A Tip on passing down your vacation home: Establish a Family Limited Partnership
Family Limited Partnerships are powerful estate planning tools that enable the smooth and tax-efficient transfer of business ownership from one generation to the next.
If you own a vacation home you want your children to own after you’re gone, you can set up a family limited partnership. Typically, this involves establishing a general partnership and then making heirs and family members limited partners. As the general partner, you’ll still be able to call the shots. But your partners (whether they’re your children or another relative) will have a stake in your company or own a portion of your assets. As a result, the size of your estate will be smaller.
WHAT IS A FAMILY LIMITED PARTNERSHIP?
A family limited partnership (FLP) is a holding company owned by two or more family members, created to retain a family’s business interests, real estate, publicly traded and privately held securities, or other assets contributed by its members. The purpose of creating such an entity is generally to achieve creditor protection and reduce gift and estate taxes while maintaining control over the management and distribution of the partnership’s assets.
This establishes two classes of owners;
The first: General Partners (GPs) – responsible for managing the FLP and its assets. They are typically the business-owning parents, or a limited liability company owned by these parents to protect them from the unlimited liability of operational risks of the business.
The second: Limited Partners (LPs) – have an economic interest in the partnership, but lack the ability to control, direct, or otherwise influence the operation of the FLP. In fact, the LPs typically lack even the ability to sell their interest in the partnership, unless it is to an immediate family member. These are typically the children and grandchildren of the business-owning parents. They have the right to their proportional share of partnership income. As the name suggests, they are liable only to the extent of their investment in the partnership.
Essentially, the GPs are the operators of the partnership and the LPs are passive owners.
PRESERVING CONTROL, SAVING TAXES
Generally, the senior generation will create and donate assets to a FLP in exchange for GP and LP interests, and then gift those LP interests to their children and grandchildren over time.
To help understand, as a result of the Tax Cuts and Jobs Act of 2018, an individual can pass along $11.18 million to their heirs. A married couple can pass along $22.36 million free and clear of federal estate taxes. Assets above those exemption limitations are subject to a 40% federal estate tax rate. Many states will impose an additional estate or inheritance tax as well.
For this reason, enterprising families often will choose to gift large portions of their estate to their heirs through the use of a FLP while they are still alive. By doing so, they can avoid estate and inheritance taxes entirely while also stretching out their available federal estate tax exemption by transferring property at a discount. If executed properly, one could reasonably pass 115% to 130% of the value of their exemption to their heirs, free of estate taxes, by encumbering assets in the wrapper of a family limited partnership. By retaining the general partnership interests, it is common for a business owner to maintain control of the family business within a family limited partnership. This enables the children to own interest in the business while the parents retain full control over its operations.
As an added bonus, any increase in the value of the underlying property occurs free of estate and inheritance taxes. Therefore, if a business, real estate, or investment portfolio is particularly fast-growing, this can be a very effective way of avoiding future estate and gift taxes.
When the GP is no longer in a position to exercise control over the FLP, they can determine who will receive their GP interests moving forward. This can be a specific family member or a trusted third-party advisor.
This flexibility is important, as FLPs are often created well in advance of having recognized one’s final successors.
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