Los Angeles Estate Plans: Using Family Limited Partnerships (FLPs) to Reduce Estate Tax Exposure

What Is a Family Limited Partnership?

A Family Limited Partnership (FLP) is a limited partnership formed under California law in which family members hold interests as general partners (GPs) and limited partners (LPs). The GP manages the partnership; LPs generally have limited control and limited liability. Families often contribute investment portfolios, closely held business interests, or real estate to the FLP, then make gifts or sales of limited partner interests to younger generations or trusts.

California limited partnerships are governed by the Uniform Limited Partnership Act of 2008 (Corp. Code § 15900 et seq.). Formation typically involves filing a Certificate of Limited Partnership with the Secretary of State and executing a written partnership agreement.

Why Los Angeles Families Consider FLPs

• Centralized management of complex assets (e.g., real estate, operating businesses).
• Consolidation for easier bookkeeping and succession planning.
• Creditor posture: For a judgment creditor of a partner, California law generally limits remedies to a charging order against distributions, which can enhance separation between a partner’s personal creditors and partnership assets (Corp. Code § 15907.03), subject to facts and court orders.
• Potential valuation discounts for lack of control and lack of marketability when transferring LP interests, which can reduce the taxable value of gifts and estates if respected by the IRS (IRS Valuation Guide).
• Facilitates gradual wealth transfers while a senior generation retains control via GP interests.

Key Tax Considerations

Transfers of LP interests can be subject to federal gift and estate tax rules. Valuation discounts may apply to limited interests given appropriate facts and strong appraisal support, but they are not automatic and may be challenged (IRS Valuation Guide).

The IRS may invoke IRC § 2036 to include transferred assets in a decedent’s estate if there was no bona fide sale or if the transferor retained certain benefits or control; aggressive or last-minute funding can increase audit risk.

For income tax purposes, partnerships are generally pass-through entities; partners report their allocable share of income, deductions, and credits on their own returns.

Avoiding Common IRS Challenges

• Establish and document a significant, non-tax business purpose (e.g., consolidated management, investment discipline, liability management).
• Observe partnership formalities: separate accounts, minutes, Schedule K-1s, capital accounts, and distributions consistent with interests.
• Avoid commingling FLP assets with personal funds or personal use of FLP property without market-rate arrangements.
• Avoid funding on the eve of death or retaining unfettered access to contributed assets (IRC § 2036).
• Use qualified appraisers for both asset and interest-level valuations; memorialize discount methodologies (IRS Valuation Guide).

California Law and Formation Basics

California limited partnerships are governed primarily by the Uniform Limited Partnership Act of 2008 (Corp. Code § 15900 et seq.). Formation usually requires filing a Certificate of Limited Partnership and adopting a written partnership agreement. Many families choose a California FLP when assets and management are centered in Los Angeles, although alternative jurisdictions are sometimes considered for specific liability or administrative reasons.

State taxes and filings: Limited partnerships registered or doing business in California generally owe the state’s $800 annual tax and must satisfy return-filing and other compliance obligations; requirements vary by entity type and activity (California Franchise Tax Board). General partnerships do not owe the $800 annual tax but may have filing obligations. Consult your tax advisor for specifics.

Choosing the Right Assets for an FLP

Common candidates include income-producing real estate, diversified investment portfolios, and operating or holding company interests. Assets that are heavily used personally by senior family members (such as a primary residence) can undermine tax objectives. Transferring encumbered real estate requires careful review of loan covenants and potential transfer taxes; consider separate entities (e.g., LLC subsidiaries) to hold individual properties with the FLP as the parent partner.

Gifting and Sales Strategies

• Annual exclusion gifts of LP interests, supported by qualified appraisals.
• Sales of LP interests to intentionally defective grantor trusts (IDGTs) for estate freeze planning.
• Preferred and common partnership interest recapitalizations to manage cash flow and transfer economics.

File timely gift tax returns with adequate disclosure to start the limitations period on assessment (Treas. Reg. § 301.6501(c)-1(f)).

Documentation and Appraisals

A defensible plan requires: (1) a well-drafted partnership agreement reflecting business purposes and restrictions typical for third-party arrangements, (2) contemporaneous asset appraisals, (3) a qualified valuation of the LP interests including any discounts, and (4) consistent books, records, and tax reporting. Clear assignment documents and letters of transmittal for gifts, and timely filed gift tax returns with adequate disclosure, help start limitation periods and reduce audit exposure (IRS Valuation Guide; Treas. Reg. § 301.6501(c)-1(f)).

Coordination With Your Overall Estate Plan

An FLP should integrate with revocable trusts, powers of attorney, and beneficiary designations. Update pour-over wills and trust schedules to reflect FLP interests. Consider how GP control transitions on incapacity or death to avoid management gaps. Review insurance coverage and liability shields for properties or operating companies owned by the FLP.

When an FLP May Not Be the Best Fit

If the primary assets are personal-use, if family members require frequent cash withdrawals inconsistent with partnership formalities, or if governance friction is likely, alternatives such as LLCs with voting/non-voting units, directed trusts, or straightforward gifting may be more appropriate.

FAQ

Can an LLC serve as the general partner?

Yes. Many families use a manager-managed LLC as GP to add liability protection for individual decision-makers.

Are valuation discounts guaranteed?

No. Discounts depend on facts, restrictions, and credible appraisals, and may be challenged by the IRS.

Can I contribute my primary residence?

Generally not advisable. Personal use can undermine non-tax purposes and risk estate inclusion under IRC § 2036.

What ongoing formalities matter most?

Separate accounts, consistent distributions, accurate capital accounts, timely K-1s, and avoiding personal use of FLP assets without market terms.

Getting Started in Los Angeles

Begin with a comprehensive asset and goal review. Your attorney can model transfer options, coordinate with valuation professionals and CPAs, and prepare state filings. Expect an iterative process: draft the partnership agreement, structure GP/LP economics, obtain appraisals, execute transfers, and align tax reporting. Ongoing compliance—separate accounts, minutes, K-1s, and California tax payments—is essential to preserve benefits.

Talk with a Los Angeles estate planning attorney

To discuss whether an FLP fits your goals, contact our team.

California-specific disclaimer: This post summarizes California law and federal tax concepts as of the review date below. It is for general information only and is not legal or tax advice. Reading it does not create an attorney-client relationship. Results depend on your facts; consult California counsel and a qualified tax advisor.

Last reviewed: 2025-08-19