Overview

Family Limited Partnerships (FLPs) are structured partnerships created to hold family assets—real estate, business interests, investment portfolios, or marketable securities—while giving senior family members continuing management control. FLPs are used to transfer economic value to younger generations without surrendering day-to-day decision-making. They can produce estate planning, asset protection, and tax-planning benefits when properly formed and managed (IRS; estate planning practice guides).

This article explains how FLPs work, when they make sense, critical tax and valuation issues, setup steps, common pitfalls, and practical compliance guidance. It also points to complementary strategies (for example, trusts and LLCs) where an advisor’s guidance is important.

How an FLP is structured and how it works

An FLP typically has two classes of partners:

  • General partners (GPs): one or more family members (often the senior generation) who run the partnership, make investments and distributions, and control the business or asset management.
  • Limited partners (LPs): family members who own partnership units but do not have management authority. LP interests are often transferred to heirs as gifts.

The senior generation contributes assets (for example, rental real estate or closely held business shares) to the FLP in exchange for partnership interests. Over time, the GPs can gift limited partnership interests to heirs. Those gifted LP interests usually carry valuation discounts for lack of control and marketability—reducing the value of the gifted interest for gift‑tax and estate‑tax purposes when the discounts are reasonable and defensible.

Key economic and control features:

  • Economic ownership vs. control: LPs receive economic benefits (income, appreciation) but not managerial authority.
  • Discounting: Limited, non‑controlling interests can be valued lower than pro rata ownership because of restrictions in the partnership agreement (lack of control, transfer limitations).
  • Succession planning: GPs retain control during life; on death, careful drafting and complementary planning determine how management shifts.

Why families use FLPs (benefits)

  • Control: Parents or senior family members usually remain GPs and keep decision authority.
  • Wealth transfer with tax considerations: Gifting LP interests uses annual exclusion amounts and can leverage lifetime exemptions; discounts may reduce reported taxable gift value (subject to IRS review).
  • Creditor protection: Creditors of an individual LP may find it harder to reach partnership assets because of transfer and redemption rules in the partnership agreement (state law dependent).
  • Centralized management: An FLP consolidates family assets under a single governance document and distribution rules.

These potential benefits are attractive, but they require careful execution and professional documentation.

Tax and valuation considerations (what to watch for)

  1. Gift and estate tax rules: Transfers of partnership interests are gifts for gift‑tax purposes. Families must follow gift‑tax reporting rules and consider annual exclusions and lifetime exemption amounts (check current figures with the IRS; limits are adjusted periodically) (IRS).

  2. Valuation discounts: Discounts for lack of control and marketability are common, but aggressive discounts invite IRS scrutiny. Proper appraisals and defensible valuation methodologies are essential.

  3. Income taxes: The FLP is typically a partnership for income‑tax purposes; income flows through to partners and is reported on Schedule K‑1. Ensure tax allocations and basis tracking are accurate.

  4. Transfer restrictions and formalities: The partnership agreement should impose legitimate restrictions on transfers and distributions; these are part of the factual basis for discounts. Courts and the IRS will review whether the partnership is a genuine business entity or a device solely for tax avoidance.

  5. Step‑up in basis: At a partner’s death, estate tax rules and the partnership’s documents affect whether built‑in gains receive a step‑up in basis; interplay with other estate planning vehicles matters.

Set up: practical steps and documentation

  1. Choose the entity form and state: Form the partnership under the state law where assets are located and consider filing and franchise tax consequences.
  2. Draft a robust partnership agreement: Define capital contributions, distributions, valuation processes, restrictions on transfers, management authority, buy‑sell provisions, and dissolution terms.
  3. Capitalize the FLP: Transfer assets into the FLP with appropriate deeds, assignments, and title transfers, plus careful consideration of triggering taxes (e.g., transfer taxes on real estate).
  4. Obtain valuations: For gifts, obtain a qualified independent appraisal to support valuations and discounts.
  5. Perform gift‑tax reporting: File Form 709 when required and keep clear records of gifts, valuations, and related appraisals.
  6. Maintain records and governance: Hold partnership meetings, issue K‑1s, record decisions, and respect entity formalities to support the FLP’s legitimacy.

Common mistakes and red flags (and how to avoid them)

  • Treating the FLP as a tax dodge: The IRS challenges arrangements that are thinly capitalized, lack genuine restrictions, or where GPs benefit personally without genuine partnership conduct. Maintain genuine business purpose and documentation (IRS audits of FLPs are well documented).
  • Poor valuation support: Using unsupported or exaggerated discounts is a top audit trigger. Use qualified valuation professionals and document assumptions.
  • Neglecting governance: Failing to hold meetings, mixing personal and partnership funds, or ignoring the partnership agreement can lead courts or tax authorities to disregard the FLP.
  • One‑size‑fits‑all templates: Every family’s assets, state law, and goals differ. Customize agreements and integrate FLPs into the larger estate plan.

When an FLP makes sense — and when it doesn’t

Good candidates:

  • Families with concentrated assets that can be centralized (real estate portfolios, closely held business, marketable investment blocks).
  • Families seeking controlled, multigenerational transfers where senior family members want to continue managing assets.
  • Situations where creditor protection and centralized governance are valuable.

Poor candidates:

  • Small estates where the setup and maintenance costs outweigh benefits.
  • Families needing liquid, marketable interests for heirs who prefer direct ownership.
  • Cases where heirs need active roles immediately and management control shouldn’t be concentrated.

Interplay with trusts and other vehicles

FLPs are often used alongside trusts and limited liability companies. Two helpful FinHelp resources that explain complementary options are:

Use trusts to address step‑up in basis, liquidity for taxes at death, or to set spendthrift protections. An FLP’s documents should harmonize with trust terms to avoid conflicts at funding or on death.

Realistic example (illustrative)

A family with rental properties forms an FLP. The parents contribute title to several rentals and hold GP interests; they gift annual limited partnership interests to their adult children over several years. Because the LP interests include restrictions on transfer and no voting power, appraisers apply reasonable discounts. The parents maintain management as GPs; the children receive rental income allocations and eventually inherit a larger share after staged succession planning. The family documents everything—valuations, partnership meetings, and tax filings—to withstand scrutiny.

Compliance, ongoing management, and exit strategies

  • Annual tax filings: Partnerships file Form 1065; partners receive K‑1s. Stay current with partnership tax rules.
  • Periodic valuations: Revalue illiquid assets on major transfers or material changes in the business.
  • Buy‑sell and redemption clauses: Draft exit mechanics so a remaining GP can buy out heirs or the partnership can redeem units on specified terms.
  • Review with estate counsel: Revisit the plan after major life events (divorce, death, significant changes in tax law).

Practical tips from practice

  • Work with a team: Use estate attorneys, qualified appraisers, and tax advisors experienced with FLPs.
  • Keep capital and distributions consistent with partnership documents to avoid piercing arguments.
  • Consider staged implementation: Small initial gifts with strong documentation reduce audit risk and let the strategy scale.
  • Use the annual gift tax exclusion where appropriate; combine with lifetime planning when needed.

Frequently asked questions (short answers)

Q: Will the IRS disallow my valuation discounts? A: The IRS can challenge discounts; proper appraisals and credible business purpose reduce risk.

Q: Are FLPs the same as Limited Liability Companies (LLCs)? A: They’re different legal entities. FLPs are partnerships with GP/LP roles; LLCs offer member limited liability and flexible management. Both can be used together; consult counsel (see FinHelp’s article on LLCs and trusts).

Q: Do FLPs eliminate estate taxes? A: Not automatically. FLPs can reduce taxable estate value through gifting and discounts—if properly executed—but they don’t guarantee the elimination of estate taxes.

Checklist before you form an FLP

  • Confirm strategic goals (control, creditor protection, transfer timing).
  • Inventory transferable assets and check title/transfer tax consequences.
  • Obtain an independent valuation of illiquid assets.
  • Draft a detailed partnership agreement and ancillary documents.
  • Plan for gift‑tax reporting and ongoing partnership tax compliance.

Professional disclaimer

This article is educational and does not substitute for individualized tax, legal, or financial advice. Where federal tax rules are referenced, current limits and forms change over time—confirm the latest information with the IRS or your tax advisor before acting (IRS). Consult experienced estate planning counsel before implementing an FLP.

Sources and further reading

  • Internal Revenue Service, guidance on estate and gift taxes (see IRS.gov for current exemption and filing rules).
  • State statutes and case law on partnerships and creditor protection.
  • Professional valuation and appraisal literature on discounts for lack of control and marketability.
  • Related FinHelp articles: Leveraging Grantor Trusts for Estate Tax Efficiency and How to Use LLCs and Trusts for Asset Protection.

(Author: Senior Financial Content Editor, FinHelp.io)