Overview

Family Limited Partnerships (FLPs) are intentionally structured partnerships family owners use to hold and manage assets such as real estate, family businesses, investment portfolios, and other property. The design separates management control (general partners) from economic ownership (limited partners), allowing older generations to keep decision-making authority while transferring value to heirs over time.

This article explains how FLPs work, the estate and tax opportunities they can create, practical implementation steps, common pitfalls, and when to consider alternatives. It draws on IRS guidance and professional practice considerations; it is educational and not a substitute for tailored legal or tax advice.

Sources: IRS business-entity guidance (see IRS.gov/businesses) and current gift/estate tax rules; always confirm current limits with the IRS (irs.gov).

Who typically forms an FLP and why

Families that commonly use FLPs share one or more of the following characteristics:

  • Significant illiquid assets (rental portfolios, operating businesses, farms, or closely held companies).
  • A desire to keep management centralized (often with parents or a senior generation).
  • Intent to transfer wealth gradually to children or grandchildren while reducing the taxable estate.
  • Concern about creditor risk, business continuity, or privacy in succession.

FLPs are not strictly limited to ultra-high-net-worth families—smaller family businesses and real-estate owners sometimes benefit—but the costs of setup, valuation, and professional advice mean FLPs are most cost-effective when substantial assets are involved.

Basic structure and roles

An FLP generally consists of:

  • General partner(s): Individuals (often one or both parents) or a corporate general partner that manages day-to-day activities and controls business decisions. General partners owe fiduciary duties and retain management authority.
  • Limited partners: Family members (children, grandchildren) who own partnership interests but do not manage operations. Limited partners have restricted control and limited liability for partnership debts.
  • Partnership agreement: The governing document that defines capital contributions, distributions, transferability of interests, buy-sell rules, voting rights, and dissolution terms. This agreement is central to demonstrating the partnership’s bona fide nature.

Documents should clearly reflect legitimate business or family governance reasons for the FLP—not merely tax avoidance.

How FLPs can help with estate and gift taxes

  1. Gift and estate tax planning via interest transfers
  • General partners can transfer limited partnership interests to heirs as gifts. Those transfers remove future appreciation of contributed assets from the donor’s taxable estate while allowing donors to retain control if structured properly.
  • Transfers may use the annual gift tax exclusion (amount adjusted by IRS annually) and, if appropriate, the donor’s lifetime gift/estate tax exemption. Always verify current IRS limits before planning (irs.gov).
  1. Valuation discounts
  • Limited partnership interests often trade at a lower value than an equivalent pro rata share of underlying assets because they lack control and marketability. Those ‘‘valuation discounts’’—for lack of control (minority interest) and lack of marketability—can reduce the gift tax value when interests are transferred.
  • Important: Discounts must be supported by credible, objective valuation work and realistic partnership terms. The IRS and tax courts scrutinize excessive discounts and any arrangement lacking economic substance.
  1. Freezing estate value
  • By moving future appreciation into the hands of limited partners (heirs) through gifts or sales of limited interests, the senior generation can ‘‘freeze’’ the taxable value of their own estate while allowing growth to accrue to the next generation.
  1. Liquidity and funding for taxes
  • Because FLPs concentrate assets, families can plan distributions or insurance strategies more efficiently to fund estate taxes or provide liquidity to pay expenses (see life insurance strategies). Consider pairing an FLP with appropriate liquidity planning.

Creditor protection and other non-tax benefits

  • Creditor protection: Limited partners generally cannot force distributions, and courts sometimes respect the protection that limited partnership status provides against creditor claims. This protection is fact-dependent and varies by state law.
  • Centralized management: General partners can preserve business continuity and avoid fragmented decision-making.
  • Privacy and probate avoidance: Holding assets inside an FLP can simplify transfers without public probate filings, depending on the asset and state rules.

These benefits are not absolute. Courts can look through entities that lack bona fide economic purpose or where transfers are sham transactions.

Implementation checklist (practical steps)

  1. Evaluate asset suitability. Illiquid or hard-to-value assets often present the strongest case for FLPs, but each asset class has its own considerations (leases, mortgages, business contractual terms).
  2. Choose the partnership form and state of formation. LLCs taxed as partnerships are common alternatives with similar planning mechanics; state law differences can be material.
  3. Draft a robust partnership agreement. Include clear governance, capital accounts, distribution rules, transfer restrictions, and buy-sell terms.
  4. Fund the partnership. Transfer title to the partnership for contributed assets with proper documentation and valuations.
  5. Obtain independent appraisals or qualified valuations. If you plan to gift interests, a contemporaneous valuation report prepared by a qualified valuation professional strengthens the position with the IRS.
  6. Make gifting or sale decisions. Use annual exclusion gifts to transfer small interests annually and consider using the lifetime exemption or intra-family loans/sales when appropriate.
  7. File required tax forms. Partnership returns (Form 1065) and K-1s for partners, and gift tax returns (Form 709) when gifts exceed annual exclusions. Consult a tax advisor to confirm current filing requirements.
  8. Review regularly. Revisit the agreement and valuations periodically, especially when family dynamics, regulations, or asset values change.

Common pitfalls and IRS scrutiny

  • Insufficient economic substance: The IRS challenges FLPs that are entitled only to tax benefits and lack legitimate business or family purpose.
  • Excessive valuation discounts: Large discounts without solid valuation support draw IRS attention and may be reduced in audit or litigation.
  • Poor documentation: Failure to follow partnership formalities (regular meetings, accounting, cash distributions) undermines the structure’s credibility.
  • Gift tax reporting failures: Not filing Form 709 when required or failing to properly document gifts can cause penalties.

To reduce audit risk, maintain thorough documentation, use independent appraisals, follow formalities, and work with experienced legal and tax professionals.

Real-world example (illustrative)

A family with a portfolio of rental properties contributed their holdings to an FLP and received 10% general partnership interests (parents) and 90% limited partner interests (heirs). Over several years, the parents gifted limited partnership interests using annual exclusion gifts and occasional larger gifts utilizing part of their lifetime exemption. Independent appraisals supported valuation discounts due to transfer restrictions and lack of marketability. Because management authority stayed with the parents as general partners, the family preserved control while moving expected appreciation outside the parents’ taxable estate. This is a simplified example; individual results vary and depend on valuation and legal compliance.

Alternatives and when to consider them

  • Grantor retained annuity trusts (GRATs) for highly appreciating assets with shorter-term planning horizons.
  • Intentionally defective grantor trusts (IDGTs) for certain estate-freezing techniques.
  • Revocable or irrevocable trusts for direct estate planning with different control and tax trade-offs.

Your advisor can compare trade-offs between FLPs and these alternatives based on liquidity needs, desired control, and tax objectives.

How professionals help

Attorneys draft the partnership agreement and ensure state-law compliance. CPAs and tax attorneys advise on tax reporting, valuations, and transactional timing. Accredited valuation experts prepare defensible appraisals for gift transfers. In my practice, combining legal drafting with independent valuations and disciplined administration significantly reduces audit risk and improves outcomes.

Further reading and related FinHelp guides

Practical tips — quick checklist

  • Always get an independent valuation before gifting partnership interests.
  • Keep partnership books, minutes, and regular distributions to support the entity’s legitimacy.
  • Avoid using an FLP solely as a vehicle to claim discounts—document legitimate non-tax business or family reasons.
  • Revisit plans annually; IRS rules and gift-tax limits change.

Disclaimer

This article is educational only and not legal, tax, or investment advice. Use this information as a starting point and consult a qualified estate planning attorney, tax advisor, and valuation professional before forming or transferring interests in a Family Limited Partnership.

Authoritative sources

(Last reviewed: 2025).