What Is a Family Limited Partnership?

A family limited partnership (FLP) is a legal structure that families can use to hold, manage and transfer assets. An FLP can provide centralized control over family property and support estate planning, but its tax and asset protection benefits depend on how the partnership is structured and operated. Families considering an FLP should also account for formation costs, ongoing administration and IRS rules that can affect transfers of partnership interests.

A financial advisor can also help you determine whether an FLP or another legal structure is appropriate for your family.

How a Family Limited Partnership Works

A family limited partnership typically has two types of owners: general partners and limited partners. General partners manage the partnership and make decisions involving its assets. Limited partners hold economic interests in the FLP but generally do not participate in its management.

An FLP can own assets such as real estate, investments and interests in a family business. Parents or other senior family members may establish the partnership, contribute property and serve as general partners. They can then transfer limited partnership interests to children or other relatives over time.

This structure can allow one generation to transfer ownership interests while retaining responsibility for managing partnership property. However, transferring an interest does not automatically remove the underlying value from the transferor’s estate for federal estate tax purposes. Retained rights and continued personal use of transferred property can affect whether assets are included in the gross estate.

FLPs can also provide some protection from liabilities associated with limited partnership ownership, although the extent of creditor protection depends on state law and the circumstances. They should not be viewed as providing complete protection against creditors.

Establishing a Family Limited Partnership

Establishing an FLP requires creating a partnership under applicable state law and properly transferring assets into it. The specific process varies by state and by the assets involved.

Here are six common steps to creating one:

Choose partners: Identify which family members will serve as general partners and limited partners and determine their respective ownership interests.
Draft a partnership agreement: The agreement establishes management authority, ownership percentages, distributions, transfers of partnership interests and other operating rules.
Contribute assets: Property such as real estate, securities or business interests can be transferred to the partnership. Legal title should be transferred where required rather than simply treating the assets as though they belong to the FLP.
Value the assets: Appraisals may be needed to establish the fair market value of contributed property and partnership interests, particularly when interests will be transferred as gifts.
Formalize the FLP: Complete the formation requirements imposed by the state, which can include filing a certificate of limited partnership.
Maintain the partnership: Keep partnership records, follow the agreement and maintain appropriate separation between partnership property and personal assets.

The IRS specifically considers whether a family limited partnership was validly formed and funded under state law when examining estate and gift tax issues involving these entities.

Advantages of a Family Limited Partnership

A woman looks over the family limited partnership (FLP) agreement that her family has drafted.

FLPs can offer centralized asset management and a way to transfer interests in family property across generations. Potential advantages depend on the partnership agreement, state law and applicable federal tax rules.

Increased Control Over Assets

One reason families use FLPs is to separate ownership from management. General partners can retain authority over partnership decisions even after limited partnership interests have been transferred to other family members.

For example, parents could transfer limited partnership interests to their children while continuing to oversee investment or business decisions as general partners. The partnership agreement determines the authority associated with each type of interest.

Asset Protection

Limited partners generally are not personally liable for partnership obligations solely because they hold a limited partnership interest. Depending on state law, creditors of an individual partner may also face restrictions on accessing partnership property directly.

Those protections are not absolute. Creditor rights and remedies vary by jurisdiction and transferring assets to an FLP generally cannot be used to defeat existing legitimate creditor claims.

Tax Benefits

An FLP can be used to transfer partnership interests to younger generations through gifts or as part of an estate plan. These transfers are subject to federal gift and estate tax rules.

In some circumstances, a transferred limited partnership interest may have a fair market value below a proportional share of the partnership’s underlying assets because the interest lacks control or is difficult to sell. However, valuation discounts are not automatic. Sections 2701 through 2704 contain special rules affecting certain transfers of interests in family partnerships and other closely held entities.

An appraisal and careful documentation can be particularly important when a taxpayer claims a reduced value for a transferred partnership interest.

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How FLP Valuation Discounts Work

Valuation is one of the most important tax considerations when families transfer FLP interests. For federal gift and estate tax purposes, property generally must be reported at fair market value.

A limited partnership interest may be worth less than its proportional share of the assets held by the partnership. For example, a limited partner may lack authority to control investments, force distributions or liquidate partnership property. There may also be no readily available market where the interest can be sold. Those characteristics can support discounts for lack of control or marketability in appropriate circumstances.

The amount of any discount depends on the facts and cannot simply be selected by the family. Federal tax rules can also require certain partnership restrictions to be disregarded when valuing transfers among family members.

Families claiming a valuation discount generally need a defensible appraisal and records supporting both the value of the underlying property and the characteristics of the transferred partnership interest. The IRS can examine the partnership’s formation, funding, ownership and retained rights when reviewing the reported value.

Disadvantages of Family Limited Partnerships

FLPs can also create significant costs and administrative responsibilities. Families should weigh those requirements against the estate planning benefits they expect to receive.

Cost of Setup

Creating an FLP can involve attorney fees, appraisal costs, accounting expenses and state filing fees. Additional professional expenses may arise when assets are transferred or partnership interests are gifted.

The partnership also requires ongoing administration. Tax preparation, recordkeeping, valuations and legal work can make an FLP less practical for families whose assets do not justify the added expense.

Potential Family Conflicts

Separating management authority from economic ownership can create disagreements. Limited partners may have financial interests in the partnership while having little authority over investment decisions, distributions or sales of assets.

A detailed partnership agreement can establish procedures for distributions, transfers, management changes and disputes, but it cannot eliminate the possibility of conflict among family members.

Liquidity Issues

Assets placed in an FLP may be less readily accessible to individual family members. A limited partner generally owns an interest in the partnership rather than direct ownership of each asset held by it.

Selling a partnership interest may also be difficult, particularly when transfer restrictions apply or there is no active market for the interest. Families that expect substantial cash needs should consider how those expenses will be funded before transferring significant property to an FLP.

Tips for Starting a Family Limited Partnership

Because FLPs involve state partnership law as well as federal income, gift and estate tax rules, legal and tax advice can be important when establishing one. An estate planning attorney can draft the partnership agreement and address state requirements, while a tax professional can evaluate the consequences of contributions and subsequent transfers.

The partnership should have a legitimate structure that distinguishes general partners from limited partners. General partners manage partnership property, while limited partners generally hold economic interests without exercising the same management authority.

Families should also treat the FLP as a separate legal entity after it has been established. Assets intended for the partnership should actually be transferred to it, partnership records should be maintained and personal and partnership finances should remain appropriately separated. The IRS can examine whether property was legally transferred and whether a person continued to use or receive income from assets after placing them in the partnership.

A partnership agreement should address distributions, transfers of interests, management authority and what happens when a partner dies or becomes incapacitated. Families planning to transfer interests by gift should also keep valuation records and determine whether a federal gift tax return is required.

Bottom Line

A father and son look over their family limited partnership (FLP) agreement.

FLPs can give families a structure for managing shared assets and transferring ownership interests between generations while retaining centralized management. They can also involve valuation, gift and estate tax considerations that depend heavily on how the partnership is created and operated. Formation expenses, administrative requirements, family disagreements and limited liquidity can make the structure less suitable in some cases. Legal, tax and financial professionals can help evaluate whether an FLP fits a family’s estate and wealth transfer plans.

Estate Planning Tips

A financial advisor with estate planning expertise can be a valuable partner in this important but potentially complex process. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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