Lesson 75: Creating Family Limited Partnerships (FLPs) for Real Estate

In this lesson, we will delve into the creation and use of Family Limited Partnerships (FLPs) in real estate planning, particularly for ultra-wealthy clients. This advanced estate planning strategy offers significant benefits but also comes with specific complexities and trade-offs. We'll explore these ideas in depth, and provide practical examples to illustrate their application.

What is a Family Limited Partnership (FLP)?

A Family Limited Partnership (FLP) is a type of limited partnership where family members hold ownership interests. It is primarily used in estate planning to consolidate family assets, provide asset protection, and facilitate the transfer of wealth to younger generations while minimizing estate and gift taxes.

Structure of an FLP

An FLP typically consists of two types of partners:

• General Partners (GPs): They manage the FLP and have control over its assets. GPs are usually the senior family members.
• Limited Partners (LPs): They have no management responsibilities but hold an ownership interest in the FLP. LPs are typically the younger generations or other family members.

Benefits of Using FLPs in Real Estate Planning

• Tax Advantages: FLPs can help reduce estate and gift taxes through valuation discounts for lack of marketability and minority interests.
• Asset Protection: FLPs provide a layer of protection from creditors by limiting the direct ownership of assets.
• Centralized Management: Ensures that the decision-making process for family-owned assets remains with the family.
• Succession Planning: Facilitates the transfer of wealth and management responsibilities to the next generation in a structured manner.

Setting Up an FLP

Creating an FLP involves several key steps:

• Drafting the Partnership Agreement: This legal document outlines the roles, responsibilities, and ownership percentages of the partners.
• Valuation of Assets: Accurate valuation of the real estate and other assets being transferred to the FLP is essential for determining partnership interests.
• Filing with the State: The FLP must be registered with the appropriate state authorities, including paying any necessary fees.

The following diagram illustrates the structure of a typical FLP:

Valuation Discounts and Tax Implications

The value of limited partnership interests in an FLP can be subject to significant valuation discounts. These discounts can reduce the taxable value of the estate, leading to substantial tax savings. Two primary types of valuation discounts are:

For further reading on valuation discounts, consider these books on Amazon.

• Discount for Lack of Marketability (DLOM): Reflects the difficulty in selling a limited partnership interest due to the lack of a public market.
• Minority Interest Discount: Applies to limited partners who do not have control over the partnership, reducing the value of their interest.

Example Scenario

Consider an ultra-wealthy client who owns $20 million in real estate. By transferring these assets into an FLP and gifting limited partnership interests to their children, the client can achieve substantial estate tax savings.

Here's an illustrative example in code:

Valuation Discounts and Tax Implications (Continued)

The valuation discounts not only reduce the taxable estate but also can provide gift tax savings. For example, if the limited partnership interests are discounted by 30%, the actual gifted value is significantly lower than the fair market value, reducing potential gift taxes.

$\[ \text{Gifted Value} = \text{Fair Market Value} \times (1 - \text{Discount}) \] \text{Example:} \\ \text{Fair Market Value} = \$10,000,000 \\ \text{Discount} = 30\% \\ \text{Gifted Value} = \$10,000,000 \times (1 - 0.30) = \$7,000,000$

Legal and Administrative Considerations

Establishing an FLP involves compliance with various legal and administrative requirements, such as:

• Drafting a Comprehensive Partnership Agreement: This document should outline the rights and responsibilities of the partners and address issues like distribution of profits, contributions, and dissolution procedures.
• Periodic Valuations: Regular valuations of the FLP’s assets are necessary to ensure accurate accounting and tax reporting.
• Annual Filings: FLPs must comply with state-specific filing requirements, including annual reports and fee payments.

It is crucial to involve experienced legal and tax professionals to navigate these complexities and ensure compliance with state and federal laws.

Challenges and Risks

While FLPs offer significant benefits, they also come with certain challenges and risks:

• IRS Scrutiny: The IRS closely scrutinizes FLPs for potential valuation abuses. It is essential to have thorough documentation and legitimate business purposes for the FLP.
• Management Conflicts: Potential conflicts between general and limited partners can arise, particularly in families with complex dynamics or differing financial goals.
• Legal and Administrative Costs: The costs associated with setting up and maintaining an FLP, including legal fees, valuation fees, and annual administrative costs, can be significant.

Conclusion

Family Limited Partnerships (FLPs) are a powerful estate planning tool for ultra-wealthy clients, offering substantial tax benefits, asset protection, and centralized management of family assets. However, they require careful planning, ongoing management, and expert legal and tax advice to navigate the complexities and avoid potential pitfalls.

For further reading, consider exploring related lessons:

• Conducting a Comprehensive Financial Review
• Understanding Client's Personal and Family Goals
• Examples of When to Use Dynasty Trusts vs. Family Limited Partnerships (FLP)