Using Family Limited Partnerships for Asset Protection and Control

Quick overview

A Family Limited Partnership (FLP) is a common estate‑planning entity that groups family assets under one partnership. The general partner (GP) manages the assets and makes decisions; limited partners (LPs) hold financial interests without day‑to‑day control. Used correctly, an FLP can help protect assets from some creditor claims, permit structured gifting to younger generations, and maintain centralized management of family wealth.

This article explains how FLPs work, what they can and can’t do, the key tax and regulatory issues to watch, and practical steps to set one up properly.

Why families use FLPs

• Asset consolidation: Put real estate, privately held business interests, investment accounts, and other family assets into one legal vehicle to simplify management.
• Control: The GP role lets one or a few family members retain decision‑making authority while passing economic benefits to others.
• Creditor protection: Because limited partners have no management control, creditors generally cannot seize partnership assets to satisfy a claim against an LP’s personal obligations, subject to exceptions described below.
• Estate‑planning and gifting: Transferring limited partnership interests to children or trusts can reduce estate tax exposure when legitimate valuation discounts apply.

These advantages are the reason FLPs are used alongside other tools such as trusts or family LLCs. See our guide on Essential Estate Planning Documents Everyone Should Have for complementary documents and how an FLP fits in a broader plan.

How an FLP actually provides protection and control

1. Separation of ownership and control: The GP controls operations; LPs hold cash flow and capital interests but cannot control management. That separation is central to the protection FLPs offer.
2. Charging order protection: In many states, a creditor’s remedy against an LP is limited to a charging order—a lien against distributions—rather than forcing a sale of partnership assets. That preserves the partnership’s continuity and makes assets less attractive targets for collection.
3. Concentration and oversight: Consolidating family assets makes it easier to apply consistent investment policy, professional management, and succession rules.

Important: charging order protection and creditor remedies vary by state and sometimes by the type of creditor. Courts have ordered different outcomes depending on facts. FLPs are not a universal shield against legitimate claims such as taxes, fraud, or piercing the partnership veil.

Tax and reporting basics (what to expect)

• Partnership taxation: An FLP is usually taxed as a partnership and files Form 1065 annually. Each partner receives a Schedule K‑1 showing their share of income, deductions, and credits (IRS, Instructions for Form 1065).
• Gift and estate tax planning: When you gift limited partnership interests to heirs, valuation discounts for lack of control and marketability often reduce the taxable value of the gift. However, discounts must be reasonable and well‑documented—discounts that look contrived will attract IRS scrutiny.
• Income allocation: Income allocated to partners flows through to their individual returns; operating agreements should clearly state allocation methods to avoid disputes.

Reference: IRS instructions for Form 1065 explain partnership reporting requirements and partner statements (IRS, Instructions for Form 1065, https://www.irs.gov/instructions/i1065).

Common structures and roles

• General partner(s): Run day‑to‑day operations and have fiduciary duties to the partnership. Often parents or senior family members.
• Limited partners: Receive income and capital appreciation but have limited voting or management powers. Often children or trusts for descendants.
• Manager or advisor roles: Families commonly name a paid manager, bank, or corporate GP if they prefer an arm’s‑length governance layer.

Many families choose a limited liability company (LLC) as the GP to limit personal exposure of the managing family members.

Setting up an FLP: practical steps and best practices

1. Identify appropriate assets: Concentrated real estate, privately held businesses, and illiquid investments are top candidates. Avoid placing assets with unrelated creditor exposure or regulatory problems into an FLP.
2. Choose the right entity documents: Draft a clear partnership agreement that sets distributions, decision authority, transfer restrictions, buy‑sell rules, and valuation processes.
3. Use independent valuations: Get appraisals for complex or illiquid assets before making gifts. Independent valuation reports support discount claims and show a good‑faith approach to compliance.
4. Observe formalities: Hold periodic meetings, document distributions and management decisions, and treat the partnership as a separate entity to preserve legal protections.
5. Coordinate with tax and legal advisors: Work with a CPA and an estate‑planning attorney to align your FLP with federal tax rules and state partnership laws.

In my practice, clients who follow these steps avoid many post‑transfer disputes and reduce the chance that courts will ignore the partnership form.

Risks, limits, and common pitfalls

• IRS and tax‑court challenges: The IRS can challenge abusive discounts or transfers lacking a bona fide business purpose. Valuations must be defensible and supported with contemporaneous appraisal reports.
• Piercing the partnership veil: If GPs use the partnership as an alter ego—commingling assets, ignoring formalities, or diverting funds—courts may pierce the veil and hold individuals liable.
• State law variation: Creditor protection and charging‑order rules differ by state. Some states offer strong protection for LLCs but weaker protections for partnerships; choose structure and jurisdiction carefully.
• Liquidity constraints: Limited partners often can’t force distributions. This illiquidity must be understood before gifting interests to family members who may need cash.
• Not hurricane‑proof: FLPs don’t protect against every liability—tax liabilities, criminal judgments, or obligations arising from fraud are not avoided simply by using an FLP.

Practical examples and when an FLP is a good fit

Good fit:

• A family with several rental homes wants centralized management and an orderly succession plan.
• A business owner transferring minority economic interests to children but retaining voting control.
• A family consolidating low‑risk investments and real property for easier management.

Poor fit:

• Individuals with minimal assets or primarily liquid investments who need immediate access to cash.
• Situations where the primary goal is to hide assets from legitimate creditors—this is illegal and ineffective.

A case I handled involved a family who transferred vacation rentals into an FLP, retained GP control, and gradually gifted limited interests to children. Proper appraisals and careful documentation prevented valuation disputes and reduced estate exposure without sacrificing family governance.

Checklist before you form an FLP

• Inventory and appraise assets you plan to contribute.
• Confirm state law on charging orders and creditor remedies.
• Draft partnership agreement with clear governance and buy‑sell provisions.
• Obtain independent valuations for gifts and document business purposes.
• Set a schedule for annual meetings, distributions, and recordkeeping.
• Coordinate trust, will, and beneficiary documents with the FLP strategy.

For how the FLP fits with other estate documents, see Essential Estate Planning Documents Everyone Should Have.

When to consult professionals

Use an FLP only after you’ve consulted both an estate‑planning attorney and a tax professional familiar with partnership law and valuation. If you already have an estate plan, an annual review can confirm whether an FLP still makes sense; see our Estate Planning Checkup: Documents to Review Every Five Years for timing guidance.

Final thoughts

FLPs are a useful tool for families who need centralized control, want to plan gifts to the next generation, and are comfortable with the governance and liquidity tradeoffs they create. The benefits depend on careful drafting, independent valuations, honest business purpose, and diligent recordkeeping. Done correctly and coordinated with other estate‑planning tools, an FLP can reduce friction in succession and add a meaningful layer of protection.

Professional disclaimer: This article is educational and does not constitute legal or tax advice. Before forming an FLP or making gifts, consult a qualified estate‑planning attorney and a tax advisor.

Selected authoritative sources

• IRS, Instructions for Form 1065 and Schedule K‑1 (partnership reporting): https://www.irs.gov/instructions/i1065
• Nolo, Family Limited Partnerships for Asset Protection: https://www.nolo.com/legal-encyclopedia/family-limited-partnerships-asset-protection-30247.html
• Investopedia, Family Limited Partnership: https://www.investopedia.com/terms/f/family-limited-partnership.asp

Other related FinHelp resources:

• Family Limited Partnerships: Estate Planning Uses and Pitfalls — https://finhelp.io/glossary/family-limited-partnerships-estate-planning-uses-and-pitfalls/
• Essential Estate Planning Documents Everyone Should Have — https://finhelp.io/glossary/essential-estate-planning-documents-everyone-should-have/