Tax Court Includes Property in FLP in Decedent's Gross Estate

The Tax Court has held that a decedent's transfer of real estate to a family limited partnership (FLP) was not a bona fide sale (Estate of Liljestrand v. Commissioner, Dec. 58,801(M), TC Memo. 2011-259). Therefore, the value of the property transferred to the FLP was included in the decedent's estate.

Comment
The Tax Court has ruled on this issue before, such as in Estate of Strangi v. Commissioner, Dec. 55,160(M), TC Memo. 2003-145, where the transferred property was included. Among other factors similar to this case, the decedent was found to have retained enjoyment of the property where he had used partnership funds to pay for his personal needs.

The decedent transferred more than $5 million in real estate to the FLP in exchange for a 98.8-percent limited partner interest. No other parties contributed to the FLP. Starting two years later, the FLP began paying the decedent's personal expenses along with gifts to his grandchildren. The FLP sold some of its real estate holdings to pay these personal expenses.

After the decedent's death in 2004, the IRS issued a notice of deficiency in the amount of $2.5 million. The IRS included the value of the real estate transferred to the FLP in the decedent's gross estate. The estate challenged the IRS's determination in the Tax Court.

The court rejected the estate's arguments in favor of exclusion of the transferred property, holding that it met all three conditions under which the value of the transferred property must be included in the gross estate under Code Sec. 2036(a): (1) the decedent made an inter vivos transfer of property; (2) the decedent's transfer was not a bona fide sale for adequate and full consideration; and (3) the decedent retained an interest in the transferred property, which he did not relinquish before his death.

The court further found the decedent did not have a legitimate non-tax reason for creating the FLP. The transaction lacked any arm's length bargaining before the formation of the partnership. Rather, the decedent "stood on all sides of the transaction," the court found. The FLP also failed to follow the most basic of partnership formalities, the court noted. The court was also not persuaded that the decedent had created the FLP to protect the real estate from potential creditors.

Additionally, the court noted that the decedent had retained the possession and enjoyment of the income from the transferred property. The decedent lacked sufficient funds outside the FLP to pay his personal expenses, including future obligations such as federal and state estate tax. Distributions were heavily weighted in the decedent's favor, the court observed.

Reference: PTE §34,125.20