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A family limited partnership (FLP) is an arrangement in which family members pool money to run a business project. Each family member buys units or shares of the business. Profits are shared in proportion to the number of shares each member owns, which is outlined in the partnership operating agreement.
Family Limited Partnerships have two types of partners:
FLPs vary depending on the nature of the business. For example, suppose an individual wants to start a luxury apartment venture. They expect the project to cost $1 million, including working capital, and take in about $200,000 in cash each year before interest on mortgage payments and taxes. They calculate that they'll need at least a 50% down payment of $500,000 and decide to work with family members to fund the business. The family members agree to establish an FLP that will issue 5,000 limited partnership shares at $100 each for a total of $500,000. The limited partnership agreement states that units cannot be sold for at least six years, and the FLP will pay 70% of cash earnings in the form of dividends.
As the general partner, the original individual who made the calls buys 500 shares by contributing $50,000 to the FLP. Family members buy the remaining shares. Now, each family member owns a stake in an FLP and the business has $500,000 available to begin operations.
The general partner can get a first mortgage loan for the rest of the $500,000 to start the $1 million luxury housing project. The FLP then leases these apartments to tenants and begins taking income from rent. As the mortgage is paid off, profits and dividends are distributed, and each family member profits.
There are some estate and gift tax advantages of forming a family limited partnership. These allow families that form an FLP to more easily pass the wealth they are building onto their children and grandchildren, increasing their family's generational wealth.
Individuals can gift FLP interests tax-free to other individuals every year up to the annual gift tax exclusion. For calendar year 2022, the gift exclusion is $18,000 for individuals (or $36,000 per married couple). This is an increase from $17,000 for calendar year 2023 (or $34,000 per married couple).
Suppose a couple amassed savings worth $5 million. They have three children and nine grandchildren. The couple decides to transfer the entire amount to the FLP they established. If the gift tax exclusion remains at 2024 levels, the couple can gift $36,000 to each of their 12 kids or grandkids each year. This means the couple can transfer $432,000 worth of FLP interests gift-tax-free every year. However, since the gift tax exclusion is generally adjusted annually for inflation, this amount will likely increase each year.
Assets in an FLP effectively leave the partners' estates, as far as the IRS is concerned. This means that any future returns would be excluded from estate taxes. The couple's children and grandchildren would benefit from any interest, dividends, or profits generated from the FLP. This further preserves wealth for future generations.
Partners can set stipulations in the partnership agreement to protect these gifts from being squandered or mismanaged. For example, they can develop a rule stating that gifted shares can't be transferred or sold until the beneficiaries reach a certain age. If any beneficiaries are minors, the shares can be transferred through a Uniform Transfers to Minors Act (UTMA) account.
Because the structure of FLPs and the tax laws that govern them are complex, families should consult qualified accountants and tax professionals before establishing an FLP.
There are downsides to creating an FLP. First, it can be expensive to set up and maintain because of its complexity. Most often, setting up an FLP will call for a tax specialist and estate planning attorney, and you may need to call on other professionals associated with helping to support an FLP.
For tax purposes, an FLP has to run as a business. This can expose the partners to liabilities and debts if the business is mishandled by the general partners. Other drawbacks include capital gains liability and the difficulty transfering ownership interest to minors.
A family limited partnership is an arrangement in which family members pool money to run some sort of business, like a real estate venture. This structure provides tax benefits to partners, which can help families build generational wealth.
It can be expensive to set up and run a family limited partnership. Members will need to work with a tax specialist and/or estate lawyers to establish the partnership. Members may also need professional tax advice throughout the life of the FLP to properly manage their taxes as participants.
A family limited partnership like a holding company or business must have at least two members. These members must be related to each other and both enter into the business together. At least one partner must be a general partner who is responsible for the management and operation of the business.
A family limited partnership (FLP) is a structure for a business or holding company in which two or more family members can buy shares in the venture. Family members then become either general partners or limited partners in the business and share profits based on the percentage of shares that they own. General partners are responsible for the management and operation of the business.
Family limited partnerships provide gift and estate tax advantages. These advantages allow members to more easily pass profits from the business to their heirs, increasing the family's generational wealth. However, as with any business, there is a chance of the venture failing. Members can lose their investments or even incur debt is the business doesn't succeed or is poorly managed.