return to home page FAMILY LIMITED PARTNERSHIPS
A Family limited partnership is a formally established business entity. It can be the owner of life insurance, family vacation property or other assets. A limited partnership consists of general partnership interests and limited partnership interests. A family limited partnership is typically structured with the general partnership portion representing five (5%) percent or less of the total value of the assets of the partnership, with the limited partnership portion representing the balance. The owners of the property to be transferred to the partnership will own the partnership interests in the same ratio as they own the property immediately prior to the transfer.
The partnership is structured so that the owners of the general partnership interests have control over the use and management of the property. The limited partners possess only the proportionate ownership interest. The shares of the limited partners are usually structured to restrict transferability.
The IRS may seek to circumvent the limited partnership on the basis that the partnership lacks the essential characteristics necessary to treat it as a partnership for tax purposes. It is necessary that the document establishing the limited partnership evidence the business purposes of the partnership. For example, the partnership may be created to provide centralized control and management; provide asset protection in the event of divorce; avoid out-of-state probate or any of several other reasons.
The owners of the limited partnership interests can now systematically transfer (by sale or gift) their interests to others, usually family members. Since the limited partnership interests represent only ownership without control and without marketability, their value is accepted as being less than the proportionate interest they represent. A one-third discount is generally accepted. This means that an individual can give limited partnership shares representing proportionately $15,000 and consider it a $13,000 gift without tax consequences. For example, assume that a husband and wife own property with a value of $200,000 and they transfer it to a family limited partnership with ninety (90%) percent limited partnership interests. Immediately after the transfer, they would own ten (10%) percent of the total value as general partners and ninety (90%) percent of the total value as limited partners. They can they, EACH transfer $15,000 interests to each member of the next generation each year without incurring any adverse tax result. If they have three children, $90,000 in value can be thus gifted out in each of two successive years leaving the couple with only the general partnership interests representing a proportionate value of only $20,000 yet having retained complete control over the property. Their combined estate has been reduced by $180,000, potentially saving thousands of dollars in estate taxes.
The transfer of limited property interests can be restricted to family members. In the event of a divorce and the award of a limited partnership interest to the spouse who will cease to be a family member, the partnership documents can require a transfer back to the family for fair market value, thus keeping the asset within the family structure.
One disadvantage to this property transfer approach is that, while significantly reducing potential estate taxes, it does not allow the step-up in tax basis that would occur had the original owners retained full ownership until death. However, if it is intended that the property be retained and passed on to successive generations, this may not be a crucial factor.
Another advantage of this form of family property ownership is to relative to creditors. Under current tax law, the owners of a partnership interest must report the partnership's income and deductions on their personal tax return in proportion to their interests. A creditor attaching or taking a limited partnership interest may end up with a tax liability and no benefit. This has proven to be a major deterrent to creditors. The restrictions on sale and/or transferability in the partnership documents would also serve to deter a creditor.
From a practical standpoint, the family limited partnership must be structured with both the present and future owners in mind. If the owners of all interests are family members, they can usually amend the partnership agreement as family circumstances change.
The family limited partnership is an excellent vehicle for holding family assets such as a vacation home that is to be passed from the present generation to the next. By the transfer of the limited partnership interests, the parents can down-size their estate significantly while keeping control for their lifetime(s). If the property is located in another state, additional probate costs can be avoided. The limited partnership can also be used for a joint family venture. The generation that founded the business can maintain control as the general partner while passing the value off to the next generation in a succession of gifts. If the particular venture has a high risk of liability, the general partner can be a corporation with the parents being the sole shareholders of the corporation. Also, depending upon the relative estate planning objectives and needs, the general partner might be a trust or even another partnership.
A limited partnership must file an information tax return starting the first year it has income.
It has been argued that a limited partnership share as a gift will not qualify for the annual $10,000 per year per person exclusion because the gift does not include any control element. If this is a problem based upon the nature of the asset, there can be a cash gift of $10,000 and the interest (which might represent $15,000 in proportionate value) purchased directly. Since the share would be worth the discounted value of $10,000 there would be no gain/loss in the transaction.
If the family limited partnership is the owner of life insurance it can serve to isolate most of the proceeds from the estate of the deceased.
There are many technical, legal and functional requirements and considerations for the drafting and forming of a limited partnership. Legal advice is essential.
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