Overview
A Family Limited Partnership (FLP) is a long-standing tool in U.S. legacy planning that combines centralized management, ownership transfer mechanics, and potential tax efficiencies. In practice, an FLP places family assets—real estate, a family business, marketable securities, or other investments—inside a partnership entity where one or more family members act as general partners (GPs) and others as limited partners (LPs). The GP controls day-to-day decisions and voting rights; LPs have economic interests but limited control.
I have worked with families who used FLPs to consolidate rental properties, transfer a closely held business interest, or create a governance framework for multigenerational ownership. When structured and documented carefully, FLPs can support orderly succession, protect assets from creditor claims, and enable gifting strategies that may reduce the taxable estate. However, FLPs require careful legal drafting and up-to-date tax analysis because the IRS scrutinizes transactions that appear primarily tax-motivated.
(For technical partnership tax rules, see the IRS guidance on partnerships: https://www.irs.gov/businesses/small-businesses-self-employed/partnerships.)
Background and evolution
FLPs became widely used in the 1970s–1990s as estate and gift tax planning gained profile among affluent families. Over the decades, courts and the IRS have clarified when discounts for minority interests and lack of marketability are acceptable, and when they should be disregarded. That history means outcomes depend on both the legal form (the partnership agreement and actions taken) and the economic substance (who controls assets and how they are used).
Key historical lessons:
- Formal governance matters: Courts often look to partnership agreements, required meetings, distributions, and documented transfers to determine whether an FLP is respected.
- Economic substance matters: The IRS may recharacterize gifts if LPs retain the practical ability to control assets or receive de facto benefits that undermine the stated ownership structure.
How an FLP is commonly structured
Typical elements of an FLP:
- General partner(s): Usually one or two trusted family members or a corporate GP. GPs manage assets, sign contracts, and make distributions. They usually assume unlimited liability unless a corporate GP or LLC serves as GP.
- Limited partners: Family members who receive limited partnership interests. They share in profits and losses but do not run daily operations.
- Capital accounts and partnership units: Interests are issued as partnership units or percent ownership. Transfers to heirs are usually done by gifting LP interests over time.
- Partnership agreement: A written document that sets voting rules, transfer restrictions, buy-sell terms, distribution policies, and how valuations are calculated.
Common operational features include periodic valuations, written distributions policies, required family meetings, and transfer restrictions to prevent unwanted third-party ownership.
Tax mechanics and valuation
One of the primary reasons families use FLPs is that partnership interests often sell or transfer at a discount compared with the pro rata value of underlying assets because limited interests lack control and marketability. That discount can reduce the value of gifts or estate inclusions when interests are transferred to family members, potentially lowering gift and estate taxes.
Important tax points:
- Gift and estate tax exemptions change over time; always check the current federal exclusion amounts on the IRS site before relying on numeric thresholds (https://www.irs.gov/). Many taxpayers combine annual exclusions and lifetime exemptions when transferring partnership interests.
- Valuation must be defensible. Use a qualified, independent business or real estate appraiser and document methodology (discounts for lack of control and marketability, comparable sales, income capitalization, etc.). The IRS will review appraisal quality when partnership interests are contested.
- Filing requirements: Large gifts of partnership interests may trigger Form 709 (U.S. Gift Tax Return). Partnership income and allocations require proper tax reporting at the partnership level (Form 1065) and K-1s to partners when required.
IRS scrutiny is real: discounts that are too aggressive or unsupported valuations often lead to audits and adjustments. The IRS has litigated cases where courts have disallowed or reduced claimed discounts when the partnership’s economic reality did not match the paperwork.
Governance, control and fiduciary duties
Merely labeling an arrangement an FLP is not enough. The partnership agreement should clearly state how decisions are made, how distributions and capital calls work, and how new participants are admitted or interests transferred. General partners owe fiduciary duties to limited partners; state partnership law commonly governs those duties unless the agreement modifies them within legal limits.
Practical governance steps I recommend:
- Maintain regular minutes and meeting records. That helps show the partnership operates as described.
- Follow the partnership agreement consistently — if distributions are supposed to follow a formula, apply it every year.
- Use independent valuations and advisors for significant transactions (related-party sales, buyouts, or gifting events).
Common uses of FLPs in legacy planning
- Structured gifting: Gradual gifting of limited interests over time to use annual gift exclusions and reduce the donor’s taxable estate.
- Business succession: Facilitate step-down of ownership while keeping management control with the senior generation.
- Asset protection: In some states, properly formed partnerships can provide limited protection from creditors of some partners (structure and state law matter).
- Family governance: A partnership agreement can create rules for buy-sell events and voting, reducing family disputes at transition points.
Limits, risks, and IRS challenges
- Recharacterization risk: If limited partners effectively control assets or if distributions contradict the stated economic rights, the IRS may recharacterize transfers.
- Valuation risk: Aggressive discounts without comparable market support invite challenges.
- State law and liability: General partners face potential personal liability unless the GP role is assigned to an entity (an LLC serving as GP is common to limit exposure).
- Operational burden and costs: Legal drafting, yearly valuations, tax filings, and governance can be costly. For smaller estates, these costs may outweigh benefits.
Alternatives to FLPs
FLPs are one of several tools for legacy planning. Alternatives or complements include:
- Family limited liability companies (LLCs) — similar economics but different governance rules (more flexible operating agreements and limited liability by default).
- Grantor retained annuity trusts (GRATs) and other trusts — useful for short-term wealth transfers with different tax profiles.
- Irrevocable trusts, including intentionally defective grantor trusts (IDGTs), for asset transfers while retaining certain tax attributes.
Choosing among these tools depends on asset types, family dynamics, and tax objectives. In my practice, I evaluate both FLPs and LLCs side-by-side because many families can use either form; the difference often comes down to desired governance language and state law effects.
Setup checklist (practical steps)
- Inventory assets to move into the FLP (real estate, business interests, securities).
- Consult estate planning counsel and a tax advisor experienced with FLPs. Consider appointing outside counsel for valuation disputes.
- Decide the GP/LP split and whether an entity will serve as GP to limit personal liability.
- Draft a detailed partnership agreement that sets transfer restrictions, distribution formulas, meeting schedules, and valuation procedures.
- Obtain independent valuations and maintain appraisal files.
- Execute formal transfers and file required gift tax returns (Form 709) when appropriate.
- Operate the partnership according to its terms, document meetings and distributions, and conduct periodic valuations.
Practical examples (anonymized patterns from practice)
Example A: Real estate consolidation. A family with multiple rental homes moved the properties into an FLP and gifted 10% limited interests annually to adult children. Because LP interests had transfer restrictions and no management power, annual gift values used a modest marketability discount. This allowed multiyear estate reduction while the senior generation retained control as GP.
Example B: Closely held business transition. An entrepreneur transferred minority LP interests to adult children and used buy-sell terms inside the partnership agreement to force a future valuation and purchase if one sibling wanted to exit. That provided a predictable path for transfers and reduced conflict.
Each example required clean documentation, independent valuation, and consistent operation to withstand potential IRS or family disputes.
Common mistakes and how to avoid them
- Treating the FLP as a paper exercise. Prevention: Operate the partnership actively and document decisions.
- Skimping on valuations. Prevention: Hire a credentialed appraiser and retain the report.
- Ignoring state law or liability exposure. Prevention: Consider an LLC as GP, confirm state partnership statutes, and review creditor protection rules.
How to decide if an FLP is right for you
An FLP makes the most sense when:
- You have significant illiquid assets (real estate, a business) to centralize.
- You want to pass value gradually to heirs and potentially use valuation discounts.
- You need a governance framework to manage a multigenerational business or asset pool.
It is less likely to make sense when assets are small, highly liquid, or when the cost of administration outweighs potential tax benefits.
Key resources and further reading
- IRS page on partnership tax rules: https://www.irs.gov/businesses/small-businesses-self-employed/partnerships
- Consumer Financial Protection Bureau — basic estate planning resources: https://www.consumerfinance.gov/consumer-tools/estate-planning/
- FinHelp glossary pages: Family Limited Partnerships: Estate Planning Uses and Pitfalls, Valuing Private Company Interests for Gifting and Estate Planning, and Essential Estate Planning Documents Everyone Should Have — these articles provide complementary, practical checklists for estate documentation and valuations.
Professional tips (from practice)
- Use neutral third parties for valuation and dispute resolution clauses to reduce family friction.
- Keep distributions consistent with the partnership agreement; deviations are often the first sign the IRS uses to challenge form over substance.
- Periodically review the FLP with counsel — tax laws and family dynamics change.
Disclaimer
This article is educational and does not provide individualized legal, tax, or investment advice. FLPs raise complex tax and liability issues; consult a qualified estate planning attorney and a tax advisor before implementing any strategy. Always confirm current federal gift and estate tax exclusion amounts and filing requirements with the IRS (https://www.irs.gov/) and your tax professional.
Short FAQ
Q: Will an FLP eliminate estate taxes?
A: No. An FLP can reduce estate tax exposure by transferring interests at discounted values, but it does not eliminate tax obligations and may prompt IRS review.
Q: Can limited partners sell their interests?
A: Usually transfer restrictions are written into the partnership agreement; sales to outsiders are often limited or prohibited without GP approval.
Q: How often should valuations be updated?
A: At least when material transactions or gifting events occur; many families do periodic valuations every 1–3 years depending on asset volatility.
(Prepared by a senior financial editor providing general guidance. For specific advice, consult licensed professionals.)
