Overview
A Family Limited Partnership (FLP) lets family members place assets—real estate, privately held business interests, investment portfolios, or other property—into a partnership where control and ownership are split between general partners and limited partners. The senior generation usually acts as the general partner(s) to manage assets, while children or other family members receive limited partnership interests as gifts or sales. This structure can simplify family governance and support multi-generational wealth transfer.
In my practice advising families for over 15 years, FLPs have succeeded when used with clear family governance, up-to-date valuations, and professional legal and tax oversight. Where they fail is almost always linked to poor documentation, unsupported valuation discounts, or ignoring evolving family dynamics.
(For IRS guidance and the agency’s position on FLPs and valuation issues, see IRS information on family limited partnerships: https://www.irs.gov/.)
Why families consider an FLP
- Centralized management: Parents or senior family members can manage investments and business operations through the general partner role without transferring full control.
- Controlled wealth transfer: Limited partnership interests can be given or sold to heirs over time, allowing gradual transfers that may use gift tax exemptions or annual exclusions.
- Potential valuation discounts: Limited, non-controlling interests can be worth less than the pro rata share of the underlying asset because of lack of control and limited marketability—discounts that can lower reported transfer values when gifts are made. However, these discounts are scrutinized by the IRS and must be supported by credible appraisals and documentation.
- Estate administration efficiency: Holding family assets in a single partnership often streamlines accounting, tax filings, and succession planning.
Common estate-planning objectives for FLPs
- Reduce the taxable estate value passed at death by transferring limited interests to heirs.
- Keep decision-making centralized while moving economic ownership to beneficiaries.
- Protect family assets from third-party creditors to a limited extent (dependent on state law and timing).
How an FLP is typically structured
- General Partner(s): Usually one or more senior family members or a corporate general partner who retain management authority and personal liability (or the entity reduces personal exposure).
- Limited Partner(s): Heirs or other family members who hold economic interests but do not control day-to-day management. Their liability is generally limited to their investment.
- Partnership Agreement: The governing document that specifies management powers, distribution rules, transfer restrictions, valuation gates, buy-sell provisions, and dissolution terms.
Practical steps to set up an FLP
- Inventory assets appropriate for contribution (illiquid assets such as rental real estate or family business interests are common candidates).
- Choose the entity form and jurisdiction. Many advisors recommend forming an FLP under state law with favorable partnership statutes and predictable case law.
- Draft a detailed partnership agreement that documents management authority, capital accounts, distributions, transfer restrictions, and procedures for gifts/sales to family members.
- Obtain independent, well-supported valuations before making gifts or sales of partnership interests.
- Make transfers with clear gift documentation and consider whether transfers should be structured as gifts, installment sales, or a combination (each has different tax consequences).
- Maintain corporate formalities, separate records, bank accounts in the partnership’s name, and annual meetings/minutes to prevent recharacterization risks.
Key tax and valuation issues (and IRS scrutiny)
- Valuation discounts: Courts and the IRS often dispute claimed discounts for lack of control and marketability if valuations are not supported by objective evidence (independent appraisals, comparable transactions, or accepted valuation methodologies).
- Recharacterization risk: The IRS may challenge a transaction if the partnership wasn’t a legitimate business purpose or if the partnership agreement and operations don’t reflect the claimed economic arrangement.
- Gift and estate tax reporting: Transfers of partnership interests are reportable, and improper reporting or undervaluation can lead to penalties, adjustments, and interest.
- Income tax consequences: Contributing appreciated property to an FLP can trigger built-in issues if future sales occur; tax-efficient planning requires anticipating future transactions and how the partnership will be taxed.
Authoritative resources: IRS guidance and examples can be found at the IRS website (https://www.irs.gov/). For practical overviews, see Investopedia and Nolo for consumer-facing summaries (https://www.investopedia.com/, https://www.nolo.com/).
Pitfalls and when FLPs backfire
- Inadequate documentation: A shaky partnership agreement, informal transfers, or commingled accounts invite IRS audits and potential partnership reclassification.
- Overreliance on discounts: Discounts are fact-specific and often challenged. A strategy that assumes large, guaranteed discounts without back-up appraisal is risky.
- Timing and creditor attacks: Transfers executed when litigation or creditor threats are reasonably foreseeable can be set aside under fraudulent transfer rules.
- Loss of step-up in basis: Gifting appreciated assets away from the eventual decedent can reduce the potential step-up in basis on death, increasing future capital gains taxes for heirs.
- Family conflict: Unequal control or lack of clarity about distributions and responsibilities often leads to disputes, which can destroy the intended benefits of an FLP.
When an FLP makes sense (and when it doesn’t)
Consider an FLP when: you have concentrated, illiquid family assets (commercial real estate, a family business, or a large investment portfolio); you want to centralize management; and you’re prepared to maintain formalities and documentation. It is less useful when assets are liquid and small in value, family relationships are fragile, or when the main goal is simple creditor protection—other structures (trusts, LLCs, insurance) may perform better.
For a broader comparison of entity choices in estate and asset protection planning, see our Entity Selection Roadmap (https://finhelp.io/glossary/entity-selection-roadmap-when-to-use-an-llc-corporation-or-trust/).
Practical tips and a short checklist
- Use independent valuation firms before making transfers; keep valuation reports in your file.
- Draft a partnership agreement that reflects real business reasons and economic substance, not just tax benefits.
- Observe formalities: separate bank accounts, regular meetings, minutes, tax filings, and consistent management actions.
- Phase transfers over time to use available exemptions and to observe whether the structure holds up under operational scrutiny.
- Coordinate FLP planning with estate plans (wills and trusts) to align beneficiary designations, successor management, and liquidity needs. See our primer on wills vs. trusts for coordinating estate documents (https://finhelp.io/glossary/wills-vs-trusts-which-do-you-need/).
Alternatives and complementary structures
- Limited Liability Companies (LLCs) can achieve many of the same management and transfer goals as FLPs and may offer liability advantages with simpler formalities in some states.
- Irrevocable trusts (including generation-skipping trusts or Grantor Retained Annuity Trusts) are alternatives for wealth transfer with different tax and creditor profiles.
- Life insurance, buy-sell agreements, and properly funded family trusts often complement FLPs in a broader estate plan.
Explore how trusts can be used alongside entity structures for asset protection in our guide to using trusts for asset protection (https://finhelp.io/glossary/using-trusts-for-asset-protection/).
Examples (anonymized, based on common practice)
- Sibling business transfer: Parents place a small family business into an FLP, contribute management shares to a general partner corporation they control, and gift limited partnership interests to children over several years, reducing estate exposure and keeping operational control centralized.
- Real estate holding: An FLP receives rental properties; parents retain general partner control while transferring limited interests to children. The partnership manages rentals, reinvests cash, and distributes income according to the agreement.
Each example required independent appraisals, clear documentation, and annual reviews to avoid IRS challenges.
Questions to ask your advisor before forming an FLP
- What business purposes beyond tax savings justify the FLP?
- Who will serve as general partner(s), and how will liability be managed?
- How were valuation discounts calculated, and who performed the appraisal?
- How will distributions, capital accounts, and buy-sell events be handled?
- What state law governs the partnership and how might that affect creditor protection and partnership governance?
Final takeaways
Family Limited Partnerships can be powerful estate-planning tools when used for the right assets, with strong documentation, and coordinated legal and tax advice. They can centralize management and enable gradual transfers to heirs, but discounts and asset protection claims are frequently contested, and poor execution can lead to more tax and conflict than benefit.
This article is educational and does not substitute for personalized legal, tax, or financial advice. Consult a qualified estate planning attorney and tax advisor before forming or transferring assets into an FLP.
Sources and further reading
- IRS — Family Limited Partnerships and guidance (https://www.irs.gov/).
- Investopedia — Family Limited Partnership overview (https://www.investopedia.com/).
- Nolo — Family Limited Partnerships (https://www.nolo.com/).
- FinHelp: Entity Selection Roadmap (https://finhelp.io/glossary/entity-selection-roadmap-when-to-use-an-llc-corporation-or-trust/).
- FinHelp: Using Trusts for Asset Protection (https://finhelp.io/glossary/using-trusts-for-asset-protection/).
