By effectively using a Family Limited Partnership (FLP), a family may reduce or even eliminate federal estate and gift taxes. But an FLP is not just for tax savings! Through an FLP, those who built the family wealth can protect and retain control of the family assets. An FLP can be used to hold, control, and pass on real estate, stocks, bonds, and most other types of investment assets, including life insurance.
Creating and properly using an FLP can do many things for your family. With an FLP, you can better:
- Build family wealth;
- Maintain control of family assets;
- Consolidate fractional interests in family assets;
- Make gifts to family without fractionalizing ownership of family assets;
- Head off disputes among family members to preserve family harmony;
- Restrict strangers' ability to force sale of or acquire interests in family assets;
- Make family assets unattractive to family members' future creditors;
- Avoid family assets being lost through children's divorces;
- Provide flexibility in succession planning for a family business;
- Facilitate administration and reduce costs if a family member is disabled;
- Avoid multi-state probate; and
- Promote family knowledge of and communication about family assets.
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Controlled Disbursement of Assets
Usually, making estate planning gifts means losing control of what you give away. Giving fractional interests in real estate is even more problematic since every owner (and their creditors) in real estate can force a partition, which usually means sale. Practical difficulties arise when all of the owners (and sometimes their spouses) of real property must sign deeds or mortgages. And, the likelihood of disagreement increases with ownership responsibility dispersed.
With an FLP, it will own the assets and its management and control will be by a general partner, typically a special purpose company that the FLP's founders control. Although they give away limited partnership interests, they maintain control over the FLP and its assets through the general partner. The limited partners' interests are passive. They have virtually no ability to remove the general partner or right to participate in partnership decisions. Thus the founders' estates are reduced and the interests given away escape estate taxation, yet the founders remain in control as long as they want.
Just the ability to make gifts while retaining control would be sufficient to recommend using an FLP as an estate planning device, but it has asset protection advantages noted above and valuation advantages, too.
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"Turbo charged" Gifting: Tax-Exempt Reductions
The FLP agreement generally severely restricts the limited partners' ability to give away or sell their FLP interests. Both lack of marketability and the lack of management control discussed above substantially reduce the fair market value of the limited partners' interests in the FLP as compared to the underlying FLP assets. This valuation discount can really boost the effectiveness of its founders' gifting strategy.
It is not uncommon to see a 40% or greater discount of the underlying FLP assets because of the limited partners' lack of control and the lack of marketability of their FLP interests. With a 40% discount, $18,333 in value of underlying FLP assets can be given away using the current $11,000 per-donee annual exclusion, thus leveraging your gift-giving and accelerating the tax-exempt reduction of your taxable estate.
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How Reducing Remaining Estate Value can Benefit your Heirs
If you die still owning limited partnership interests in the FLP, they, too, can be valued for estate taxes using marketability and control discounts. With a combined 40% discount, $800,000 of assets in an FLP would have a value for estate tax purposes of less than $500,000. At a marginal estate tax rate of 40%, that reduction in estate value would mean an additional $120,000 in asset value going to your heirs instead of being paid out in cash to Uncle Sam!
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Further Advantages of a Family Limited Partnership
Only the general partner's signature is needed to sell or mortgage the FLP's property;
Through the general partner, the founders and members of their family can be paid "reasonable" compensation for management and other services performed, thus putting partnership income where it is needed;
An FLP can make investment loans at favorable rates to family members to help with business needs, home purchases, etc.
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