Gifting And Discounts Of Family Limited Partnership Interest
The Family Limited Partnership is set up so that the transferor can contribute assets to the FLP in exchange for both general and limited partner interests. The general partners maintain virtually all of the power and determine what happens to the assets in the FLP. The limited partners will enjoy an ownership interest but have few rights or power.
Typically, the bulk of the initial contribution is assigned to the limited partner interest. For example, the partnership might assign 2% or 3% of the initial capital contribution to the general partner interest and the remaining 95% plus to the limited partner interest. The transferor then gifts the limited partner interests to other family members while retaining the general partner interest. Circumstances will dictate whether the transferor will immediately gift all or a large block of the limited partner interests or whether the transferor will retain majority ownership of the limited as well as the general partner interest.
The gifts are not cash or the assets themselves but rather limited partner interest units or shares somewhat similar to non voting shares of stock of a closely held corporation. The FLP allows the transferor to significantly discount the value of the gifts to other family members based on the concept that when valuing minority limited partner interests the sum of the parts does not equal the whole.
Most valuation experts estimate that the value of a limited partner interest can be substantially discounted for lack of marketability and lack of control up to as much as 50% in the aggregate because the limited partners cannot vote on how the partnership is operated or when it will terminate, because they cannot use the funds or assets in the partnership and because the Partnership Agreement typically limits their ability to sell or transfer their interests. Therefore, they are severely restricted with respect to the economic value of their interest.
The limited partners cannot even obtain distributions unless the general partners so determine and they cannot normally use the partnership interest as collateral on a loan. At the time of the making of the gift, the underlying real property should be appraised by a qualified appraiser based on its value in the aggregate. The aggregate value then should be further appraised for the Minority Discount and the transferor should then have a Gift Tax Return prepared and filed. If the IRS does not audit the Gift Tax Return within three years of the due date of the filing of the Return, the Gift Tax Return is deemed accepted.
The Availability of Minority Interest Discount The Minority Interest Discount is basically comprised of two components. The first is the Lack of Control Discount which is appropriate when valuing an interest in an entity that precludes the owner of the interest from determining when distribution of earnings will be made or when the entity will be dissolved or when the owner's interest will be redeemed and various other factors directly effecting the economic benefits of the ownership interest in the entity including non transferability restrictions.
These factors revolve around the lack of voting or management rights which are inherent in the status of a limited partner in a the Family Limited Partnership. A lack of Marketability Discount is present in most closely held business contexts because there is no active trading market for the interest due to the fact that it is difficult to sell and may require the expenditure of substantial funds to do so, i.e., legal, accounting and syndication fees.
For purposes of valuing gifts, the property transferred is valued utilizing the standard of an arms length transaction between a willing buyer and a willing seller both of whom have reasonable knowledge of all relevant facts and neither of whom is acting under a compulsion to buy or sell. Accordingly, a gift of an interest in a Family Limited Partnership should be valued on the basis of what a willing buyer would be willing to pay to a willing seller having access to the Limited Partnership Agreement with all of its built in restrictions on voting control and management and also being aware of the fact that no ready market exists for the sale of such an interest.
The Discount for Lack of Marketability is grounded on the circumstance that the limited partner interest is very much less attractive and more difficult to sell than publicly traded stock. Although this discount is recognized in the Valuation Guide For Income Estate And Gift Taxes, published by the IRS, it is not given full weight as a discount as such but is only a factor in determining "a conservative capitalization weight or weight of certain of the other factors from a conservative standpoint to give effect to this marketability factor". There have been a multitude of court cases dealing specifically with the lack of Marketability Discount, but some of the decisions have confused the Marketability Discount with the Minority Interest Discount which will be discussed later.
Briefly speaking, the Minority Interest Discount deals with lack of control whereas the Marketability Discount involves the limited marketability of the asset in question. The Marketability Discount can apply both to the majority and minority interests whereas the minority discount obviously only applies against the minority interests. Although there is some overlapping between the two discounts in that the lack of control reduces marketability, even controlling shares can be subject to a lack of marketability because of the absence of a ready private placement market.
When both the marketability and minority interest discounts are applied they are not added together. The marketability interest discount is taken first and then the minority discount interest is applied. The three most generally accepted methods of quantifying the marketability discount are as follows:
(a) The projected estimated cost of making a public offering;
(b) the prices of closely held company shares that are compared to the prices of subsequent initial public offerings of the same company share; and,
(c) studies dealing with the sales of restricted shares of publicly traded companies compared to unrestricted sale shares in these publicly traded companies. Normally, the Marketability Discount when it has been utilized and approved by the courts is a substantial one.
As was previously indicated, the Minority Interest Discount is grounded on the fact that the limited partner interest lacks management, the voting rights, the right to require the entity to redeem the limited partner's interest and restrictions on the limited partner's ability to transfer ownership rights. In other words, the Minority Discount reflects the very limited nature of the Limited Partnership interest. The limited partner has no ability to control the earnings and distributions, executive compensation, liquidation, future long range planning goals and day-to-day management of the Limited Partnership.
Copyright (c) 2011 Jeffrey Matsen
Typically, the bulk of the initial contribution is assigned to the limited partner interest. For example, the partnership might assign 2% or 3% of the initial capital contribution to the general partner interest and the remaining 95% plus to the limited partner interest. The transferor then gifts the limited partner interests to other family members while retaining the general partner interest. Circumstances will dictate whether the transferor will immediately gift all or a large block of the limited partner interests or whether the transferor will retain majority ownership of the limited as well as the general partner interest.
The gifts are not cash or the assets themselves but rather limited partner interest units or shares somewhat similar to non voting shares of stock of a closely held corporation. The FLP allows the transferor to significantly discount the value of the gifts to other family members based on the concept that when valuing minority limited partner interests the sum of the parts does not equal the whole.
Most valuation experts estimate that the value of a limited partner interest can be substantially discounted for lack of marketability and lack of control up to as much as 50% in the aggregate because the limited partners cannot vote on how the partnership is operated or when it will terminate, because they cannot use the funds or assets in the partnership and because the Partnership Agreement typically limits their ability to sell or transfer their interests. Therefore, they are severely restricted with respect to the economic value of their interest.
The limited partners cannot even obtain distributions unless the general partners so determine and they cannot normally use the partnership interest as collateral on a loan. At the time of the making of the gift, the underlying real property should be appraised by a qualified appraiser based on its value in the aggregate. The aggregate value then should be further appraised for the Minority Discount and the transferor should then have a Gift Tax Return prepared and filed. If the IRS does not audit the Gift Tax Return within three years of the due date of the filing of the Return, the Gift Tax Return is deemed accepted.
The Availability of Minority Interest Discount The Minority Interest Discount is basically comprised of two components. The first is the Lack of Control Discount which is appropriate when valuing an interest in an entity that precludes the owner of the interest from determining when distribution of earnings will be made or when the entity will be dissolved or when the owner's interest will be redeemed and various other factors directly effecting the economic benefits of the ownership interest in the entity including non transferability restrictions.
These factors revolve around the lack of voting or management rights which are inherent in the status of a limited partner in a the Family Limited Partnership. A lack of Marketability Discount is present in most closely held business contexts because there is no active trading market for the interest due to the fact that it is difficult to sell and may require the expenditure of substantial funds to do so, i.e., legal, accounting and syndication fees.
For purposes of valuing gifts, the property transferred is valued utilizing the standard of an arms length transaction between a willing buyer and a willing seller both of whom have reasonable knowledge of all relevant facts and neither of whom is acting under a compulsion to buy or sell. Accordingly, a gift of an interest in a Family Limited Partnership should be valued on the basis of what a willing buyer would be willing to pay to a willing seller having access to the Limited Partnership Agreement with all of its built in restrictions on voting control and management and also being aware of the fact that no ready market exists for the sale of such an interest.
The Discount for Lack of Marketability is grounded on the circumstance that the limited partner interest is very much less attractive and more difficult to sell than publicly traded stock. Although this discount is recognized in the Valuation Guide For Income Estate And Gift Taxes, published by the IRS, it is not given full weight as a discount as such but is only a factor in determining "a conservative capitalization weight or weight of certain of the other factors from a conservative standpoint to give effect to this marketability factor". There have been a multitude of court cases dealing specifically with the lack of Marketability Discount, but some of the decisions have confused the Marketability Discount with the Minority Interest Discount which will be discussed later.
Briefly speaking, the Minority Interest Discount deals with lack of control whereas the Marketability Discount involves the limited marketability of the asset in question. The Marketability Discount can apply both to the majority and minority interests whereas the minority discount obviously only applies against the minority interests. Although there is some overlapping between the two discounts in that the lack of control reduces marketability, even controlling shares can be subject to a lack of marketability because of the absence of a ready private placement market.
When both the marketability and minority interest discounts are applied they are not added together. The marketability interest discount is taken first and then the minority discount interest is applied. The three most generally accepted methods of quantifying the marketability discount are as follows:
(a) The projected estimated cost of making a public offering;
(b) the prices of closely held company shares that are compared to the prices of subsequent initial public offerings of the same company share; and,
(c) studies dealing with the sales of restricted shares of publicly traded companies compared to unrestricted sale shares in these publicly traded companies. Normally, the Marketability Discount when it has been utilized and approved by the courts is a substantial one.
As was previously indicated, the Minority Interest Discount is grounded on the fact that the limited partner interest lacks management, the voting rights, the right to require the entity to redeem the limited partner's interest and restrictions on the limited partner's ability to transfer ownership rights. In other words, the Minority Discount reflects the very limited nature of the Limited Partnership interest. The limited partner has no ability to control the earnings and distributions, executive compensation, liquidation, future long range planning goals and day-to-day management of the Limited Partnership.
Copyright (c) 2011 Jeffrey Matsen
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