CaliforniaFamily Limited Partnerships
Families are often required to make some very difficult decisions, especially when it comes to how the family handles their money, family investments, and property. For families who have significant holdings or real estate, one way to effectively manage assets is by using a tool called a family limited partnership. A family limited partnership can save your family many thousands of dollars in estate taxes and gift taxes and be extremely profitable if you establish the limited family partnership correctly. Additionally, one of the family limited partnership advantages is that it can protect your assets from creditors. Further, it offers a lot of flexibility that other types of trusts cannot, as it can be both changed or amended as needed.
What is a Family Limited Partnership?
A family limited partnership is similar to other limited partnerships, but the partners in the partnership are family members. Just like other types of limited partnerships, the family limited partnership may also have both general partners and limited partners. The investment and management decision of the family limited partnership is made by the general partners and those general partners also bear all of the risk associated with the family limited partnership. On the other hand, limited partners doe not manage the partnership or engage in management decisions, and as a result, their liability is limited. Family limited partnership taxation is similar to all other limited partnerships, in that the entity itself is not taxed, but rather, the individual partners report the income from the limited family partnership according to their interest percentages.
It is common practice for families who use family limited partnerships to set it up where the older generation, such as parents or grandparent, contribute the assets to the partnership in exchange for a large portion of limited partner interest and a small portion of general partner interest. Upon the death of the older generation, all or a portion of the limited partner interest can be passed on to their children or grandchildren either directly or through another trust.
Family Limited Partnership Advantages
In most cases, the advantages are many while the family limited partnership disadvantages are few. By transferring the interest of a limited partner to that partner’s family member, the family can reduce the senior family member’s taxable estate. If the older generation transfers the value of a piece of property to their child or grandchild through the family limited partnership, it is then removed from that individual’s estate for the purposes of the federal estate tax. However, by retaining a small general partnership interest, the senior family member can continue to retain and exercise control over the investment and management decisions of the property. Because the children or grandchildren would only have limited partnership interests in this scenario, they are unable to make investments or control distributions, thereby entitling them to discounts on valuation a the date of transfer.
There are further family limited partner taxation advantages. If you transfer limited partnership interest, they are eligible for the annual tax exclusion for gifts. This is an incredibly helpful tool when you wish to reduce your income and your gift and estate taxes. Under the current state of the law, you may discount the value of a limited partnership interest if you transfer the interest to a family member. Also, family limited partnerships are extremely flexible, so as circumstances change with your family or your financial picture, it is usually possible to amend the partnership agreement to fit your changing needs.
Creditor protection (as well as protection from spouses in divorce proceedings) are another benefit of family limited partnerships. A creditor is unable to vote, force a cash distribution, or own any interest of a limited partner unless the general partner consents to the arrangement. If a limited partner were to divorce and no longer be a member of the family, the partnership documents can be structured to require the limited partnership interest to be available to be transferred back to the family in return for fair market compensation. This ensures the asset in question is never at risk of being transferred outside the family.
If you combine family investments into the family limited partnership, you can significantly reduce your family’s investment fees. You no longer are required to maintain separate brokerage accounts or separate trusts for each of your children and grandchildren, as the family limited trust can simply hold one brokerage account. The children and grandchildren can then be issued limited partnership interests.
How to Set Up a Family Limited Partnership?
A family limited partnership has to be structured with both the older and younger generations in mind in order to adequately protect the assets today and in the future. The first step in establishing your family limited partnership is to draft the family limited partnership agreement. This document should be prepared using the services of an experienced attorney who is well versed on your family’s needs now and plans for the future. After the partnership agreement is completed, those family members who wish to contribute assets may do so. Typically, the assets transferred to a family limited partnership include real estate, corporate stocks, or even cash. Some family limited partnership disadvantages include the inability to use the partnership to transfer life insurance, retirement plans, or individual’s homes. Once the assets are transferred into the partnership, the general partner (usually the older generation) retains their interest for the balance of their life, and limited partnership interests are distributed as gifts to their heirs, such as children and grandchildren, over time.
When used correctly, a family limited partnership can be an amazing tool to help you protect your assets today and pass them on to your heirs in the future, while saving you a lot on the gift and estate taxes in the process. However, it is important to carefully create the partnership and to observe all the necessary formalities that come with operating the partnership. Utilize the services of a skilled attorney to stay within the boundaries of state laws and to avoid missing out on any of the benefits of a family limited partnership.
Vaksman Khalfin, PC, in consultation with your other professional advisors, can help you decide whether this solution is appropriate for you and how it can become a part of your overall estate planning and asset protection strategy.