A partnership of any kind is a non-corporate association of two or more people, each of whom own shares of an undivided interest in the assets of the partnership. Unless otherwise indicated, it is assumed that partners have an equal share, but equal ownership is not a requirement. One of the most convenient features of an undivided interest in assets is that shares can be allocated to various partners without having to physically divide the property. Just like when a person buys shares of a company in the stock market, each of those shares represents a small fraction of the total asset value of the company – from its current inventory, to the desks and chairs used by employees. When the principal asset of a partnership is forest land, being able to divide the asset value of land on the basis of shares is much easier than having to divide the land and distribute parcels. Forest owning families that form partnerships often do so to take advantage of the opportunity to keep lands intact while passing land on to future generations in the form of partnership shares.
A family partnership is usually set up as a ‘limited partnership’ with two types of partners: (1) general partners who make all decisions and are responsible for day-to-day affairs, and (2) limited partners who have only a beneficiary interest in the partnership. Although limited partners own an undivided interest in the assets, they have no authority to make decisions. In most family partnerships, parents are the general partners and children, grandchildren and other prospective heirs are the limited partners. When the principal asset is forests and the business is forest management, the family forest partnership is a great way to pass well-managed lands intact.
In terms of liability, general partners are fully liable for the claims against the partnership resulting from the combined acts of the general partners or even the acts of any one general partner. Although limited partners are always protected from liability, the general partners’ exposure to liability is a major failing of family partnerships. For this reason, some family partnerships have decided to form a ‘limited liability company’ (LLC) as an umbrella for the family partnership which then becomes the principal asset of the LLC.
So how does all this work for a forest-owning family? First, the parents learn as much as they can about family partnerships. Next, they locate an attorney who has experience forming partnerships (which may be a more difficult task than it sounds) to draw up the family partnership ‘charter.’ Forest land and any other assets the family wants to include in the partnership are appraised and then the parents develop a ‘gifting’ strategy.
Children, grandchildren and other heirs are vested in the family forest as limited partners using the annual gift exclusion allowed by law. This year (2007) the gift exclusion is $12,000 per taxpayer to as many different recipients as he or she chooses. Married couples can double this amount to $24,000 per taxpayer per gift to each person they want to include in the family partnership. So long as gift amounts are at or below the limits, there are no taxes assessed either the parents or the children.
If the family partnership charter limits the marketability of the gift (as it should, to discourage children from attempting to convert their ownership interest in forest land into cash), the IRS allows gifts to be ‘discounted.’ In other words, a husband and wife can pass, say, $30,000 in forest land to create a $24,000 gift for tax purposes. In this case they have discounted the fair market value of the gift by 20 percent, presumably because the family partnership charter has strict rules governing limited partners that want out.
In the world of gift appraisal for discounting purposes, a 20 percent discount is fairly conservative. But such gifts are almost always examined by the IRS – regardless of discount rate – so the actual rate must be justified, usually by experts who have experience doing these kinds of valuations. Notwithstanding, I have heard of discount rates of up to 95 percent.
Assuming a modest discount rate of 20 percent and an annual gift exclusion of $12,000, a husband and wife can vest two children into $600,000 worth of forest land in 10 years. If the discount rate is doubled to 40 percent, this same couple can pass $1.2 million dollars in forest land over the next decade.
Parents can also pass the land as a single gift so long as the amount is less than the lifetime exclusion for taxable gifts. For the period 2005 through 2009, the lifetime gift exclusion is $1 million per taxpayer, or $2 million per married couple, plus any discounts for lack of marketability. Also, the estate and generation skipping transfer exemption is reduced by the amount of the gift tax exemption used.
The primary benefit of a family partnership is that it allows parents to disperse the value of forest to heirs while keeping land intact. Because their estate (or a large share of the estate) has been dispersed to the partnership, little or no estate tax is due when they pass. And the parents maintain control -- even if their share of the partnership is small compared to that of the children -- until new general partners are appointed. The new general partners are, in the opinion of the parents, prospective heirs best suited to carry on in the parent’s tradition. Other heirs – the limited partners – share income and other benefits of owning forests, but they make no decisions.
Forming a family forest partnership and vesting prospective heirs into it is easy compared to making a decision when it comes time to appoint a new general partner(s). It isn’t always the oldest child, or the male, or the smartest, or the nicest. Parents need to pick a person who is willing to execute the terms of the partnership agreement while treating the other partners fairly. Even though limited partners do not have a say in management decisions, a wise general partner allows them to share their ideas.
The key to developing an effective family forest partnership agreement is open, thorough and candid conversation between spouses. Yet two subjects spouses avoid, almost as if it were a condition of marriage, are estate planning and children. No one likes to discuss estates because it necessitates talking about dying, a subject we all try to avoid. And conversations about children are tough because it usually results in an expression of favor of one child over another, and everybody knows you should never show favoritism toward children.
The only way to have these conversations is to focus on the future, the long-term good of the forest, and to view children with a hard, cold edge of objectivity. Remember, the goal is to develop a family partnership that provides guidelines to care for land well into the future, and to do so in such a way that the result is equitable and agreeable to your heirs. If heirs don’t accept the premise of a family forest partnership, the chances of it succeeding after the founders pass away are limited.
One final bit of advice is this: Never under any circumstances include the spouses of your children in gifts of land. Why? Because the prospects of divorce, even for the ‘perfect’ couple, are too great to risk having the family forest treated as a marital asset in a bitterly contested divorce proceedings. Children of family forest partnerships should also be encouraged to execute prenuptial agreements with prospective spouses, just so it clear to all that the family forest is not up for grabs.
