Combining a GRAT with an FLP to increase transfer tax leverage on gifts of family assets.

• Author: Ellentuck, Albert B.
• Position: Grantor retained annuity trust; family limited partnership

Facts: Lionel Trane, age 55, owns an old farmstead and surrounding real estate, known as Tangled Webb Farms. Tangled Webb Farms has been in Lionel's family for years and is located outside Biggalopolis. Development in the Biggalopolis area has recently expanded toward this property. * Tangled Webb Farms was recently appraised at $1 million. Lionel believes that the value of the property, even with no development, could quadruple in the next few years because of its prime location; with development, the appreciation could be even greater. Lionel would like to transfer the property to his three adult, unmarried children (Sam, Cokie and George) as soon as possible, to remove this appreciation from his estate with as little transfer tax as possible. Issue: Would combining a partnership with a grantor retained annuity trust (GRAT) make sense for Lionel?

Analysis

Lionel's tax adviser suggested that he form a family limited partnership (FLP) with his wife (Jane, age 52) and use this as a vehicle to gift the property. A reliable appraiser has indicated that minority limited partnership (LP) interests would have a value that is 30% less than their proportionate share of the underlying asset values.

Based on this, Lionel gives a gift of 50% of Tangled Webb Farms to Jane, and together they form TWF LP, with Lionel owning a 1% general partnership interest and a 49% LP, interest and Jane owning a 50% LP interest.

Based on the appraisals mentioned, a 1% TWF LP has a value of $7,000 (70% of its 1% share of the underlying $1 million value). Both Lionel and Jane give each of their children 1.425% LP interests, using their annual $10,000 gift tax exclusions. After these gifts, however, Lionel and Jane still own 91.45% of the partnership.

Lionel would like to give an additional 89.45% to the children as soon as possible. (He and Jane each would like to retain 1% interests, with Lionel's being the general partnership interest.) Outright gifts of the 89.45% interests would be valued at $626,150. With such gifts, Lionel and Jane each would use up approximately $313,075 of the ability they have to make roughly $675,000 of tax-free gifts under their applicable credit amounts (previously referred to as the unified tax credit). They wish to preserve their applicable credit amount for the time being.

Lionel's tax adviser suggests that Lionel and Jane each consider making these gifts through a GRAT. A donor using a GRAT transfers assets to an irrevocable trust...