A Guide to Family Limited Partnerships
For families with substantial assets, protecting and efficiently transferring wealth across generations requires thoughtful planning and sophisticated strategies. One powerful tool that high net worth families use is the Family Limited Partnership (FLP). This structure may offer a unique combination of asset protection, income and estate tax efficiency, and family governance that can be particularly valuable for families with significant holdings in real estate and business interests.
Understanding Family Limited Partnerships
A Family Limited Partnership is a legal entity in which family members pool assets and hold them under a partnership structure. The partnership consists of two types of partners: general partners, who maintain control over management decisions and operations, and limited partners, who hold ownership interests but have no management authority or control.
Typically, parents or senior family members serve as general partners, retaining decision-making power over the partnership's assets. Children or other family members receive limited partnership interests, giving them an economic stake in the family's wealth without the ability to make unilateral decisions about asset management or disposition. This separation of control from ownership creates several strategic advantages that make FLPs an attractive option for wealth transfer and estate planning.
Who Should Consider a Family Limited Partnership?
FLPs are not appropriate for every family, but they can be particularly valuable for those in specific circumstances. Families with substantial estates—typically those exceeding multi-million dollars—who are concerned about estate tax implications often find FLPs beneficial. The structure works especially well for families holding assets that generate income, such as rental properties and business interests.
Families who own illiquid assets, including closely held businesses, commercial real estate, or agricultural land, may find FLPs particularly useful. These structures allow for gradual wealth transfer while maintaining centralized management of assets that require ongoing oversight and expertise. Additionally, families concerned about asset protection from potential creditors or litigation may value the protective features that FLPs can provide to limited partners.
Perhaps most importantly, FLPs work best for families committed to long-term wealth preservation and who are willing to observe the formalities and ongoing compliance requirements. The structure requires family members to act in accordance with legitimate business purposes rather than simply as a tax avoidance scheme.
Key Benefits and Considerations
The primary advantages of FLPs center around valuation discounts, centralized management, and asset protection. When transferring limited partnership interests to family members, these interests can often be valued at a discount compared to their proportionate share of the underlying assets. This occurs because limited partnership interests lack control (the holder cannot make management decisions) and lack marketability (they cannot easily be sold to outside parties). These discounts—which, depending on facts and circumstances, may be available in certain situations—allow families in some cases to transfer more wealth within their lifetime gift tax exemptions.
Centralized management represents another significant benefit. By keeping control in the hands of general partners, families ensure that assets are managed consistently and professionally, even as economic ownership gradually shifts to younger generations. This proves particularly valuable for complex assets like operating businesses or diverse real estate portfolios that require experienced oversight.
From an asset protection standpoint, limited partnership interests may, under certain circumstances, offer creditors limited recourse. If a limited partner faces a lawsuit or creditor claims, the creditor typically cannot seize partnership assets directly but may only obtain a charging order against distributions—and only if and when distributions are made. Your legal guidance from an experienced law firm is of utmost importance.
However, families must also consider the responsibilities and limitations that come with FLPs. The IRS scrutinizes these structures carefully, and courts have disallowed tax benefits when partnerships lack legitimate business purposes or when families fail to respect partnership formalities. The structure requires ongoing compliance, including maintaining separate bank accounts, holding regular partnership meetings, keeping detailed records, and avoiding commingling of personal and partnership assets.
The Setup Process and Professional Team
Establishing an FLP requires careful planning and the involvement of multiple professionals. The process typically begins with comprehensive planning sessions with your financial advisor, CPA, and estate planning attorney. During these meetings, you'll identify which assets to contribute to the partnership, determine the appropriate percentage of general and limited partnership interests, and establish the partnership's business purposes and operational guidelines.
Your estate planning attorney will draft the partnership agreement, which serves as the foundational document governing the FLP. This agreement specifies management authority, distribution policies, transfer restrictions, valuation procedures, and dissolution provisions. The attorney will also prepare the necessary formation documents required by your state and ensure compliance with securities laws if applicable.
A qualified appraiser plays a crucial role in establishing and documenting the value of contributed assets and the subsequent valuation of limited partnership interests. Proper valuation and documentation of applicable discounts are essential for defending against potential IRS challenges. Many families work with appraisers who specialize in business valuations and are experienced in partnership interest appraisals.
Your CPA or other tax advisor will guide you through the tax implications of formation and operation, prepare annual partnership tax returns (Form 1065), advise on gift tax reporting for transfers of partnership interests, and provide guidance on income distribution strategies. For families with significant real estate or business holdings, specialized advisors in those areas may also contribute their expertise.
Risks and Potential Pitfalls
While FLPs offer substantial benefits, several risks warrant careful consideration. The IRS has successfully challenged FLPs that appear to exist primarily for tax avoidance rather than legitimate business purposes. Courts have disregarded partnerships when families fail to respect partnership formalities, commingle assets, or when senior family members retain too much de facto control over assets they've purportedly transferred.
The three-year clawback rule presents another consideration: if the person who establishes an FLP dies within three years of transferring assets to the partnership, those assets may be pulled back into their estate for estate tax purposes. This makes early planning essential for maximizing estate tax benefits.
Families must also navigate complex family dynamics. Limited partners may grow frustrated with their lack of control, particularly if they disagree with management decisions or feel distributions are insufficient. Clear communication and a well-drafted partnership agreement that addresses potential conflicts are essential for long-term success.
Finally, changing tax laws create uncertainty. Estate tax exemptions and rates have fluctuated significantly over the years, and future legislative changes could impact the benefits of FLPs. While this uncertainty shouldn't necessarily deter families from implementing sound planning strategies, it does underscore the importance of flexibility and periodic review.
Is a Family Limited Partnership Right for Your Family?
FLPs represent powerful tools for wealth management, but they're not one-size-fits-all solutions. The structure works best for families with substantial, income-producing assets who are committed to long-term planning and willing to observe the necessary formalities and compliance requirements.
At Brickley Wealth Management, we work closely with families to evaluate whether an FLP aligns with their specific goals, assets, and family dynamics. Our integrated approach—combining financial advisory expertise with tax and accounting knowledge—allows us to provide comprehensive guidance throughout the planning, implementation, and ongoing management of these structures.
If you're interested in exploring whether a Family Limited Partnership might benefit your family's wealth management strategy, we invite you to schedule a consultation. Together, we can assess your unique circumstances and develop a plan that protects your legacy and serves your family's interests for generations to come.