Family units looking for ways to shift assets to the next generation and limit the amount of taxes involved should consider transferring assets to a family limited partnership (FLP). This technique provides a flexible structure that will reduce gift and estate taxes. The FLP has two classes of ownership. A general partner (GP) is usually the older generation and limited partners (LP) are usually the next generation. The GP ownership percentage is usually limited to a small percentage (e.g., 2 percent), leaving the LP ownership percentage to the remaining portion of ownership (e.g., 98 percent). The GP has complete control of the partnership.
The lack of control regarding the LP allows the GP to continue the management of the underlying assets and the cash flow to the limited partners as desired.
Real estate has been found by the Internal Revenue Service to qualify for valuation discounts, as real estate is not readily marketable. If the entire property is not owned (fractional shares), there could also be a minority interest valuation discount. These valuation methods regarding the gifts of real estate allow a lower value for the transfer of the property.
Most formations of FLP and the related gifting to the next generation of the LP interest involve using a portion of the gift/estate unified exemption credit equivalent. The individual exemption for 2013 is $5.12 million and for spouses, a combined amount of $10.24 million is available for use, along with the annual gift exclusion. If a large gift is not under consideration, the transfer of the LP interest can also qualify for the annual gift tax exclusion each year, which presently, on an individual basis, is $13,000, and for spouses, $26,000, to each donee.
It is important in successfully implementing a family limited partnership for estate planning that proper procedure is used in the transfer of the partnership interest. The partnership should have a business purpose for existing. If the only purpose of the partnership and the gifting of the assets is tax avoidance, it will not meet the criteria of a business purpose. The partnership assets should be set up as a separate business and not commingled with other assets of the donor.
The IRS reviews FLPs carefully because valuation discounts are taken, especially where a larger portion of the asset is gifted to the family member at a reduced value. The IRS has challenged these discounts with some success. As a result, it becomes essential that the transaction is properly structured.
In conclusion, a family limited partnership owning real estate can be an excellent technique for transferring assets and appreciation of the assets out of the estate of the donor.