Tax Benefits of FLP's
One question we often get from parents and grandparents is how to move wealth to the next generation in a tax efficient way without losing control over the assets. For some families, a family limited partnership (FLP) provides just the right answer.
Creating the FLP
Senior generation transfers assets to a partnership in exchange for both general partnership and limited partnership interests. Senior generation retains the general partnership interests (which can be as little as 1% of the assets) and transfers the limited partnership interests to the younger generation(s). The general partner retains total control and can continue to manage the assets. Limited partners receive purely financial interests and do not participate in day-to-day decisions regarding operations or investments.
Giving More for Less – Estate and Gift Tax Benefits in Overdrive
Currently, each person can transfer approximately $12 million (married couples approximately $24 million) worth of assets before triggering a gift or estate tax. These generous exemptions will be slashed in half by 2026 (assuming Congress fails to act sooner). Any assets transferred during life reduce dollar for dollar what we can leave at death. So, when gifting assets, the goal is to assign as low a value as the rules will allow.
Under IRS rules, gifts must be valued at their fair market value. The IRS recognizes that selling something with no control or ready market makes them worth less to a potential buyer. Since limited partners hold no control and cannot sell their interests without the general partner’s consent, the IRS says these interests should be valued at a discount.
If you were to transfer $1 million worth of your real estate portfolio directly to your children. This means that you would use up $1 million of your exemption. However, if you were to first transfer the $1 million portfolio to an FLP and transfer, retain 1% general partnership interest, and gift the 99% limited partnership interest to your children, the IRS might say the gift is worth only $700,000. You retain an additional $300,000 exemption which you can use for later gifts or as part of your estate exemption to pass additional assets to next generation estate tax free. Not only that, you have also removed future appreciation from your estate as well. That $1 million worth of real estate could be worth $5 million when you pass away. So you have effectively moved $5,000,000 from your estate using only $700,000 of exemption.
Income Tax Arbitrage
FLPs are taxed just like any partnership. Generally, income flows through to the partnership for income tax purposes. Younger generations might be in a lower tax bracket. This means that overall family income taxes might go down. For example, in 2022 single individuals, earning less than $40,000 pay no long-term capital gains taxes or taxes on qualified dividends. Your CPA would be able to review the entire picture and provide counsel as to this aspect of your planning.
Call Tresp, Day & Associates, Inc. today at (858) 755-6672 to schedule your consultation with one of our experienced attorneys to create your family limited partnership.