T.C. Memo. 2012-48
UNITED STATES TAX COURT
ESTATE OF JOANNE HARRISON STONE, DECEASED, COSBY A. STONE
AND MICHAEL D. STONE, PERSONAL REPRESENTATIVES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 23290-09. Filed February 22, 2012.
Dudley W. Taylor, for petitioner.
Caroline R. Krivacka, for respondent.
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MEMORANDUM FINDINGS OF FACT AND OPINION
GOEKE, Judge: Respondent determined a $2,563,290 Federal estate tax
deficiency against the Estate of Joanne Stone (estate). After settlement of certain
issues, the sole issue remaining for decision is whether the value of real property
transferred by Joanne Stone (decedent) to a family limited partnership should be
included in the value of her gross estate pursuant to section 2036(a).1 We hold that
the value of the property transferred should not be included.
FINDINGS OF FACT
Decedent was a resident of Tennessee when she died on July 2, 2005, at the
age of 81. Two of her sons, Cosby A. Stone and Michael D. Stone, are the personal
representatives of the estate. Both reside in Tennessee.
1. Background of Decedent, Her Family, and Her Land
Decedent was married to Roy A. Stone (Mr. Stone) and had six adult children
and numerous grandchildren at the time of her death. Decedent and her family
members were a very close-knit family in terms of living close together and working
1
Unless otherwise indicated, all section references are to the Internal Revenue
Code (Code) in effect for the date of decedent’s death, and all Rule references are
to the Tax Court Rules of Practice and Procedure.
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together. Decedent, Mr. Stone, and at least four of their six children had worked at
a publishing company started by the Stone family in the 1930s.
The Stones were a prominent family in their hometown of Crossville,
Tennessee (which is in Cumberland County), and had held significant amounts of
real estate in the area for several generations. Decedent owned, either wholly or in
part, approximately 30 parcels of real property in Cumberland County in 1997.
Nine parcels of decedent’s land (totaling approximately 740 acres) were mostly
undeveloped woodlands without utilities or roads (woodland parcels). The
woodland parcels were jointly owned by decedent and Mr. Stone.
In the early 1990s Steve Stone, one of decedent’s sons, acquired real estate
near the woodland parcels. Steve Stone built a home on his property and desired to
form a lake in the area through the construction of a dam on his property. He
discussed the lake project with decedent and Mr. Stone, as well as his siblings, and
entered into an agreement with Crab Orchard Water Utility District (Crab Orchard)
by which Crab Orchard would construct the dam at a cost of approximately $1.5 to
$2 million. In exchange, Crab Orchard would be entitled to use a portion of Steve
Stone’s property for construction of a water treatment plant and would be able to
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use the lake as a water reservoir for the county. Once the dam was completed in the
mid-1990s, a portion of the woodland parcels fronted the newly formed lake.
Once the lake had been constructed, decedent and Mr. Stone concluded that
they wanted the woodland parcels to become a family asset. They hoped that the
family would one day be able to develop and sell homes near the lake, although
there were long-term issues to be worked out. The first issue was that the shallow
soil depth in the area makes it difficult to connect sewage systems to potential
homes near the lake. The second issue is that the operations of Crab Orchard result
in a significant drawdown of the water in the lake during the summer months.
Potential solutions to these problems included construction of additional sewer lines
closer to the lake and of a new primary reservoir for Cumberland County.2
2. The Stone Family Limited Partnership of Cumberland County and Gifts of
Partnership Interests
To further their family planning regarding the woodland parcels, decedent and
Mr. Stone sought the advice of their attorney, Joe Looney. Mr. Looney referred
decedent and Mr. Stone to Harry Sabine, another attorney in the area. At their first
2
Cosby Stone testified that there have been “grumblings” of new sewer lines
to be constructed near the lake. In addition, the rapid population growth in
Cumberland County could spur the construction of a new primary reservoir.
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meeting with Mr. Sabine, decedent and Mr. Stone informed Mr. Sabine that they
wanted to give gifts of real estate to various family members and were seeking the
best way of doing so. Mr. Sabine discussed the use of a limited partnership and told
decedent and Mr. Stone that it would simplify the gift-giving process by not
requiring execution and recording of new deeds every year. Mr. Sabine also
believed that using a limited partnership would help guard against partition suits,
which could cause the land to be divided into smaller tracts.
Decedent and Mr. Stone decided to form a limited partnership to hold the
woodland parcels. Mr. Sabine prepared the Stone Family Limited Partnership of
Cumberland County (SFLP) agreement and helped decedent and Mr. Stone file a
certificate of limited partnership with the Tennessee secretary of state on December
29, 1997. Decedent and Mr. Stone signed the SFLP agreement as both general and
limited partners. A revised partnership agreement was executed December 31,
1997. This revised agreement made no material changes but allowed decedent’s
children, children’s spouses, and grandchildren who received interests in the
partnership to sign as limited partners. Decedent and Mr. Stone also signed the
revised agreement as both general and limited partners.
The SFLP agreement provided that SFLP’s purpose was to hold and manage
property for the family members. The agreement provided that “The family
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members desire to provide for the health, education, maintenance and welfare of
each other and their children.” The agreement listed various ways in which SFLP
may be terminated, including by written agreement of partners owning 67% of SFLP
or upon sale of all SFLP property and distribution of proceeds. The agreement
placed various restrictions on a partner’s ability to transfer their partnership interest
and allowed SFLP to purchase the interest of any partner upon his or her death.
As general partners of SFLP, decedent and Mr. Stone had considerable
powers, including the sole rights to: (1) determine whether properties would be
sold; (2) manage the day-to-day business of SFLP; and (3) determine the amounts of
any distributions to partners. The partnership agreement provided: “The limited
partners will have the right to dismiss the general partner upon written agreement of
those limited partners owning sixty-seven (67%) percent of percentage of ownership
then held by all the limited partners.” The partnership agreement also provided that
upon the death, withdrawal, removal, or bankruptcy of a general partner a new
general partner would be elected by the limited partners.
Upon its formation, decedent and Mr. Stone each obtained 1% general
partnership interests and 49% limited partnership interests in SFLP. On December
30, 1997, decedent and Mr. Stone quitclaimed the woodland parcels to SFLP and
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the parcels became SFLP’s only assets. Before quitclaiming the woodland parcels
to SFLP, decedent and Mr. Stone had the combined parcels appraised. Decedent
and Mr. Stone used the appraisal value of $1,575,600 as the basis for all
computations of SFLP interest values and did not discount the value of SFLP
interests for gift tax purposes. Accordingly, decedent and Mr. Stone valued each
1% interest in SFLP at $15,756 for gift tax purposes.
On December 31, 1997, decedent and Mr. Stone gave portions of their
limited interests in SFLP as gifts to their 21 children, children’s spouses, and
grandchildren. Each of the 21 recipients received a .634% limited partnership
interest in SFLP from both decedent and Mr. Stone, so that the 21 recipients held a
combined 26.628% limited partnership interest in SFLP at the end of 1997. Similar
gifts were made in 1998 and 1999. In 2000 the recipients received only a .477%
limited partnership interest from both decedent and Mr. Stone and two of the
children’s spouses no longer received interests as a result of divorce proceedings.
As a result of the gifts, by the end of 2000 decedent and Mr. Stone each owned a
1% general partnership interest in SFLP and the children, children’s spouses, and
grandchildren owned the remaining 98% in limited partnership interests.
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Xavier Ironside and Margaret Stone Ironside (one of decedent’s daughters)
began divorce proceedings in 1999. In an attempt to keep SFLP interests in family
hands, SFLP and Mr. Ironside reached a deal whereby Mr. Ironside would receive
approximately four acres of SFLP property on the lake. The decision to transfer the
four acres was made by decedent and Mr. Stone, who had discussed it with various
limited partners. In exchange for the four acres of lake property, on December 9,
1999, Mr. Ironside quitclaimed to Margaret Stone Ironside his interest in the
woodland parcels still held by SFLP. No mention was made of the SFLP limited
partnership interest then owned by Mr. Ironside in the quitclaim deed although it
was mentioned that the parcels involved were the same ones conveyed to SFLP by
decedent and Mr. Stone.
Patricia Connelly Stone and Michael Stone began divorce proceedings in
2000. As part of a financial settlement between them, Patricia Connelly Stone
quitclaimed to Michael Stone her interest in the woodland parcels still held by SFLP
on October 18, 2000. In exchange for the quitclaimed interest, Michael Stone gave
up valuable consideration in the financial settlement. Again, no mention was made
of the SFLP limited partnership interest then owned by Patricia Connelly Stone in
the quitclaim deed, but it was mentioned that the parcels involved were the same
ones conveyed to SFLP by decedent and Mr. Stone.
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3. Additional Information
SFLP has yet to develop or otherwise improve the woodland parcels. SFLP
initially had a bank account in its name but closed the account because SFLP earned
no income, either from the property it held or otherwise. SFLP’s only expenses
were property taxes of approximately $700 per year due on the real property it held.
Decedent and Mr. Stone paid these property taxes from their personal funds.
Documents labeled “Bill[s] of Sale” were used to transfer the SFLP limited
partnership interests to decedent’s children, children’s spouses, and grandchildren.
Although each document recites payment of $1.00 and other “good and valuable
consideration”, the recipients paid nothing to decedent and Mr. Smith and the
transfers constituted gifts. Mr. Sabine testified that he used a bill of sale for each
transfer because he thought it was the same thing as a document reflecting a gift of
the SFLP interest.
Decedent and Mr. Stone made no particular use of the woodland parcels held
by SFLP other than to fish and visit Steve Stone. Each of the limited partners had
the same access to the land as decedent and Mr. Stone.
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As of the time of trial in June 2011, Mr. Stone was age 95. Decedent taught
Sunday school for 60 years, up to and including the last Sunday before she passed away.
The estate’s estate tax return was filed September 26, 2006. An amended
estate tax return was filed October 31, 2008. Respondent issued a notice of
deficiency to the estate on August 27, 2009, in response to which the estate timely
filed a petition for redetermination of the deficiency.
OPINION
I. Burden of Proof
Generally, taxpayers bear the burden of proving, by a preponderance of the
evidence, that the determinations of the Commissioner in a notice of deficiency are
incorrect. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). The estate
has not argued that respondent should bear the burden of proof.
II. Whether Section 2036(a) Applies to Decedent’s Transfer of the Woodland
Parcels to SFLP
The purpose of section 2036 is to include in a deceased taxpayer’s gross
estate the value of inter vivos transfers that were testamentary in nature. United
States v. Estate of Grace, 395 U.S. 316 (1969). Section 2036(a) generally provides
that if a decedent makes an inter vivos transfer of property other than a bona fide
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sale for adequate and full consideration and retains certain enumerated rights or
interests in the property which are not relinquished until death, the full value of the
transferred property will be included in the decedent’s gross estate. Section 2036(a)
is applicable when three conditions are met: (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 or right
enumerated in section 2036(a)(1) or (2) or (b) in the transferred property which he
or she did not relinquish before death.
Respondent argues that these three conditions were satisfied by decedent’s
transfer of the woodland parcels to SFLP, while the estate argues that the latter two
conditions were not satisfied. The parties agree that decedent made an inter vivos
transfer of property. We find that decedent’s transfer of the woodland parcels to
SFLP was a bona fide sale for adequate and full consideration. As a result, we
conclude that section 2036(a) does not apply to decedent’s transfer of the woodland
parcels to SFLP.
A. Whether Decedent’s Transfer of the Woodland Parcels to SFLP Was a
Bona Fide Sale for Adequate and Full Consideration
In the context of family limited partnerships, the bona fide sale for adequate
and full consideration exception is met where the record establishes the existence of
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a legitimate and significant nontax reason for creating the family limited partnership
and the transferors received partnership interests proportional to the value of the
property transferred. Estate of Bongard v. Commissioner, 124 T.C. 95, 118 (2005).
The objective evidence must indicate that the nontax reason was a significant factor
that motivated the partnership’s creation. Id. A significant purpose must be an
actual motivation, not a theoretical justification. Id. A list of factors to be
considered when deciding whether a nontax reason existed includes: (1) the
taxpayer standing on both sides of the transaction; (2) the taxpayer’s financial
dependence on distributions from the partnership; (3) the partners’ commingling of
partnership funds with their own; (4) the taxpayer’s actual failure to transfer the
property to the partnership; (5) discounting the value of the partnership interests
relative to the value of the property contributed; and (6) the taxpayer’s old age or
poor health when the partnership was formed. Id. at 118-119; Estate of Jorgensen
v. Commissioner, T.C. Memo. 2009-66, aff’d, 431 Fed. Appx. 544 (9th Cir. 2011);
Estate of Hurford v. Commissioner, T.C. Memo. 2008-278. We separate the bona
fide sale exception into two prongs: (1) whether the transaction qualifies as a bona
fide sale; and (2) whether the decedent received adequate and full consideration.
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Estate of Bongard v. Commissioner, 124 T.C. at 119, 122-125; see also Estate of
Jorgensen v. Commissioner, T.C. Memo. 2009-66.
1. Whether Decedent’s Transfer of the Woodland Parcels to SFLP
Was a Bona Fide Sale
Whether a transfer is a bona fide sale is a question of motive. Estate of
Liljestrand v. Commissioner, T.C. Memo. 2011-259. We must separate the true
nontax reasons for SFLP’s formation from those that merely clothe transfer tax
savings motives. See Estate of Bongard v. Commissioner, 124 T.C. at 121.
The estate argues that decedent had two nontax motives for transferring the
woodland parcels to SFLP: (1) to create a family asset which later may be
developed and sold by the family; and (2) to protect the woodland parcels from
division as a result of partition actions. Respondent argues that decedent was
motivated only by a desire to simplify the gift-giving process by not having to
execute deeds each time a gift of a portion of the woodland parcels was made. We
consider each of the parties’ arguments.
a. Gift Giving
One of the reasons decedent transferred the woodland parcels to SFLP was to
simplify the process of making gifts of the woodland parcels to her children, her
children’s spouses, and her grandchildren. Respondent claims that gift giving was
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decedent’s only motive in transferring the woodland parcels to SFLP and that no
nontax motive existed because “gift giving is considered a testamentary purpose and
cannot be justified as a legitimate, non-tax business justification.” Estate of
Bigelow v. Commissioner, 503 F.3d 955, 972 (9th Cir. 2007), aff’g T.C. Memo.
2005-65. While we agree with respondent that gift giving alone is not an acceptable
nontax motive, we disagree that gift giving was decedent’s only motive in
transferring the woodland parcels to SFLP.
b. Creation of a Family Asset
Testimony at trial established that a significant purpose of decedent’s transfer
of the woodland parcels to SFLP was to create a family asset managed by
decedent’s family. Decedent and Mr. Stone desired that their children, their
children’s spouses, and their grandchildren work together to develop and sell homes
near the lake. We have previously found that a desire by a decedent to have assets
jointly managed by family members, even standing alone, is a sufficient nontax
motive for purposes of section 2036(a). Estate of Mirowski v. Commissioner, T.C.
Memo. 2008-74.
We find that decedent’s desire to have the woodland parcels held and
managed as a family asset constituted a legitimate nontax motive for her transfer of
the woodland parcels to SFLP. Although this transfer to SFLP was also made with
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testamentary purposes in mind, we have previously noted that “Legitimate nontax
purposes are often inextricably interwoven with testamentary objectives.” Estate of
Bongard v. Commissioner, 124 T.C. at 121.
c. Other Factors
Respondent argues that other facts show a nontax purpose did not actually
exist. Respondent first argues that decedent stood on both sides of the transaction,
as both transferor of the woodland parcels and general manager of SFLP.
Respondent points out that decedent and Mr. Stone had almost complete control
over the woodland parcels until 1999, when the limited partners acquired enough
interest in SFLP (67%) to remove decedent and Mr. Stone as general partners.
Where a taxpayer stands on both sides of a transaction, we have concluded
that there is no arm’s-length bargaining and thus the bona fide transfer exception
does not apply. Estate of Liljestrand v. Commissioner, T.C. Memo. 2011-259.
However, we have also stated that an arm’s-length transaction occurs when mutual
legitimate and significant nontax reasons exist for the transaction and the transaction
is carried out in a way in which unrelated parties to a business transaction would
deal with each other. Estate of Bongard v. Commissioner, 124 T.C. at 123.
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We have already found the existence of a legitimate nontax motive for the
transaction between decedent and SFLP. See supra pp. 14-15. We also believe
decedent received interests in SFLP proportional to the property she contributed.
See Estate of Bongard v. Commissioner, 124 T.C. at 123. Therefore, this factor
does not weigh against the estate.
Respondent next argues that the partners of SFLP failed to respect
partnership formalities because: (1) in divorce proceedings, Mr. Ironside and
Patricia Connelly Stone quitclaimed their interests in the woodland parcels to their
former spouses but did not transfer actual SFLP interests; (2) some inadequate
documentation was kept for the partnership, such as using bills of sale to make gifts
of SFLP interests; and (3) decedent and Mr. Stone paid SFLP property taxes out of
their personal funds. We agree with respondent that the partners of SFLP failed to
respect some partnership formalities.
Other factors, however, support the estate’s argument that a bona fide sale
occurred. First, decedent and Mr. Stone did not depend on distributions from SFLP
as no distributions were ever made. Second, decedent and Mr. Stone actually did
transfer the woodland parcels to SFLP. Third, there was no commingling of
partners’ personal and partnership funds, as SFLP had no partnership funds. Fourth,
no discounting of SFLP interests for gift tax purposes occurred; decedent and Mr.
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Stone had the woodland parcels appraised and valued the SFLP interests so that the
total value of SFLP interests was equal to the appraised value of the woodland
parcels. Finally, the evidence presented tended to show that decedent (and Mr.
Stone) were in good health at the time the transfer of the woodland parcels was
made to SFLP. Although decedent was over age 70 at the time of transfer in 1997,
she lived until 2005 and was healthy enough to continue teaching Sunday school up
to and including the last Sunday before she passed away. Although Mr. Stone was
over age 80 at the time of transfer, he was still alive at the time of trial in June 2011.
d. Conclusion on Bona Fide Sale Issue
After considering all facts presented, we find that decedent had a legitimate
and actual nontax motive in transferring the woodland parcels to SFLP. We
therefore find that the bona fide sale prong is satisfied.
2. Whether Decedent Received Full and Adequate Consideration for
Her Transfer of the Woodland Parcels to SFLP
A taxpayer’s receipt of a partnership interest is not part of a bona fide sale for
full and adequate consideration where an intrafamily transaction merely attempts to
change the form in which the decedent holds property. Estate of Gore v.
Commissioner, T.C. Memo. 2007-169. We have stated that--
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Without any change whatsoever in the underlying pool of assets or prospect
for profit, as, for example, where others make contributions of property or
services in the interest of true joint ownership or enterprise, there exists
nothing but a circuitous “recycling” of value. We are satisfied that such
instances of pure recycling do not rise to the level of a payment of
consideration. To hold otherwise would open section 2036 to a myriad of
abuses engendered by unilateral paper transformations.
Estate of Harper v. Commissioner, T.C. Memo. 2002-121. With regard to recycling
of value, we have stated that when a “decedent employ[s] his capital to achieve a
legitimate nontax purpose, the Court cannot conclude that he merely recycled his
shareholdings.” Estate of Schutt v. Commissioner, T.C. Memo. 2005-126.
We have already found that decedent had a legitimate and actual nontax
purpose in transferring the woodland parcels to SFLP. See supra pp. 13-17. We
therefore find that the transaction was not merely an attempt to change the form in
which decedent held the woodland parcels and that the full and adequate
consideration prong is satisfied.
B. Conclusion Regarding Section 2036(a)
We have found that decedent’s transfer of the woodland parcels to SFLP was
a bona fide transfer and that decedent received full and adequate consideration from
SFLP as a result of the transfer. Because decedent’s transfer was bona fide and for
adequate and full consideration, section 2036(a) is inapplicable to the transfer and
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does not operate to include the values of the woodland parcels in the value of
decedent’s gross estate.
In reaching our holding herein, we have considered all arguments made, and,
to the extent not mentioned above, we conclude they are moot, irrelevant, or without
merit.
To reflect the foregoing,
Decision will be entered
under Rule 155.