by Lorie Woodward Cantu
Standing alone or working together, family limited partnerships and conservation easements are practical tools for passing land to the next generation.
“A family limited partnership is an orderly way to transfer wealth or property to the next generation,” said Stephen J. Small, an attorney based in Boston who specializes in estate tax planning. In 2010 and again in 2011, Small led conservation easement workshops for TALT, the Texas Agricultural Land Trust.
“A conservation easement protects land from development in perpetuity and can reduce land values, thereby lowering the potential estate tax burden. Depending on a family’s needs and desires, these tools can be used singly or collectively.”
A family limited partnership is a traditional limited partnership where all the partners are family members. In a family situation, the parents put their assets into the partnership. Initially, the parents are both the general partners and the limited partners. Then, under the most common and simplest form, they gift their limited partnership interests to their children over a period of years. “There are potentially important gift tax issues here,” Small said. “So each family needs to check with an experienced advisor.”While the parents have given away the limited partnership interests, because they remain the general partners they retain full control over all the assets in the partnership, and maintain full liability for its debts.
The children, or limited partners, may lose any value they have in the partnership, but their “liability” can’t go any further than that. “Again, these are generalizations,” Small said. “Families need to be careful to follow all of the tax rules.” The limited partners can become the general partners upon the death of both parents and also own and have title to the limited partnership interests. “Traditionally, the family limited partnership has been one of the vehicles of choice for transferring wealth and value,” Small said.
“One of the primary benefits of a family limited partnership is that families can create rules for how the partnership will run. By its nature, families are forced to consider the future.” This stands in stark contrast to the potential chaos created when parents abdicate estate planning by vowing to “pass the land equally to all siblings.” While this is a simple legal process, it is fraught with peril, he said. It creates a situation where the siblings are considered tenants in common, and every major decision made for the land must be unanimous. Oftentimes, the siblings find themselves in court fighting over the fate of the land. To create a family limited partnership, families have to discuss things such as: Who will manage the land? Will it be the same person or will the responsibility rotate to all of the siblings? How will major capital expenditures be approved and paid for? What happens if someone wants to sell their interests? “These are family questions, not lawyer questions,” Small said. “In a perfect world, the family gets together and works through the questions and collectively determines the fate of their property.”
In the real world, though, Small has witnessed two pitfalls. A family limited partnership created to pass along agricultural land has some unfamiliar challenges for advisors who are used to dealing with businesses in partnership. “If a family is passing along a thriving business, chances are the business is generating profit that periodically be distributed to the partners,” Small said. “If a family is transferring land, there is a strong chance that it may require infusions of capital for its maintenance and upkeep. Some of the most beautiful land in the world runs at a loss.” In many instances, the older generation has been willing and able to absorb the costs. When that responsibility is passed to the next generation, some family members may not be able or willing to contribute to the land’s upkeep. “Four siblings may agree on the future course for the land, but they could be at very different places financially,” Small said. “It is important for parents to find out what their children want and are able to do before they embark on estate planning.” For instance, if two of four siblings want nothing to do with the land, there may be other estate planning tools and options that make more sense for the family, he said.
A family limited partnership offers tax advantages, but by itself it does not reduce the overall value of an estate. This point becomes crucial for many farming and ranching families because the land often makes up the bulk of an estate’s value. It is a complicated area, but certain “discounts” are available for ownership of partnership interests in many cases. Conservation easements can come into play as a complementary tool, he said. “For many farming and ranching families, the value of their land has skyrocketed, leaving them facing a huge estate tax bill without the means of paying it,” Small said. “Without planning, oftentimes, people are forced to sell a portion of their most valuable asset simply to pay taxes. “Because a conservation easement removes the potential for development, it also reduces the land’s value,” Small said. “As a result, it can make the estate tax bill more manageable, or, in some cases make it disappear.”
It is advisable to execute a conservation easement before creating the family limited partnership, he said. The reason is simplicity. “If Mom and Dad want to protect the property in perpetuity, they can complete the conservation easement with just two signatures – theirs,” Small said. “The process becomes much more complicated – and sometimes impossible – if the family has to take into account divergent views of many partners.” He continued, “Families need to define the long-term objectives for their land. Then, working with a qualified advisor, develop a deliberate plan that allows them to achieve their goals. With planning and foresight, it is possible to pass the land to the next generation while maintaining family relationships and treasured open spaces.”
Disclaimer: This article is presented for information purposes only. TALT does not claim to give legal or tax advice, and encourages the reader to consult with your tax
attorney, CPA or financial adviser to determine whether a conservation easement or family limited partnership is right for you. For additional resources, check TALT’s
website at www.txaglandtrust.org