Purposes of Family Limited Partnerships
People form family limited partnerships (FLP’s) to (i) transfer ownership of properties or assets to family members while still maintaining control; (ii) to save on estate and gift taxes; (iv) to shift income from parents’ higher tax brackets to children’s lower tax brackets; (iii) to provide some asset protection against liabilities of the property or assets put into the limited partnership or (iv) to provide asset protection against creditors of the limited partners.
Typical example-an apartment building
A mom and dad own a 10 unit apartment building which is paid for and provides substantial cash flow income. They have 3 children and 1 of the children is heavily in debt and cannot handle money. They transfer the apartments into a FLP and the FLP agreement provides that the parents own 40% of the assets and income and the children own 60%. It is set up so that payment of income is discretionary with the parents who are the general partners. The FLP prevents any creditors of the building from going after the parents’ or the childrens’ individual assets outside of the FLP.
The FLP prevents any of the childrens’ creditors from forcing a payment of income to pay the children’s debts. The parents essentially still control the money flow and manage the property. There are many variations possible to this so the entire financial and legal picture needs to be gone into before jumping into any FLP.
A Limited Partnership is a legally recognized type of partnership entity that has one or more general partners and one or more limited partners. The designation as a “family” limited partnership simply means that family members are the owners. It maintains its own bank accounts and accounting records, its own tax id# and files its own tax returns, including partnership forms: IRS form 1065 and California FTB form 565.
A legal contract known as a limited partnership agreement is prepared and signed by all the partners and there are also registration forms which must be filed with the state. After that, various transfer documents are done to place property and assets into the FLP.
The role of the partner types
||What they do
|♦ General Partners
||Manage and control all of the money, business and affairs of the partnership. They sign all checks and all contracts that the partnership enters into.
|♦ Limited Partners
||Limited partners have no voice in the management and no control. They only have voting rights to vote on specific things such as sale of property or removal of the General Partner
Limited liability and asset protection for limited partners
The law governing limited partnerships (including family limited partnerships) provides that the limited partners do not have individual liability for debts and claims against the partnership. The most that a limited partner can lose is his or her investment in the limited partnership. In addition, a limited partner has asset protection, depending upon how the FLP agreement is prepared, where the general partner retains discretion to decide if income is to be paid out the limited partners.
Unlimited liability for general partners
The general partners are personally liable for the debts and obligations of the limited partnership. A solution to this in some situations is to form a corporation and have the corporation serve as the general partner. The corporation could be a California corporation or it could be a corporation formed in another state or country for more confidentiality and more asset protection.
A limited partnership is a permanent legal contract between the general partners and the limited partners. It therefore cannot be changed or revoked unless all of the limited partners and general partners agree in writing to do so. Property and money cannot be removed or paid out unless everyone agrees. Contrast this with living trust arrangements where properties can be freely taken in and out of a living trust and percentages of what various beneficiaries will receive can be changed solely by the parents.
Planning and formation issues
In preparing the limited partnership agreement, there are many custom variables and options which the estate attorney forming it should consider including: (i) how long will the FLP last; (ii) what happens on the death, divorce or disability of a partner; (iii) what will the limited partners be permitted to vote on; (iv) should the general partner be an individual or a corporation; (v) how frequently will money and profits be paid out to the partners and can some money be held back for reserves; (vi) will there be any requirement for partners to put more money into the partnership; (vii) what will the percentages of ownership of capital and profits/losses be among the partners; (viii) what property and assets will go into the FLP and (ix) will there be some asset provision protections built in.
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FLP’s once formed are permanent and eliminate some tax flexibility such as individual partners being able to sell their shares or being able to do a tax deferred exchange of their share. For example, if the family mentioned in the example above decided to not do a FLP and instead decided to hold ownership to the apartment building as tenants in common, there is nothing in the tax law preventing any owner from selling their share or doing a tax-deferred exchange with their share. On the other hand, owning as tenants in common eliminates asset protection and leaves all owners open to liabilities of the apartment building and of their own personal liabilities. Also, there are estate and gift tax considerations which must be understood and discussed before putting any assets into a family limited partnership. There may be a loss of basis step up which would otherwise occur on the death of a partner as one example.