A Family Limited Partnership allows high-net-worth families to transfer assets to heirs at a significant valuation discount, shift income to lower-bracket family members, and protect assets from creditors — all simultaneously. Here is how it works.
A Family Limited Partnership (FLP) is a limited partnership in which family members hold interests. The senior generation (parents or grandparents) typically serves as the general partner, retaining control, while transferring limited partnership interests to heirs at a valuation discount of 15–40%. This reduces the taxable estate, shifts income to lower-bracket family members, and protects assets from creditors — all simultaneously.
The parents create a limited partnership and contribute assets — typically investment real estate, a business interest, or a portfolio of stocks and bonds. The parents serve as the general partner, retaining control over all investment and distribution decisions. They then gift limited partnership interests to their children or a trust for their children's benefit.
The Valuation Discount: Limited partnership interests are worth less than the underlying assets because limited partners have no control over the partnership and cannot easily sell their interests. The IRS and tax courts have consistently recognized valuation discounts of 15–40% for FLP interests.
A $1 million FLP interest might be valued at $600,000–$850,000 for gift and estate tax purposes.
Example: Parents transfer $5 million in real estate to an FLP. They gift 40% limited partnership interests to their children. The 40% interest is worth $2 million in underlying assets — but valued at $1.2–$1.7 million for gift tax purposes after the discount.
The parents have transferred $2 million in economic value while using only $1.2–$1.7 million of their gift tax exemption.
Income Shifting: The FLP can allocate income to lower-bracket family members — children or grandchildren who are in lower tax brackets. A family in the 37% bracket who shifts $100,000 of income to a child in the 22% bracket saves $15,000 in taxes annually.
Asset Protection: Limited partnership interests are protected from creditors. A creditor of a limited partner can only obtain a 'charging order' — the right to receive distributions if and when the general partner decides to make them. The creditor cannot force a sale of the underlying assets or take control of the partnership.
The IRS Scrutiny: FLPs are heavily scrutinized by the IRS. The agency will challenge FLPs that lack genuine business purpose, that are funded with personal use assets (vacation homes, personal residences), or that are created on the deathbed. To withstand IRS scrutiny, an FLP must have a genuine non-tax business purpose, be properly formed and operated, and maintain arm's-length transactions between the partnership and its partners.
FLPs are one of the most powerful estate planning tools available, but they are frequently implemented incorrectly — without a genuine business purpose, without proper formalities, or with assets that do not belong in a partnership. The result is an IRS challenge that can undo the entire strategy.
IRS scrutiny — FLPs are heavily audited, and the IRS will challenge FLPs that lack genuine business purpose.
Estate inclusion — if the general partner retains too much control or the FLP is funded with personal use assets, the IRS may include the FLP assets in the taxable estate.
Kiddie tax — income shifted to children under 19 (or full-time students under 24) is taxed at the parents' rate under the kiddie tax rules.
State law requirements — FLPs must comply with state partnership law, including annual filings and partnership agreement requirements.
An FLP is a core component of the Mini Family Office for families with business interests, investment real estate, or large investment portfolios. It works best when combined with a revocable living trust (to hold the general partner interest), a private foundation (to receive charitable contributions from the partnership), and a coordinated investment strategy.
An FLP can make charitable contributions to a private foundation or donor-advised fund, generating a deduction at the partnership level that flows through to the partners. This allows the family to coordinate their charitable giving strategy with their investment and income shifting strategy.
Family Limited Partnership — valuation discounts, income shifting, asset protection
Family LLC — similar benefits with simpler management structure
Revocable Living Trust — holds the general partner interest
Private Foundation — receives charitable contributions from the partnership
Qualified Appraisal — documents the valuation discount for gift and estate tax purposes
Access our full research library for case law, IRS codes, and government sources supporting this topic.
View ResearchA Family Limited Partnership is one of the most powerful estate planning tools for families with significant assets — but it must be implemented correctly to withstand IRS scrutiny. Our pro bono assessment evaluates whether an FLP is appropriate for your situation.
An FLP must have a genuine non-tax business purpose — investment management, asset protection, and family governance are all valid purposes.
Fund the FLP with investment assets, not personal use assets — the IRS will challenge FLPs funded with vacation homes or personal residences.
Maintain proper partnership formalities — annual meetings, capital accounts, and arm's-length transactions between the partnership and its partners.
Get a qualified appraisal of the FLP interests for gift and estate tax purposes — the valuation discount must be supported by a credible independent appraisal.
Every FLP must have a genuine non-tax business purpose documented in the partnership agreement — investment management and asset protection are the most commonly used purposes.
The FLP should be funded with assets that have a genuine investment character — not personal use assets.
Coordinate with the client's CPA on the income tax implications of the FLP — the allocation of income and losses among partners must comply with the substantial economic effect rules.
Get a qualified appraisal of the FLP interests for gift and estate tax purposes — the valuation discount is the core benefit of the strategy and must be supported by credible evidence.
Estate Planning Hotline — c/o Estate Law Training Center / Law & Tax Foundation
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