FLPs Offer More Than Just Tax Advantages

Estate Planner May-Jun 1997

In recent years, family limited partnerships (FLPs) have become synonymous with gifts and deep discounts. Yet FLPs have played an important role in family estate and management planning for more than 40 years because of the many nontax advantages they offer over making outright gifts.

Simplicity of Gifting

It is often easier to make gifts of property through an FLP, especially when the gifted asset is real estate or tangible personal property (such as art). You contribute assets to the FLP and gift limited partnership interests to your children. This is simpler than giving your children undivided fractional interests. Why? Undivided interests complicate the ownership and sale of real estate, both mechanically and from the standpoint of possible title issues, and of artwork, because all of the owners are entitled to possession rights of some sort.

Control of Property

When you transfer your interest in real estate, art, cash or securities to an FLP and gift limited partnership interests, you retain control over the actual property. Your children are entitled to receive only their own shares of the distributed cash flow as determined by you, the general partner. You can control this cash flow by reinvesting all or part of the FLP earnings. This power is a byproduct of being the general partner, not an estate tax retained power over the limited partnership interests, which would cause estate inclusion. On the other hand, if you make outright gifts of property that is readily divisible, such as cash or securities, you immediately have transferred control of that property to your children.

Modernization of Investments

An FLP can function like a private investment company and improve cash management. This can be particularly helpful when family wealth has already been distributed among two or more generations. The investment assets of the family members and family trusts are contributed to an FLP, which can have a managing general partner or management committee.

This consolidation can permit a reduction in the number of advisors and administrative assistants, eliminate the need to maintain multiple accounts, and allow access to investments that have minimum participation levels. In addition, modern portfolio theories can be more effectively applied and daily cash flow investment techniques can be used.

This can make an FLP a better option than a trust, where some flexibility is lost because the trustees are required to invest based on the prudent person rule (or variations). This standard is more limiting than the business judgment rule that applies to managing partners, under which a bad investment outcome may be easier to defend to other family members.

Protection of Assets

The FLP also serves as asset protection against future creditors. If a family member holding an FLP interest is subject to creditor claims that cannot be met, the creditor cannot attack the actual FLP assets, assuming there has not been a fraudulent conveyance. The creditor generally can only obtain a charging order against the family member’s partnership interest, which would entitle the creditor to FLP distributions only when the family member would have received them.

Parents are often concerned about making gifts of cash or securities to children whose marriages might be shaky. Even though gifted property may be separate property and not subject to a divorce proceeding, cash and securities often become commingled. However, a gift of an FLP interest creates wealth for your child that, by its nature, is segregated.
Buy/sell agreements within the FLP agreement further assist in minimizing creditor and divorce problems. When the partnership agreement provides for a buy-back in the event of an involuntary transfer, the fair market value of the FLP interest will be less than the proportionate value of the underlying assets. Accordingly, while the divorced child or debtor family member may lose value in the redemption of his or her FLP interest, the inherent value of the partnership interest is redistributed to other family members.

Can an FLP Work for Your Family?

An FLP offers you the flexibility to exclude or include family members in administration and investment philosophy at appropriate stages in their lives. It permits you to shelter, protect, and teach, and can enhance investment return.