Texas is one of the first states in the country to recognize the use of Family Limited Partnerships (FLP’s) by estate attorneys as a method for estate planning. In their most basic terms, FLP’s are generally created with an older generation of the family serving as the general partners of the business and the younger members of the family acquiring limited partnership shares.
In years after the creation of the FLP, the general partners will engage in an Annual Gifting Program whereby they give away limited partnership shares of the FLP.
Example: In 2006, Dallas, Texas Husband and Wife own 3 pieces of real estate, including their home (valued at $500,000), and two rental properties (each valued at $1.2 million). Husband and Wife also own stocks with a value of $3 million. With 2 children and 6 grandchildren, Husband and Wife want to explore mechanisms of transferring assets of their estate to their children while still enjoying the use of some of those assets.
How Does it Work?
In 2006, when Husband and Wife form the FLP, they each acquire a small interest as general partners of the partnership, and they each acquire all of the limited partnership shares of the business. At the same time, they transfer some or all of their assets into the partnership. For instance, in the example above, they would likely transfer the rental properties and maybe the stocks into the partnership.
Each year beginning in 2006, Husband and Wife will give away shares of their limited partnership interest to their children and grandchildren.
Because limited partnership interests in a business are generally considered to be less valuable than general partnership interests, the value of the limited partnership interests is generally discounted due to the lack of marketability and lack of control associated with the partnership interests.
Example: Husband and Wife transfer both rental properties with a total value of $2.4 million and all $3 million of their stocks to the FLP. Thereafter, they give each of their children 1% of their limited partnership interest. An appraisal of the 1% limited partnership interests shows that the interests have a value of $30,000.00.
Generally, most people would assume that the value of the 1% interest would be $54,000 (or 1% of $5,400,000). However, the value is determined to be only $30,000. The lower value results from the fact that the limited partnership interests are less valuable than general partner interests.
Because of the discount, Husband and Wife can give away larger amounts of their estate at any one time by giving away the discounted partnership interests.
The Internal Revenue Service has scrutinized FLP’s very closely. As a result, the decision to create an FLP should be very carefully considered and only with very thorough advice from an attorney who practices in this area. Because these partnerships are set up as actual business partnerships, the IRS will ignore them if they do not have a legitimate business purpose. Likewise, when the assets of the partnership are used in highly personal ways, such use jeopardizes the estate planning purposes of the FLP. For instance, placing a residential home in the FLP and then continuing to live in it for personal use potentially violates the FLP restrictions.
The FLP can be a highly effective estate planning tool. It can likewise have business benefits. However, the creation of an FLP can be highly dangerous for those people who have not received very extensive advice. The creation of the FLP involves a mix of estate planning considerations, tax considerations, and business organization considerations. Before making the decision to create an FLP, please make sure that you have studied the considerations and are receiving competent advice.