Estate of Joanne Harrison Stone, Deceased, Cosby A. Stone and Michael D. Stone, Personal Representatives, Petitioners

T.C. Memo. 2012-48 UNITED STÁTES TAX COURT ESTATE OF JOANNE HARRISON STONE, I)ECEASEI COSBY A. STONE AND MICHAEL D: STONE, PERSONAL REPRESENTÂTIVES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 23290-09.

F led Februa 22, 2012.

Dudley W. Taylor, for petitione .

Caroline R. Krivacka, for respondent.

E VE FEB 22 20E

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).' 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) arid had six adult .

children and nùmerous gràndchildren at the time of her death. Deceflènt ànd her family mëmbers were a very close-knit family in terms of living close together nd '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.

working togethere ecedent, Mr. Sto ie, and at least foùr of their six children had worked at a publishiná company started by the Stone family in the 1930s.

The Stones were a prominent family in their hometo n of Crossville, Tennessee (which is in Cumberland County), and had held ignificant amounts of real estate in the atea for severalt generatioiïs. Decedent owned, either wholly of in part, approximatel 30 parcels of real property in Cumb riand Countý in 1997.

Nine parcels'of dec dent's land,(total ng approximately 74Ó acres) were mostly undeveloped woodlands without útilities or roads (woodland párcels). The woodland parcels vvere jointly owned by.decedent and Mr. Stone.

Insthe early 1990s Steve Stone, one of decedent's soi s, acquired real estate near the woodland parcels. Steve Sto ie built a home,on hi property and desired to form a lake in the area through the construction of a dam on his property. He discussed the lakeproject with decedent and lVk Stone, as ell as his siblings, and entered into an agreement with Crab Orchard Water Utility District (Crab Orchard) by which Crab Orchard would construct the dam t a cost of approximately $1.5 to $2 million.

In exchange, Crab O ch rd would be entitled to use a portion of Ste e Stone's property for construction of water treatment plant and would be able tþ use the lake as a water reservoir for the county. Oi ce Îhe dam was completed in tlie 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 totthese 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 2Cosby Stone testified that there have been "grumblings" of new sewer line In addition, the rapid population growth in to be constructed near the lake. Cumberland County could spur the construction of a new primary reservoir.

their first meeting with Mr. Sabine, d cedent and Mr. Stone informed Mr. Sabine that they wanted to give gifts of real state 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.

. 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 M . Stone signed the SFLP agreement as both general and limited partners. A revis d partnership agreemënt was executed December 31, 1997 This revised agr ement made no material changes but allowed decedent's children, children s spouses; and granddhildren who received interests in the partr ership to sign as limited partners. Decddent and Mr. Stone ' also signed the revi ed agreement as both general and limit d 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 members desire to provide for the health, education, maintenance and welfare of each other and their children." The agreement listed various ways in which SFbP may be terminated, including-by writtén agreement of partners owning 67% of SFLP. or ypon 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 whethèr properties would be soldf(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 upón written agreement of those limited partners owning sixty-seven (67%) percent of percentage of ownership then held:by all the limited partners." The partnefship agreement also provided that upon the deathi 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 the parcels became SFLP's only assets. Before quitclaiming the woodland parcels to SFLP, decedent nd Mr. Stone had the combined parcels:appraised. Decedent and Mr. Stone used the appraisal valu 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 thþir 21 children, children's spouses, and grandchildren. Each of the 21 recipients received-a .634% limited partnership interest in SFLP fro both decedent and.Mr. Stone, so that the 21 recipients held a combined 26.628% limited partnershiþ 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 fro i both decedent and Mr. Stone and two of the children's spouses no longer recei ed interests as a result of divorce proceedings. As a result ofthe gifts, y 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 theiremammg 98% in liinited partnership interests.

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Xavier Ironside ånd 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 woùld receive approximately four acres of SFLP property on the lake: The decisioirto 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 thät 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. Againino mention was made of the SFLP limited partnership interest then owned by Patriciä 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.

3. Additional Information SFLP has yet to develop or otherwise improve the woodland parcels. SFLP initially had a bank account in its nanie 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 appráximately $700 per year due on the real property it held. Decedent and Mr. Stone paid these property taxes from their personal funds.

Documents 12beled "Bill[s] of Sale" were used to transfer the SFLP limited partnership interestn to decedent's children, children's spouses, and grandchildren.

Although each docunent recites paynient of $1.00 and other "good and valuable consideration", the ecipients paid nothing to decedent and Mr. Smith and the transfers constitutec gifts. Mr. Sabind 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.

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Decedent and Mr. Stone made rio 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.

I - 10'- As of the time of trial in June 2011, Mr. Stone was age 95. Decedent tatight Sunday school for 60 years, up tó and including the last Sunday before she passed away.

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The estate's estate tax return was filed September 26; 2006. An amènded estate tax return was filed October 31, 2008. Respondent issued a notice of deficiency to the estate on August 27, 2009, in response to whiòh the estate tiniely 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 e(cid:0)541tate 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 11 - bona fide sale for adequate and full consideration and retairìs certain enumerated rights or interests in the property which are not relinquished until death, thesfull value of the transfe Ted property will 5e included;in the dec dent's gross estate.

Section 2036(a) is ipplicable when three conditions are me (1) the decedent made an inter vivos transfer of property; (2) the decedent's ransfer w'as not a bona fide-sale for adequate and full considsration; and (3).the)de edent retained an interest or right enunierated in section 2036(a)((1,) or (2) or ( ) in the transferred property;which he cr she did not relin uish before death.

Respondent argues that these t ee conditions were s tisfied by decedent's transfer of the. woodland¢parcels to SÊLP, while the estate a gues that the latter two conditions were not satisfied. The parties agree that de edent made-an inter vivos transfer of property. We find t decedent's transfer of the woodlánd parcels to SFLP was,a bona fide sale for adequate and full consideration. As a result, we conclude that section 203 ( does not apply to d cedent's transfer of the woodland parce s to SFLP:

A: Whether Decedent's Transfer of the Woodland P reels to SFLP Was a Bona FidkSale for Adequate and Full Consideration In the context of family limited partnerships, the bonå fide sale for adequate and full considerati n exception is met where the record esthblishes the existence of 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 evidénce 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 poór health when the partnership was formed.

Id. at 118- 119; Estate of Jorgensen v. Commissioner, T.C. Memo. 2009-66i 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. Estate of Bongard v. Commissioner, 124 T.C. at 119, 122-125; see also Estate of Jorgensen v Commissione , T.C. Memo 2009-66 1. Wh ther Decedent s Was a Bona Fide Sal ransfer of the Woodland Parcels to SFLP Whether a tr nsfer is a bona fide sale is a question of motive. Estate of Liljestrand v. Comnissioner, T.C. Memo. 2011-259. We n ust separate the true nontax reasons for SFLP's formation rom those that merel clothe transfer tax savings motives. See Estate of Bong rd v. Commissioner, 124 T.C. at 121.

The estate argues that decedent had two nontax moti es 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)10 protect the wo dland parcels from division as a result of partition actions. Respondent argues thàt decedent was motivated only by desire to simplify the gift-giving pröce s by not having to execute deeds each time a gift of a porti n of the woodland parcels was made.

We consider each of the parties' arguments.

a. Gift Giving One of the reason decedent traisferred the woodland parcels to SFLP was to simplify the process of mákmg gifts of the woodland parcels-to her children, her children's spouses, and her grandchik ren. Respondent claip2s that gift giving was 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 inade with testamentary purposes in mind, we have previously noted that "Legitimate nontax purposes ar often inextricably interwoven with testämentary objectives."

Estate of Bongard . Commissioner, 124 T.C. at 121.

Othér Factors Respondent argues that other facts show a nontax pu pose did not actually exist. Respondent irst argues that deåedent stood on both ides of the trañsaction, as bòth transferór ò the woodland parcels and general manáger of SFLP.

Respondent points out that decedent and Mf. Stone had almost complete control over the woodland arcels until 1999: when the!1imited partners acquired enough interest in SFLP (6 %) to temové dec:dent and Mr. Stoñe s general partners.

Where a taxp yer stands òn bot 2 sides of+attransactio 1; we have concluded that there is no arm s-length bargaining and thus the boría fide transfer exception does not apply. Estate of Liljestrand v Commissióner, T.C. Memo. 2011-259.

However, we have lso stated that an arm's length transactibn occurs when mutual legitimate and significant nontax reasòns exist for the trans etion and the transaction.is carrie out in a way in v/hich unrelated parties to a businéss transaction wouki al with each othe Fstate ofBongard Commissiòner, 124 T.C. at 123.

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 17 - occurred; decedent and Mr. Stone had the woodland parcel appraised and valued the SFLP interests o that the total value of SFLP interests as equal to the appraised value of the woodland parcéls. Finally, the evide ce presented tended to show that deced nt (and Mr. Stone were in good health f the time theiransfer of the woodland parcels was made to FLP. Although dec dent was over age 70 at the time of transfer in 1997, she lived until 2005 and was healthy enough to continue teaáhing Sunday school up to and'including.the la t Sunday before she passed away. Although Mr. Stòne was over age 80 at zhe ti e of tránsfer, he was still alive at the timë of trial in June 2011.

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1. Conclusion on Bona Fide Sále Issue After consid ring all facts presented, we find.that deþedent had a legitimate and actual nontax nfotive in transferring:the woodland parcëls to SFLP. We therefore find that the bona fide sale prong is satisfied.

2. Wh ther Decedent Received Full and Adeq ate Consideration for He Transfér of the Woodland Parcels to SÈLP A taxpayer's receipt of a partnership interest is not part of a bona fide sale for full and adequa e consideration w ere an intrafamily transactio merely attempts to change the form in which e decedent holds pròperty. Estate of Gore v. Commissioner, T.C. Memo. 2007-169. We havè stated that-- Without any change whatsoever in the ui1derlying 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 exi(cid:0)541ts 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. 4 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.

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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 forin 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 does not operate to include he values of the woodland parcels ir the value of decedent's gross estate.

In reaching oar holding herein, we have considered all arguments made, and, to the extent not mentioned above, we conclude they a e moot, irrelevant, or without merit.

To reflect the foregoing, Decisior will be entered under Rule 155.