When Natale Giustina died in 2005, he owned a 41% limited partner interest in a partnership named Giustina Land & Timber Co. Limited Partnership. The partnership owned 47,939 acres of timberland and had 12 to 15 employees. It earned profits from growing trees, cutting them down, and selling the logs. The partnership had continuously operated this business since its formation in 1980.
All limited partners in Giustina Land were members of the same family, or trusts for the benefit of members of the family. The partnership agreement provided that a limited partner interest could be transferred only to another limited partner or to a trust for the benefit of another limited partner unless the transfer was approved by the two general partners.
Although this case has a long history, the final decision determined the value based entirely on the partnership’s value as a going concern, which is the present value of the cash flows the partnership would receive if it were to continue operations. To put it another way, the value was determined based on the cash that a partner would receive from company operations rather than would might be received if the partnership assets were sold and the proceeds distributed to the partners.
For twenty-five years, general partners Larry Giustina and James Giustina ran the partnership as an operating business. The court was convinced that these two men would refuse to permit someone who was not interested in having the partnership continue its business to become a limited partner. Therefore, the only cash flow available to limited partners is the cash flow from operations. In determining the value of the partnership, the court applied a 14% capitalization rate to $6,333,600 projected normalized pre-tax cash flows to arrive at a value of $45,240,000. This value is over $105 million less than the value of the partnership assets.
Why the taxpayer prevailed
Valuation cases, especially those involving family partnerships, are very fact specific. The taxpayer prevailed in this case because the business had operated continuously for twenty-five years, and there was no indication that it would not continue to operate. The asset value was not considered the valuation because the only way that a limited partner could receive the asset value was on the dissolution of the partnership, which the court concluded was unlikely.
The taxpayer’s position in this case was strengthened by the fact that the partnership had been operating a business for twenty-five years. There is no requirement that a partnership operate for this length of time, however, a partnership formed shortly before death or asset transfer may be more susceptible to successful IRS challenge. Also, to be respected by the IRS, a family partnership must have a business purpose. Tax reduction does not qualify as a business purpose.
With proper planning, a family limited partnership may be an effective option to reduce estate and gift taxes. However, there are many technical requirements. If you are interested in establishing a family limited partnership, you should consult a tax professional.