In this video, Steve Dotterer of H2R CPA discusses the valuation of Family Limited Partnerships (FLPs) for Federal estate and gift purposes. To determine the Fair Market Value (FMV), the three primary approaches that need to be taken into consideration are income, market, and asset approach – in conjunction with the composition of the assets within the FLP.
Video Transcript: Valuation of Family Limited Partnerships (FLPs)
Hi, my name is Steve Dotterer, Director of Business Valuation at H2R.
This month, I wanted to take a few minutes to discuss an important topic in business valuation, Family Limited Partnerships, or FLPs. FLPs are important mechanisms for asset management and estate planning.
Typically, when we do a valuation of an FLP, it is for Federal estate and gift purposes. The first question we ask when valuing an FLP is, what is the appropriate standard of value? The answer for estate and gift purposes is Fair Market Value, or FMV, as defined in Revenue Ruling 59-60, treasury regulations and the Internal Revenue Code.
As with any type of business valuation, it is important to consider the three primary approaches, the income, market, and asset approaches. All three approaches should be considered, but the composition of the assets in the FLP will ultimately guide us to the appropriate method.
Let us consider a common type of FLP, one with marketable securities. Although the income approach is commonly overlooked, it is possible to apply the income methods to valuing an FLP with marketable securities. If we are able to project the future cash flows flowing from the FLP, we can apply a risk adjusted rate of return called the discount rate to bring the future cash flow value back to the present value. If the values of the cash flows are expected to be constant or to grow at a constant rate, we can also apply a method called the capitalization of cash flows.
A second method we can consider is the market approach. To apply the market approach to an FLP with marketable securities, we typically look to commercially available sources of data with published price to net asset value ratios for closed-end funds. Using this data, we can determine an indication of value for our Family Limited Partnership with marketable securities.
A third approach we can utilize is the asset approach. To use the asset approach, we need to consider the Fair Market Value of the assets as of the date of valuation. We can adjust the balance sheet to the fair market value by using a combination of sources, such as brokerage statements, notes to financial statements as of the valuation date, stock quotes and other pieces of information.
The three approaches should mutually reinforce one another and lead us to a conclusion of value. One of the questions we often receive in valuing a family limited partnership is what about discounts?
Discounts are important because they may influence the amount of tax that is paid in an estate or a gift situation. Each consideration is facts and circumstances specific. However, when we value an FLP, we consider all applicable marketability and control discounts.
A marketability discount relates to the differences in liquidity for a privately held asset versus a publicly traded asset, such as a stock. The discount for lack of control pertains to a non-controlling owner’s inability to influence the income stream and direction of the assets without the consent of the other owners in the FLP.
Once we consider this variety of factors in conjunction with available market data, we are able to determine whether or not a discount for lack of marketability and/or a discount for lack of control is warranted.
Using the methodologies we’ve discussed, we can also value a variety of other types of Family Limited Partnerships, including those with real estate, oil and gas, timber, private equity, and many other types of assets.
If you think that we can assist you with the valuation of a Family Limited Partnership, please reach out to me at the contact information listed below.
Thank you and I look forward to working with you.