Overview
Family Limited Partnerships (FLPs) are a common estate- and succession-planning tool that lets families move economic ownership in assets (real estate, businesses, investments) to the next generation while keeping management authority with one or more senior family members. In my practice advising multigenerational families, FLPs are most useful when the goals include gradual transfers of wealth, centralized management of family assets, and a formal governance structure for successor generations.
This article explains how FLPs work, the tax and non‑tax tradeoffs, common pitfalls, setup steps, and when a different strategy may be better. It also links to related estate- and wealth-transfer topics on FinHelp.io for deeper reading.
(For official tax rules and current exclusion or exemption amounts, consult the IRS and a qualified tax or estate attorney; see sources at the end.)
How an FLP works — basic mechanics
- Formation: A senior family member or couple forms a limited partnership (an entity recognized under state law) and contributes assets—business interests, rental real estate, marketable securities, or other property—into the partnership.
- Partnership roles: The founders typically serve as general partner(s), retaining management authority and responsibility for partnership operations. Children and later generations receive limited partnership interests that carry economic rights but little or no management power.
- Gifting or sale of interests: The general partners transfer limited partnership units to heirs using lifetime gifts, sales (often coupled with promissory notes), or a mix. Transfers can be immediate or staged over years to use gift-tax exclusions and exemptions.
- Valuation discounts: Limited and non-managing interests are often valued lower than controlling interests because of restraints on marketability and lack of control. These valuation discounts can reduce reported gift or estate values, but discounts must be well documented and defensible.
Tax benefits — what FLPs can do and limits to expect
- Potential to reduce taxable estate: Because limited interests often receive discounts for lack of control and marketability, transferring those interests can reduce the size of the transferor’s taxable estate. However, discounts vary by asset type and the facts and circumstances of the partnership.
- Gift-tax planning: FLPs provide a vehicle to make repeated annual transfers (using the annual gift-tax exclusion) or larger lifetime transfers using the unified credit. Structured sales backed by adequate promissory notes can also shift future appreciation out of the transferor’s estate.
- Not a guaranteed tax shelter: The IRS scrutinizes transfers into FLPs when the substance suggests the transferor retained post-transfer benefits (e.g., continuing use of property without appropriate rents or payments) or when discounts are unsupported. Tax courts have reduced or eliminated discounts in some cases.
Authoritative guidance: For basic rules on gift and estate taxes see the IRS Estate and Gift Taxes pages (irs.gov) and consult current IRS publications for valuation and reporting requirements. IRS: Estate and Gift Taxes.
Control, liability, and governance
- Control retention: The general partner retains the legal power to manage assets, negotiate sales, sign leases, and make distributions. This is the primary reason many families choose FLPs—they preserve managerial control while economically shifting wealth.
- Liability: General partners often have personal liability for partnership obligations. To protect personal assets, families frequently form a corporate general partner or use limited‑liability entities to reduce personal exposure. State law differences matter—choose your formation state with counsel.
- Governance documents: The partnership agreement should clearly document decision‑making authority, buy‑sell provisions, distributions, valuation mechanisms, and successor procedures. A well-drafted agreement reduces family conflict and creates predictable pathways for later transitions.
Practical steps to set up an FLP (high level)
- Identify the assets to fund the FLP and determine whether those assets are easily valued and transferable (e.g., real estate deeds, business membership interests).
- Select the entity structure and jurisdiction (state partnership law and tax considerations).
- Draft the partnership agreement, including distributions, management rules, transfer restrictions, buy‑sell clauses, and valuation formulas.
- Fund the FLP and record transfers properly (titles, deeds, schedules).
- Use a staged gifting or sale plan that aligns with estate, income‑tax, and liquidity needs. Document appraisals and valuation methods every time interests are transferred.
- Maintain corporate formalities and annual documentation (minutes, partnership tax returns) to demonstrate that the FLP operates as a legitimate business entity and not a mere tax device.
In my practice, the single biggest area that triggers IRS challenges is poor documentation: undocumented transfers, inconsistent valuations, or use of the assets after transfer in ways that look like retained benefits.
Common pitfalls and how to avoid them
- Poor valuation support: Always obtain a contemporaneous, qualified appraisal for transferred interests and include a clear valuation methodology in the partnership records.
- Treating the FLP informally: Commingling funds, failing to hold regular meetings, or not maintaining separate accounts undermines the legal separation between partners and weakens tax positions.
- Underestimating state law or transfer taxes: Some states impose transfer or documentary taxes on certain real‑property transfers into partnerships. Review state rules first.
- Thinking an FLP eliminates all estate taxes: It can reduce taxable estate but does not remove tax exposure—especially if discounts are disallowed.
When an FLP is a good fit—and when it isn’t
Good fit:
- Families with illiquid or hard-to-value assets (family businesses, rental portfolios) where centralized management is useful.
- Situations where founders want to slowly transfer wealth while keeping operational control.
- Families that can document arm’s-length transactions, maintain corporate formalities, and afford regular valuations and legal advice.
Less suitable:
- Small estates where setup and ongoing legal/accounting costs exceed benefits.
- When heirs need immediate control of assets or the family prefers outright gifts or trusts for simplicity.
Alternatives and complementary strategies
- Irrevocable trusts (including dynasty or generation-skipping trusts) can combine tax benefits with creditor protection and clearer fiduciary duties.
- Grantor-retained annuity trusts (GRATs) and installment sales to intentionally defective grantor trusts (IDGTs) are strategies to shift future appreciation out of the estate.
- Life insurance owned in an irrevocable life insurance trust (ILIT) can provide liquidity for estate taxes without adding to taxable estate.
See our related FinHelp.io guides on broader estate issues and tax thresholds:
- Estate Planning: https://finhelp.io/glossary/estate-planning/
- Estate Tax Overview: https://finhelp.io/glossary/estate-tax-overview-thresholds-exemptions-and-planning-strategies/
- Transferring Real Estate to Family: https://finhelp.io/glossary/wealth-transfer-tax-basis-strategies-for-transferring-real-estate-to-family/
Example scenarios (illustrative)
- A family with rental property forms an FLP and transfers non-managing interests to children over several years while parents remain general partners and continue to manage leasing and maintenance. Proper appraisals and partnership records reduced estate exposure while keeping property management in experienced hands.
- Owners of a closely held business move ownership interests into an FLP and sell a minority block to a family trust financed by a promissory note. The structure separated voting control from economic return, which helped reduce estate valuation while preserving business continuity.
These are illustrations, not tax advice. Results depend on facts, state law, and current tax rules.
Frequently asked questions (brief)
- Will forming an FLP eliminate my estate tax? No. FLPs can reduce estate exposure through valuation discounts and staged gifting, but they don’t guarantee elimination of estate taxes and will attract IRS scrutiny if not properly structured.
- Do limited partners get distributions automatically? Not necessarily. Distributions follow the partnership agreement; limited partners may have economic rights but not management or guaranteed distributions.
- Can an FLP protect assets from creditors? An FLP can offer some creditor protections—particularly for future creditors of limited partners—but protections vary by state and the timing of transfers.
Professional tips
- Work with a multidisciplinary team — estate attorney, CPA, and valuation expert — before forming and funding an FLP.
- Budget for valuations and ongoing legal compliance; the preservation of tax advantages depends on up-to-date appraisals and consistent recordkeeping.
- Use clear, written partnership governance to reduce family disputes and to provide a defensible structure if the IRS or creditors inquire.
Closing and disclaimer
Family Limited Partnerships can be powerful for coordinating gifts and control across generations, but they are complex, fact‑sensitive arrangements that require skilled legal, tax, and valuation advice. The examples and guidance above are educational and illustrative only.
Professional disclaimer: This content is for general informational purposes and does not constitute legal, tax, or financial advice. Consult a qualified estate-planning attorney or tax advisor about your specific circumstances.
Sources and further reading
- IRS — Estate and Gift Taxes. U.S. Internal Revenue Service. https://www.irs.gov/ (search “estate and gift taxes” for current rules and annual amounts).
- Consumer Financial Protection Bureau — Wealth Management topics and consumer guidance: https://www.consumerfinance.gov/.
- Investopedia — Family Limited Partnership overview: https://www.investopedia.com/terms/f/family-limited-partnership.asp.
FinHelp.io related glossary pages:
- Estate Planning: https://finhelp.io/glossary/estate-planning/
- Estate Tax Overview: https://finhelp.io/glossary/estate-tax-overview-thresholds-exemptions-and-planning-strategies/
- Wealth Transfer — Tax Basis Strategies for Transferring Real Estate to Family: https://finhelp.io/glossary/wealth-transfer-tax-basis-strategies-for-transferring-real-estate-to-family/
(Updated 2025; confirm current dollar thresholds and filing requirements with the IRS and your advisors.)
