What Is a Family Limited Partnership (FLP)?
A family limited partnership (FLP) is a formal business entity—typically established as a limited partnership—through which family members pool assets or capital to own and operate a business (common examples: real estate holdings, family operating businesses, or investment portfolios). Ownership is held in partnership interests (units or shares), with profits and losses allocated according to the partnership agreement. FLPs are often used for family asset management, centralized control of assets, and estate- and gift-tax planning. (Source: Investopedia)
Key takeaways
– An FLP has two partner classes: at least one general partner (manages the business and has unlimited liability) and one or more limited partners (have limited liability but typically no management authority). (Investopedia)
– FLPs can enable annual, tax-favored transfers of partnership interests using the annual gift-tax exclusion and may remove transferred assets from a donor’s taxable estate, helping build generational wealth. (Investopedia; IRS)
– Setting up and running an FLP often requires professional legal, tax, and valuation help. Costs and administrative burdens can be significant. (Investopedia; Walters Kluwer)
– Improper structure or management (for example, retaining excessive control as a general partner) risks IRS challenge and loss of intended tax benefits. (Investopedia; Walters Kluwer)
Understanding an FLP
Structure and roles
– General partner(s): manage operations and make binding decisions. They typically have unlimited personal liability for partnership obligations unless another structure (e.g., corporate GP) is used.
– Limited partner(s): own partnership interests, share in profits and losses, and enjoy liability limited to their capital contribution; they usually do not participate in day-to-day management.
– Partnership agreement: the governing document that sets ownership percentages, profit/distribution rules, restrictions on transfers, buy-sell provisions, management powers, voting rights, and other operational rules. This document determines how benefits flow and what controls exist.
Why families form FLPs
– Centralize management of family assets (easier to run a business or rent/maintain real estate).
– Facilitate controlled transfers of wealth across generations.
– Potential tax benefits: annual gifting of FLP interests up to the gift-tax annual exclusion; valuation discounts (for lack of control/marketability) may reduce the taxable value of gifted interests if properly supported by valuation and charter documents; assets removed from a donor’s estate may reduce estate tax exposure. (Investopedia; Walters Kluwer; IRS)
Types of partners (recap)
– General partner(s): control and management; greater liability exposure.
– Limited partner(s): passive investors; liability limited to investment amount; limited role in management.
Example (practical illustration)
– Family starts an FLP to fund a $1,000,000 luxury apartment project requiring $500,000 equity.
– FLP issues 5,000 limited partnership units at $100 each to raise the $500,000; units are subject to a six‑year transfer restriction.
– The founder is the general partner, contributes $50,000 and buys 500 units; family members buy the remaining units.
– The FLP’s $500,000 equity plus a mortgage funds construction; rental income is distributed per the agreement (example: 70% of cash earnings paid as dividends).
– Family members receive income and, over time, may receive transferred interests as gifts per the annual exclusion. (Adapted from Investopedia example)
Gift tax and annual exclusion (practical points)
– Annual exclusion: individuals can gift up to the annual exclusion amount to each recipient without using lifetime gift exemption or filing gift tax return for amounts that qualify as excluded gifts. For tax year 2025 the annual exclusion is $19,000 per donor per recipient ($38,000 for a married couple who elects gift‑splitting). (IRS announcement, 2025)
– Using the example in the source: a couple who want to transfer FLP interests to 12 descendants could gift $38,000 each per year (if filing spouse-split), moving $456,000 of FLP interest per year outside their taxable estate—assuming valuations support the transfers and compliance procedures are followed. (Investopedia; IRS)
– Valuation and documentation are crucial. Discounts and valuations must be defensible and supported by a qualified appraisal and contemporaneous documentation.
Estate tax considerations
– Assets legitimately transferred out of the donor’s estate (by gifting FLP interests or selling them at fair terms) reduce the taxable estate, potentially lowering estate tax exposure. Future appreciation in those assets typically occurs outside the donor’s estate after a completed transfer.
– The IRS scrutinizes transfers to FLPs to ensure they’re bona fide business arrangements and not sham transfers solely to avoid tax. Retaining effective control or continuing to treat assets as personal can jeopardize the estate/gift tax benefit. (Investopedia; Walters Kluwer)
Advantages of FLPs
– Centralized family asset management and simpler distributions of income.
– Facilitates multigenerational wealth transfer in a controlled manner (e.g., transfer restrictions, age thresholds).
– Potential gift/estate tax savings when properly structured and documented.
– Limited liability for limited partners (protects passive family owners from business liabilities).
– Flexibility in distributing cash vs. non-cash benefits (as defined in partnership agreement).
Disadvantages and risks
– Complexity and cost: attorneys, accountants, valuations, annual compliance and tax filings raise setup and ongoing costs.
– General partner liability: general partners face unlimited liability unless other protective structures are layered (e.g., corporate GP).
– Tax and legal scrutiny: IRS may challenge undervaluations, discounts, or the economic substance of transfers; too much retained control can lead to recharacterization.
– Illiquidity: partnership interests may be hard to value and transfer, and transfer restrictions can impede beneficiaries.
– Business risk: if the FLP’s underlying business performs poorly, family investors may lose capital and may be exposed to debts (depending on the partner role and entity structure).
Is it expensive to run an FLP?
Yes—relative to simple gifting or wills—because:
– You generally need specialized legal counsel to draft the partnership agreement and advise on entity selection and state filing.
– Tax specialists and qualified appraisers are often required, especially for yearly valuations and defensible discounts.
– Ongoing costs include bookkeeping, tax returns, possible state fees, and periodic legal reviews.
These costs are often judged worthwhile only where the asset base, complexity of the family situation, or expected tax/estate benefits justify them. (Investopedia; Walters Kluwer)
How many people are needed to set up an FLP?
– Minimum: two family members (one general partner and at least one limited partner). Partners must be related (family FLPs are designed for family members). There can be multiple general and limited partners as the situation requires. (Investopedia)
Practical steps to set up and operate an FLP (checklist)
1. Clarify objectives
– Define business/estate planning goals (income distribution, asset protection, succession planning, tax reduction).
– Decide which assets will go into the FLP (cash, real estate, business interests, investment portfolios).
2. Assemble advisors
– Engage an estate-planning attorney experienced with FLPs and an accountant/tax advisor familiar with partnership tax rules and valuation issues.
– Plan for qualified valuation appraisers if you intend to gift interests.
3. Choose entity and jurisdiction
– Determine whether to form a limited partnership in your state or use alternative structures (e.g., limited liability company taxed as partnership) as appropriate.
– Consider state law differences, privacy, and filing costs.
4. Draft the partnership agreement
– Specify capital contributions, distributions, management rights, transfer restrictions, buy-sell provisions, voting rules, reporting, dissolution procedures, and restrictions on transfers/sales.
– Include creditor-protection and succession provisions as needed.
5. Capitalization and formation
– File required state formation documents and obtain an EIN for the entity.
– Make initial capital contributions and issue partnership units per the agreement.
– Maintain arm’s-length records for contributions and distributions.
6. Valuation and gifting
– Obtain a credible valuation of partnership interests if you intend to make gifts.
– Use annual gift exclusions strategically; document gifts and, if spouses split gifts, file Form 709 when required.
– Keep detailed records (valuation, independent appraisals, contemporaneous minutes, financial statements).
7. Maintain proper operations and governance
– Run the FLP as a legitimate business—hold meetings, keep minutes, prepare financial statements, and avoid commingling personal and partnership assets.
– Ensure limited partners do not perform management functions (or your limited partner protection can be threatened).
8. Tax compliance and reporting
– File partnership tax returns (Form 1065 in many cases) and issue Schedule K-1s to partners.
– Track distributions and allocations according to the partnership agreement.
– Review annual gift exclusions and lifetime exemption considerations with your tax advisor.
9. Periodic review and adjustments
– Reassess valuations, legal structures, state law changes, and family circumstances regularly.
– Update the partnership agreement as family needs change.
Documentation and best practices to reduce IRS risk
– Maintain contemporaneous documentation demonstrating economic substance (appraisals, minutes, bank statements, partnership formalities).
– Avoid treating gifted assets as if they remain personal property (e.g., cashing partnership checks personally without proper distributions).
– Limit general partners’ day-to-day personal use of partnership property unless authorized by the agreement and documented.
When FLP tax benefits can be challenged
– The IRS has contested FLPs when transfers appear sham-like or when retained control by donors is too extensive.
– Courts may recharacterize transfers if the partnership operates merely as an alter ego of the donor. Proper formalities and genuine business purpose are essential. (Walters Kluwer; Investopedia)
Sample gifting math (2025 example)
– Annual exclusion per individual: $19,000 (2025); married couple can gift $38,000 per recipient by gift-splitting (IRS 2025 adjustment).
– Example: married couple with $5 million in an FLP has 12 intended recipients → $38,000 × 12 = $456,000 moved out of the estate per year without gift tax (assuming valuations permit and proper documentation is in place). (Investopedia; IRS)
When to avoid an FLP
– Small asset pools where setup and maintenance costs outweigh benefits.
– Families unwilling to comply with required formalities and documentation.
– Family reputations or relationships likely to generate disputes where a more direct approach (trusts or direct ownership changes) might be better.
The Bottom Line
An FLP is a powerful, flexible tool for family asset management and intergenerational wealth transfer that can provide tax and estate planning advantages when properly structured and managed. However, it is complex, costly to set up and maintain, and subject to IRS scrutiny. Families should only use FLPs with a clear business purpose and with guidance from experienced attorneys, tax advisors, and valuation professionals.
Recommended next steps (practical)
– Talk to an estate-planning attorney with FLP experience and a tax advisor to evaluate whether an FLP makes sense for your asset size and family goals.
– If proceeding, obtain a qualified business/partnership valuation before gifting and establish a compliance calendar for meetings, tax filings, and valuations.
– Keep thorough, contemporaneous records demonstrating business purpose and arm’s-length behavior.
Sources and further reading
– Investopedia. “Family Limited Partnership (FLP).” (source provided)
– Internal Revenue Service. “IRS Releases Tax Inflation Adjustments for Tax Year 2025.” (2025 annual exclusion info)
– Charles Schwab. “The Estate Tax and Lifetime Gifting.”
– Walters Kluwer. “Family Limited Partnerships 101.”
Note: This article explains common uses, benefits, and risks of FLPs but is not legal or tax advice. Always consult qualified attorneys and tax professionals before establishing an FLP.