Family Limited Partnership Can Help Reduce Estate Taxes

Can the way a property owner holds title to real estate impact the fair market value of the real estate for estate tax purposes? Absolutely! The value of a decedent’s estate can be significantly reduced depending upon how a person’s assets are owned at death. For example, if real estate is owned in a family limited partnership (“FLP”), the value of the real estate may be discounted, for estate tax purposes, due to “lack of marketability” and “minority interest” discounts, thus reducing the amount of estate taxes due upon the property owner’s death.

Estate taxes are due nine months after the death of a decedent for assets in excess of $675,000.00 in year 2000 (this amount increases incrementally up to $1,000,000 in 2006). Everyone may transfer a cumulative amount of property, either during their life or upon their death, up to $675,000.00 to take full advantage of their “unified credit.” Any assets a person owns at death above $675,000 may be subject to estate taxes. The estate tax rates commence effectively at 37% and depending upon the size of your estate and range up to 55%.

In a typical estate plan using FLP’s and real estate, parents will transfer real estate into a FLP in exchange for a 1% General Partner (“GP”) interest and a 99% Limited Partnership (“LP”) interest. The parents will retain the GP interest because the GP has the sole responsibility for decisions regarding management of the partnership; limited partners are generally not entitled to participate in management.

Valuation Discounts

If a property is owned in a FLP, upon the property owner’s death, the value of the property can be reduced due to “lack of marketability” discount. The IRS generally allows valuation discounts when the ownership interest of a property is in a closely held business because such an interest is more difficult to sell than an interest in a non closely held business. For instance, a person would be able to sell for more money a 25% tenant-in-common interest in a property versus a 25% interest in a partnership which owned the same property.

Furthermore, a person can discount the value of their property based upon their “minority interest” in the property. The IRS looks at the inability of the limited partners to (i) control the FLP; (ii) influence the day to day management of the FLP, (iii) force a liquidation of the FLP; and (iv) the inability to compel distributions from the FLP.

Once the FLP is formed, parents can make annual gifts of LP interests in the amount of approximately $15,000.00 each year to their children, claiming a one-third discount on the value of the gift so that it falls within the $10,000.00 annual gift tax exclusion. An added benefit is that personal assets of the limited partners are beyond the reach of creditors. As such, creditors can receive only the limited partner’s share of distributions, however, the creditor does not have any leverage to force the GP to make distributions.

Through valuation discounts and use of the annual $10,000 a year gift tax exclusion, a significant amount of wealth can be transferred to limited partners (children) through gifts of limited partnership interests which do not give the limited partners any significant control.

Our office is well able to assist you in this effort should the need arise. We are glad to explain our services in this area more fully and provide you with the costs associated with our representation. If you or anyone you know falls within these circumstances, it is wise for them to consult with our office to resolve these matters.