Family Limited Partnership (FLP): How to Gift $10 Million While Being Taxed on $7 Million
Family Limited Partnership (FLP): How to Gift $10 Million While Being Taxed on $7 Million
📜 WHO THIS IS FOR
- Target Profile: Families with taxable estates ($20M+) holding illiquid assets like Real Estate or Private Businesses.
- Primary Objective: Estate Tax Reduction via Valuation Discounts (squeezing more assets into the lifetime exemption).
- Not Suitable For: Portfolios consisting solely of publicly traded stocks (IRS attacks discounts on liquid assets).
EXECUTIVE SUMMARY
- The Concept: If you give your child a $1M building, the IRS values the gift at $1M. But if you put the building into an FLP and give your child a 99% “Limited Partner” interest, that interest is worth less than $990k.
- The Discount: Why? Because a Limited Partner cannot sell the interest easily (Lack of Marketability) and cannot force the General Partner to distribute cash (Lack of Control). A hypothetical buyer would demand a discount to buy such a restrictive asset.
- The Payoff: Appraisers typically justify a 30-40% discount. This allows you to transfer significantly more wealth tax-free before hitting the Estate Tax cap.
- Authority Baseline: This strategy relies on objective appraisal standards recognized by the Tax Court (e.g., *Estate of Jones*), provided there is a legitimate non-tax business purpose.
The IRS taxes “Fair Market Value.” But what is the value of a minority share in a family business that pays no dividends and cannot be sold? To an outsider, it’s nearly worthless. The FLP Strategy leverages this economic reality. By wrapping assets in a restrictive legal structure, you artificially (but legally) depress their value for tax purposes, while keeping the underlying wealth intact for the family. According to Team BMT Analysis, this is the primary engine for multigenerational wealth transfer for real estate dynasties. Source: American College of Trust and Estate Counsel (ACTEC)
Scenario: Parents own a $10M Apartment Complex. They want to gift it to kids.
- Direct Gift: Parents transfer deed to kids.
Gift Tax Value: $10,000,000.
Exemption Used: $10M. - FLP Gift: Parents contribute building to FLP. They act as General Partner (GP, 1%). They gift 99% Limited Partner (LP) interests to kids.
Appraised Value of LP Interest: $10M * 99% * (1 – 35% Discount).
Gift Tax Value: $6,435,000.
Verdict: Parents transferred $10M of real value but only used ~$6.4M of their exemption. They saved ~$1.4M in future estate taxes (at 40% rate).
BMT Verdict: The FLP is not just a tax tool; it is a governance tool. It centralizes control with the parents (GPs) while transferring equity to the children (LPs). If you have assets that are hard to divide (like a building), an FLP is functionally mandatory to prevent family wars.
Transfer Efficiency Comparison
| Transfer Method | Taxable Value of Asset | Effective “Tax-Free” Gift |
|---|---|---|
| Direct Transfer | 10000000 | 0 |
| FLP Transfer (35% Disc) | 6500000 | 3500000 |
*Chart Note: The “Effective Tax-Free Gift” represents the phantom value that disappears for tax purposes but reappears in the hands of the heirs. This arbitrage allows families to bypass the 2026 exemption sunset limits.
Judicial Warning: In *Estate of Powell* (2017), the Tax Court ruled against an FLP because the decedent retained too much implied control (used the FLP like a personal checking account). This “deathbed FLP” failed. To succeed, the FLP must be funded years before death and operated like a real business, not a piggy bank.
⛔ BOUNDARY CLAUSE: This Structure Breaks Down If:
- Assets are Personal Use: You cannot put your primary residence in an FLP and continue living in it rent-free. That pierces the veil (IRC § 2036).
- 100% Marketable Securities: If the FLP holds only Apple stock, the IRS often denies the discount, arguing it’s just a wrapped brokerage account with no business purpose. You need active management or real estate to justify the structure.
Execution Protocol
Form a Limited Partnership (or LLC taxed as a partnership) in a jurisdiction with strong charging order protection (e.g., Delaware, Nevada, Wyoming).
Transfer assets into the FLP. **Wait at least 3-6 months** before gifting any interests. “Step Transaction Doctrine” allows the IRS to collapse steps if they happen too fast (e.g., funding on Monday, gifting on Tuesday).
Hire a “Qualified Appraiser” to determine the discount. Do not guess. The appraisal report (often 50+ pages) is your shield against an IRS audit. It must quantify the “Lack of Control” and “Lack of Marketability” discounts using empirical data.
Valuation discounts are the most scrutinized area of estate tax law. Documentation and operational formality are not optional; they are the defense.
WEALTH STRATEGY DIRECTIVE
- Do This: Use an FLP to consolidate scattered family assets. It simplifies annual gifting (you just gift “units” instead of deeding partial interests in land).
- Avoid This: The “2036 Trap.” Do not retain the right to vote on liquidation or distribution as the GP if you also want to exclude the assets from your estate. Use an independent GP or specific drafting language to avoid “Retained Life Estate” inclusion.
Frequently Asked Questions
Can I maintain control?
Yes. As General Partner, you control investment decisions and distributions. The children (Limited Partners) are silent. This is the main non-tax benefit: transferring wealth without transferring authority.
What is a typical discount?
It varies by asset. Cash/Stocks: 10-20%. Real Estate: 25-40%. Private Business Interests: 30-50%. The harder the asset is to sell, the higher the discount.
Is this an audit trigger?
Yes, large discounts attract attention. However, if you have a qualified appraisal and valid business purpose (e.g., centralized management, creditor protection), the courts consistently uphold the discounts.