qualified payment right is a right to receive a cumulative distribution payable on a periodic basis (at least annually) with respect to an equity interest to the extent determined at a fixed rate or as a fixed amount. [20] Section 25.2701-3(b) provides the "subtraction method" for determining the amount of the gift when section 2701 applies. In the case of a contribution to capital, the first step is to determine the fair market value of the contribution. The second step is to subtract, from this value, an amount equal to the fair market value of any applicable retained interest received in exchange for the contribution to capital. Under step 3, the value remaining after step 2 is allocated among the transferred interests and other subordinate equity interests held by the transferor, applicable family members, and members of the transferor's family. Under step 4, the amount allocated to the transferred interests in step 3 is reduced by the amount of consideration in money or money's worth received by the transferor, but not in excess of the amount of the gift (determined without regard to section 2701). [21] In the present case, the value of the proposed contribution for purposes of step 1 of section 25.2701-3(b), will be the fair market value of the commercial property and the real estate that is transferred to the partnership (net of any indebtedness to which the property is subject). For purposes of step 2, the value of any applicable retained interest would be zero (since any distribution rights are not qualified payment rights and are valued at zero). Under step 3, the fair market value of the contribution to the partnership will be allocated based on the partnership interests of each of the partners. [22] Under step 4, the value of the contribution to the partnership allocated under step 3 is reduced by the fair market value of any consideration received by the contributing partners, the taxpayer and his spouse. As a result of the contribution of the commercial property to the partnership, the taxpayer and his spouse are to receive guaranteed payments of a fixed amount for a period of 30 years. [23] The amount of the allocation under step 3 to child A, child B, and the trust for the benefit of child C, reduced by the fair market value of the guaranteed payments under step 4, will be treated as a transfer for gift tax purposes from the taxpayer and his spouse to these other partners. [24] We conclude that section 2701 will apply in determining the gift tax consequences of the proposed contribution to the capital of the partnership of the commercial property by the taxpayer and his spouse, and the value of any gift will be determined using the subtraction method set forth in section 25.2701-3. ISSUE 3 (Taxation of income from transferred property) [25] Section 704(b) provides that a partnership's allocations of income, gain, loss, deduction, or credit (or item thereof) as set forth in the partnership agreement are respected if they have substantial economic effect. However, section 704(e) provides special rules applicable to certain partnerships in which capital is a material income-producing factor. Under section 704(e)(2), if an interest in such a partnership is created by gift, the portion of the donee's distributive share attributable to the donee's capital is not includible in his gross income to the extent that it is proportionately greater than the distributive share attributable to the donor's capital. Instead, the donee's and donor's distributive shares must be reallocated by making a reasonable allowance for the services of the donor and by attributing the balance of the partnership's income to partnership capital. [26] Section 1.704-1(e)(3)(i)(b) of the Income Tax Regulations provides that the portion of income thus attributable to partnership capital for the taxable year must be allocated between the donor and donee in proportion to their respective interests in partnership capital. [27] Section 1.704-1(e)(2)(iv) provides that the determination of whether capital is a material income-producing factor must be made by reference to all the facts of each case. Capital is a material income-producing factor if a substantial portion of the gross income of the business is attributable to the employment of capital in the business conducted by the partnership. In general, capital is not a material income-producing factor where the income of the business consists principally of fees, commissions, or other compensation for personal services performed by members or employees of the partnership. On the other hand, capital is ordinarily a material income-producing factor if the operation of the business requires substantial inventories or a substantial investment in plant, machinery, or other equipment. [28] Based on the facts submitted, we conclude that family limited partnership is a partnership in which capital is a material income-producing factor. Because child A, child B, and the trust for child C acquired part of their interests in partnership capital by gift, the family limited partnership's allocations must comply with section 704(e)(2). [29] Section 707(c) provides that, to the extent determined without regard to the income of the partnership, payments to a partner for services or for the use of capital are considered as made to one who is not a member of the partnership, but only for the purposes of section 61(a) (relating to gross income) and, subject to section 263, for purposes of section 162(a) (relating to trade or business expenses). [30] Section 1.707-1(c) provides that, for purposes of provisions of the internal revenue laws other than sections 706(b)(3), 707(b), and 708(b), guaranteed payments are regarded as a partner's distributive share of ordinary income. Accordingly, guaranteed payments to the donors will be included in determining their distributive shares for purposes of section 704(e)(2). [31] We conclude that the family limited partnership's allocations will satisfy the requirements of section 704(e)(2) if the donors' distributive shares of partnership income represent an equal or greater proportion of the total partnership income (computed without reduction for guaranteed payments) than the donors' capital represents of the total partnership capital. For this purpose, the donors' distributive shares of partnership income include guaranteed payments (as defined in section 707(c) and section 1.707-1(c)) that the donors are required to include in income for the taxable year and the donors' allocable shares (under section 704(b), but not section 704(c)) of the partnership's net income for the taxable year. ISSUE 4 (Application of section 2703) [32] Section 2703(a) provides that, for purposes of the estate, gift, and generation-skipping transfer taxes, the value of any property is determined without regard to 1) any option, agreement, or other right to acquire or use the property at a price less than the fair market value of the property (without regard to such option, agreement, or right), or 2) any restriction on the right to sell or use such property. [33] Section 2703(b) provides an exception to the application of section 2703(a) in the case of a right or restriction, where: 1) the right or restriction is a bona fide business arrangement, 2) the right or restriction is not a device to transfer the property to the natural objects of the transferor's bounty for less than adequate and full consideration in money or money's worth, and 3) at the time the right or restriction is created, the terms of the right or restriction are comparable to similar arrangements entered into by persons in an arms-length transaction. [34] Section 25.2703-1(b)(2) provides that each of the three requirements described in section 2703(b) must be independently satisfied for a right or restriction to meet this exception. Thus, for example, the mere showing that a right or restriction is a bona fide business arrangement is not sufficient to establish that the right or restriction is not a device to transfer property for less than full and adequate consideration. [35] The determination of whether the partnership agreement satisfies the exceptions set forth in section 2703(b) is a factual determination. Consequently, we decline to rule on this issue. [36] Except as we have specifically ruled herein, we express no opinion under the cited provisions or under any other provision of the Code. [37] This ruling is based on the facts and applicable law in effect on the date of this letter. If there is a change in material fact or law (local or Federal) before the transactions considered in the ruling take effect, the ruling will have no force or effect. If the taxpayer is in doubt whether there has been a change in material fact or law, a request for reconsideration of this ruling should be submitted to this office. [38] This ruling is directed only to the taxpayer who requested it. Section 6110(j)(3) provides that it may not be used or cited as precedent. Sincerely yours, Assistant Chief Counsel By: George Masnik Enclosure - Copy for 6110 purposes
So that the gift of the partnership interest can be further understood, look at a failed example so the items causing the failure can be avoided. In TAM 9751003 the IRS ruled that gifts of limited partnership interests in a family limited partnership were gifts of future interests, and thus, did not qualify for the annual gift tax exclusion. The IRS stated that the following characteristics of the partnership caused the limited partnership interests to lack the tangible and immediate economic benefit required under Code Section 2503(b):
The IRS has ruled, however, in prior situations that despite the broad control retained by parents as the general partners, gifts of limited partnership interests satisfied the present interest requirement and qualified for annual exclusion. The IRS determined that the general partner was under a fiduciary duty to act in the best interests of the partnership and its partners and distinguished the general partner's control from a trustee's discretionary power to distribute or withhold trust income or principal. TAM 9131006; PLR 9415007. See Section 759.5(a)(1) for discussion of the treatment of transfers in trust. Furthermore, if the application of a valuation discount operated to bring the value of a gift within the annual exclusion amount, it may be prudent to report the otherwise gift-tax exempt gift on a Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, or Form 709-A, United States Short-Form Gift Tax Return, as doing so will open the limitations period on the gift and, once the limitations period closes, preclude the IRS from reassessing the value of a gift at some distant future date.
Solutions are dependent upon facts & circumstances, law and the objectives. These elements vary from one time to another, from one circumstance to another and from from person or entity to another
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