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You have worked long and hard to accumulate your investment properties. Now you are faced with the problem of how best to plan for transfers to family members without having your investments decimated by income and estate taxes. If you make an outright gift, gift taxes are due. Moreover, you no longer control what you have given away. Transfers at death incur estate taxes, and the taxes are usually paid with funds that have themselves been taxed.

Don’t despair. There is a solution that allows you to both transfer your properties and retain control after the transfer: the family limited partnership.

A family limited partnership is created by a written agreement. The general partner, usually you, controls management of the partnership assets. The limited partners, both you and your children, hold ownership interests in the partnership. Assets, such as investment properties, are transferred into the partnership in exchange for partnership interests.

Because the limited partners’ interests offer limited control, restrictions on transfer, and limited marketability and liquidity, the fair market value of the interests are substantially discounted. Gift taxes are imposed on the fair market value as of the date of the gift. This means that you can give away larger interests in your partnership assets at lesser gift taxes. Because you are giving away shares of limited partnership interests, you have not lost any of your control as the general partner.

A family limited partnership offers several advantages to you and your heirs:

• Allows for centralized, streamlined and accountable management
• Reduces gift taxes
• Allows you to retain control and income from the transferred property
• Avoidsincluding the transferred property in your estate at death
• Protectes you and your family from creditors' claims

Management and Control

The general partners control the family limited partnership. Parents who transfer the family business or improved real estate into the partnership retain control as general partners, even though limited partnership interests have been given to children or other relatives.

We must increasingly rely upon new solutions to the economy. For those of us invested in real estate, the shared ownership agreement can serve to reduce exposure while participating in the income and appreciation available in real estate in a down economy. If you trust each other enough to invest together, do it the right way with a well-crafted written agreement.

Reduced Gift Taxes

Substantial valuation discounts are available for limited partnership interests gifted to children or other relatives. Valuation discounts are available because the market places a lower value on minority non-marketable interests in closely-held businesses. Substantial discounts are available because minority interests lack control of managerial decisions and are difficult to sell. Since the values are discounted, the gift taxes are lowered.

Creditor Protection

Limited partnership interests are less available to creditors seeking to attach property belonging to a judgment debtor. California law limits the remedies a judgment creditor can use against a judgment debtor’s limited partnership interest. A creditor cannot become an actual partner and cannot force a liquidation or compel the general partner to make distributions. The partners are therefore given an extra layer of protection from creditors. 

Restrictions on Transfers

Family limited partnerships generally prohibit the limited partners from borrowing against their interests and include restrictions on transfer that can help keep the partnership interests in the family in the event of divorce. Generally, a limited partnership interest in a family limited partnership owned by one spouse as his or her separate property is easily traceable and difficult to co-mingle. The partnership agreement may provide that the award of a limited partnership interest to the spouse of a family-member limited partner as part of a divorce is an event triggering the buy-sell provisions of the partnership.

Annual Giving Programs

Limited partnership interests are easier to transfer than fractional interests in the underlying assets. This is especially the case when the partnership includes out-of-state real property. Annual giving programs are therefore easier and simplified.

There are few vehicles that offer such a great combination of qualities. When properly structured, limited family partnerships save you money, support and train the next generation, and promote your continued independence.

- The Estate Planning Law Team
  Rogers Sheffield & Campbell, LLP

This article is not intended to provide legal advice. For legal advice on any of the information in this post, please contact us directly, use the form to the right or contact us by phone at 805-963-9721.