For a number of years the IRS has attacked FLPs and FLLCs on the basis that there is no valid business purpose for the entity.
Clients have argued that a key reason for using the LP form is so that capital can be concentrated or pooled and then invested for greater resulting returns. Credible evidence is cited to support the contention that money invested with a long term investment time-line and with a disciplined investment policy will yield greater returns than money invested in response to demands for quarterly or annual performance.
Many reported cases have problems because senior family members contribute assets to their LPs while keeping their current invested strategy. It is important for clients to know that the courts have repeatedly cited this lack of change in investment strategy as evidence that the creation of the LP was “only a change of title” or resulted in a “mere recycling of value.”
Best practice: After assets are transferred to the LP, it is important to work with the partnership to create an investment policy statement that outlines
• how the LP intends to invest,
• why it intends to invest in a certain way, and
• what results are expected to be achieved.
The LP should then implement the investment policy as soon as possible.
Not all assets need to be sold and reinvested immediately. Stock with built in gains or restrictions will typically have a slower exit in order to avoid or postpone capital gains taxes or to comply with SEC rules.
The more the LP can distinguish its new investment strategy from senior family member’s prior strategy, the better it will be against possible attack.
Some cases where the courts have specifically called the tax payers to task for “merely recycling of value” include:
Estate of Harper v. Commissioner, T.C. Memo 2002-121 (U.S. Tax Court 2002).
Estate of Bigelow 89 T.C. M. 954 (2005).
Estate of Strangi v. Commissioner, 85 T.C. Memo 1331 (2003)
Estate of Concetta H. Rector v. Comm., T.C. Memo 2007-367