Some of the hardest decisions a family can make involve the handling of money, property and other investments. A good answer for these difficult questions, particularly for families with considerable real estate holdings, is to establish a Family Limited Partnership (FLP). When used properly, an FLP can be profitable and save families thousands of dollars in gift and estate taxes. FLPs provide protection from creditors and flexibility not found in other trusts, since it can be amended or changed.

What is an FLP?

An FLP is a limited partnership controlled by members of one family; like other limited partnerships, an FLP has of two types of partners: general and limited. General partners control management and investment decisions and bear 100% of the liability. Limited partners cannot participate in the management of the FLP and have limited liability. The partnership itself isn't taxable. The owners of a partnership report the partnership's income and deductions on their personal tax return, in proportion to their interests.

In an FLP, generally, senior family members (parents or grandparents) contribute assets in exchange for a small general partner interest and a large limited partner interest. They can then give all or a portion of the limited partner interest to their children and grandchildren. This interest can go to the heirs directly, or be set aside in another trust.

Benefits of an FLP

Transferring limited partnership interests to family members shrinks the taxable estate of senior family members. When the value of the asset is transferred to their children, the senior family members remove it from their estates for tax purposes, while retaining control over the decisions and distributions of the investment. Since limited partners cannot control investments or distributions, they may be eligible for valuation discounts at the time of transfer.

Transfers of limited partnership interests are eligible for the annual gift tax exclusion, a powerful tool for reducing income, gift and estate taxes. According to law, the value of limited partnership shares can be discounted when transferred to family members. In addition, because of an FLP's flexibility, family member owners can usually amend the partnership agreement as family circumstances change.

An FLP protects assets from claims of future creditors and spouses of failed marriages. Creditors may not force cash distributions, vote, or own the interest of a limited partner without the consent of the general partners. In the event of a divorce, causing a limited partner to cease being a family member, the partnership documents can require a transfer back to the family for fair market value, keeping the asset within the family structure.

By combining investments together into an FLP, a family's investment fees are significantly reduced. Instead of maintaining separate brokerage accounts or trusts for each child, the partnership can hold one brokerage account, and children or trusts for children can own partnership interests.

How Do I Begin?

An FLP must be structured with both the present and future owners in mind, protecting the generations of today and tomorrow. To begin the FLP process, a written limited partnership agreement must be prepared. Once the agreement is ready, assets may be transferred, such as real estate, corporate stock, or cash. FLPs are not designed for the transfer of an individual's home, life insurance, or retirement plans.

The general partnership interests are retained by the senior partners for their lifetime, while limited partnership interests are given as gifts over time to the limited partners.

Be Careful With FLPs

Care should be taken both when creating the FLP and in observing the formalities of operating the FLP as a family business. Be sure to investigate state laws and the rights and obligations associated with transferred property, and always discuss any of these decisions with professional appraisers.

LegalZoom is not a lawfirm and can only provide self-help services at your specific direction. Information contained above is subject to change and is not applicable to every state. Visit LegalZoom.com for specific state-by state-documents.

Return to Legal Tips

Partner Center