For many successful families, building wealth is only part of the equation. Equally important is determining how to preserve that wealth, protect it from unnecessary risks, and eventually transfer it to children and grandchildren without giving up control too soon or creating an unnecessary estate tax burden.
This is especially true for families who own successful businesses, commercial real estate, rental properties, or other valuable investments. One estate planning strategy that can help accomplish these goals is a Family Limited Partnership (FLP).
When properly structured and administered, an FLP can provide significant benefits, including centralized management of family assets, opportunities for asset protection, and the ability to transfer wealth to future generations in a tax-efficient manner.
However, FLPs are sophisticated planning tools that require careful consideration, particularly when they involve substantial assets or transfers between generations.
What Is a Family Limited Partnership?
A Family Limited Partnership is a legal entity that allows family members to own and manage assets together while dividing ownership into two different categories: general partners and limited partners.
General Partners: These individuals are responsible for managing the partnership and making important decisions about its assets. They generally control investments, business operations, distributions, and other management matters.
Limited Partners: These individuals own an economic interest in the partnership but generally do not participate in its day-to-day management. They may receive distributions and benefit from increases in the value of partnership assets.
For example, parents who own several million dollars in investment real estate might establish an FLP and transfer certain properties or ownership interests into it.
The parents could retain management authority through the general partner interest, while gradually transferring limited partnership interests to their children or to irrevocable trusts established for their children's benefit.
This arrangement allows the parents to continue managing the family's investments while transferring a portion of the economic ownership and future appreciation to the next generation. Importantly, a limited partnership interest does not necessarily give its owner the right to force the sale of partnership assets or dictate how the partnership is managed.
That distinction can be particularly valuable for families who want to transfer wealth without surrendering control prematurely.
Five Important Benefits of a Family Limited Partnership
1. Maintaining Control While Transferring Wealth
One of the greatest concerns parents have about gifting substantial assets to their children is losing control over those assets.
For example, imagine a couple who has spent 30 years building a successful real estate portfolio. They want their children to eventually benefit from those investments, but they are not ready to hand over management responsibilities.
Simply gifting the properties outright could create significant challenges. The children might disagree about whether to sell properties, refinance loans, make improvements, or distribute income. An FLP can help address these concerns.
By retaining management authority as general partners, the parents can continue making important business and investment decisions while gradually transferring limited partnership interests to their children. The partnership agreement can also establish rules regarding management succession, distributions, and restrictions on transfers of partnership interests.
This allows the family to create an orderly transition plan rather than forcing the next generation to make important decisions without guidance or experience.
2. Potentially Reducing Estate and Gift Taxes
For families with substantial wealth, one of the most attractive benefits of an FLP is the opportunity to transfer assets to future generations in a manner that may reduce future estate taxes. The strategy generally involves transferring limited partnership interests to children or to irrevocable trusts established for their benefit.
Because these interests may lack control over partnership decisions and may be difficult to sell, their fair market value can be less than their proportionate share of the partnership's underlying assets. These potential reductions in value are commonly referred to as valuation discounts.
Two of the most frequently discussed discounts are:
- Lack of Control Discount: A limited partner generally cannot independently make management decisions, compel distributions, or force the sale of partnership assets. This lack of control may reduce the fair market value of the interest.
- Lack of Marketability Discount: Unlike publicly traded stocks, interests in a closely held family partnership generally cannot be sold quickly or easily. This limited marketability may also reduce their value.
When supported by a qualified appraisal and the applicable facts, these discounts can allow families to transfer meaningful economic interests while using less of their available federal gift and estate tax exemption.
3. Moving Future Appreciation Outside the Parents' Estates
Another powerful benefit of an FLP is the ability to shift future appreciation to the next generation.
Consider a couple who owns an investment portfolio through an FLP that is currently worth $8 million. They transfer limited partnership interests representing 50% of the partnership's economic value to properly structured irrevocable trusts for their children. Over the next 15 years, the partnership's assets increase substantially in value.
Assuming the transfers are completed properly and the transferred interests are not included in the parents' taxable estates, the future appreciation attributable to those interests generally belongs to the children's trusts rather than the parents. This can be particularly valuable for families who expect their real estate investments or family businesses to appreciate significantly over time.
The earlier an appropriate wealth transfer occurs, the greater the potential opportunity to shift future appreciation outside the senior generation's estate.
4. Providing an Additional Layer of Asset Protection
Asset protection is another important reason families consider establishing FLPs. Generally, assets properly owned by a limited partnership are legally distinct from assets owned individually by its partners.
If a limited partner experiences personal financial difficulties, a lawsuit, or a creditor claim, the creditor ordinarily cannot simply treat the partnership's underlying assets as the partner's individually owned property. Depending on applicable state law and the circumstances, a creditor's remedies may be limited to obtaining a charging order against the debtor-partner's transferable partnership interest.
A charging order generally gives the creditor rights associated with distributions that otherwise would be payable to the debtor-partner, rather than direct ownership or management rights over partnership assets.
However, these protections are not absolute. California law provides creditor remedies that can extend beyond simply receiving distributions in certain circumstances, and transfers made to hinder, delay, or defraud creditors can be challenged.
It is also important to understand that an FLP does not automatically protect partnership assets from liabilities arising from the partnership's own activities. For example, if the partnership owns rental real estate, claims arising from the operation of that property may still expose partnership assets to liability.
For this reason, families frequently combine FLPs with other planning strategies, including limited liability companies, appropriate insurance coverage, and irrevocable trusts.
5. Creating a Fair and Orderly Family Business Succession Plan
One of the more challenging issues facing family business owners is deciding how to treat children who work in the business compared with children who have chosen different careers. Parents often want to treat their children fairly, but fair treatment does not necessarily mean giving every child equal management authority.
An FLP can help separate the economic benefits of business ownership from the responsibility of managing the business.
For example, suppose a married couple owns a successful family business valued at $6 million. Their daughter has worked in the business for 15 years and is preparing to take over management. Their son is a physician who has no interest in operating the business. The parents want both children to share in the financial success of the company, but they recognize that their daughter should ultimately control its operations.
Through a properly structured FLP, the parents could transfer economic interests to both children while establishing a succession plan that allows the daughter to assume management responsibilities. The daughter could receive reasonable compensation for her actual work in the business, while both children benefit economically from their ownership interests.
The partnership agreement could also address future distributions, management succession, restrictions on transfers, and procedures for resolving disagreements. This type of planning can help reduce family conflict and preserve the business for future generations.
Who Should Consider a Family Limited Partnership?
FLPs are not necessary or appropriate for every family.
They are generally worth considering for individuals and families who:
- Own substantial investment real estate or a closely held family business.
- Have estates that may be subject to federal estate taxes.
- Want to begin transferring wealth to children or grandchildren while retaining appropriate management authority.
- Expect significant future appreciation in business or investment assets.
- Want to establish a structured succession plan for a family business.
- Have children who participate in the family business and others who do not.
- Want to combine business succession planning with multigenerational trust planning.
Family Limited Partnerships can be especially attractive for families with estates exceeding $15 million, depending on their circumstances, future appreciation, available estate tax exemptions, and other planning objectives. However, the costs of formation, annual tax filings, legal compliance, accounting, and periodic valuations must be weighed against the potential benefits.
At Geiger Law Office, P.C., we help California families develop sophisticated estate plans designed to protect, preserve, and transfer wealth to future generations. If your family owns substantial real estate, a closely held business, or other valuable assets, we invite you to reach out to us at (760) 448-2220 or at https://www.geigerlawoffice.com/contact.cfm to explore whether a Family Limited Partnership or another advanced estate planning strategies may be appropriate for your circumstances.
