BUSINESS ENTITY FORMATION
Forming a business entity - such as a Limited Liability Company (LLC) or Limited Partnership (LP) - is a useful estate planning tool for those looking to keep a legal wall between their personal assets and the assets of the business (such as a small-business, solo practice, or real estate investment strategy).
As it relates to real estate investing, it is wise to keep each separate property in its own separate LLC so there a legal wall between the investor’s personal and investment property, as well as legal walls between each separate property.
If you own multiple real estate properties in your own name or jointly with a friend or spouse and an injured tenant, occupant, or guest sues for damages, each owners’ personal assets and your other investment properties are fair game in the resulting lawsuit or settlement. However, by setting up separate LLCs for each property, you and your co-owner’s personal assets and the other investment properties would be shielded in any such lawsuit.
The same protection is afforded to small business owners and solo practitioners if they are sued by a disgruntled client or other litigious person. Generally, only the assets of the business would be subject to any resulting lawsuit or settlement, whereas the business owner’s personal assets would be protected.
If you have a will or trust in place, you can assign your LLC's assets to your estate or trust after your death, so that your trustee can either maintain control and operation of the LLC or sell it, and your heirs can enjoy the income generated by those assets.
It is also wise to have a business succession plan in place to ensure that your LLC continues to be properly managed or winded down and sold after you pass away. You can learn more about business succession planning here.
Family Wealth Preservation
A Family LLC or Family Limited Partnership (FLP) are also powerful estate planning tools that allow a family to control and protect its assets and preserve generational wealth.
Establishing a Family LLC allows you to effectively maintain control over your assets during your lifetime, distribute all or some of those assets as an inheritance to your children during your lifetime (without being hit as hard by gift taxes), and reduce the estate taxes your children would be required to pay on their inheritance. If done properly, it is a win-win for the whole family.
In a Family LLC, a parent maintains control over the management of the LLC during their lifetime (as a Managing Member), with their children or grandchildren holding shares in the LLC, but not having any say in the management of the LLC (as Non-Managing Members). This allows the parent to maintain control over the LLC’s assets during their lifetime and protect them from financial decisions made by less-experienced younger members.
Family LLC assets can be anything from cash to real estate property to personal belongings.
After you have established your family LLC, you can begin transferring assets into it. You then decide on how to translate the market value of those assets into LLC units of value, similar to stock in a corporation. After valuing the assets, you can begin transferring ownership of those assets to your children or grandchildren.
If you, as the parent, are the manager of the LLC, and your children are the non-managing members, the value of units transferred to them can be heavily discounted from their market value. Now, your heirs can receive an advance on their inheritance without the same tax consequences if they had received the assets outright as a gift. Moreover, the overall value of your personal estate is reduced each time a business unit is transferred, resulting in an eventual lower estate tax burden when you pass away.
Family Limited Partnership (FLP)
A Family Limited Partnership (FLP) is another advanced estate planning tool that allows family members to pool funds to run a business together. The general idea is that each family member purchases different units or shares of the business and can profit based on the amount of shares each member owns. However, FLPs are more often used as a means to transfer wealth from older to younger generations, while providing estate and gift tax benefits.
In any scenario, a partnership agreement should be drafted that outlines each family member’s interest share, each family member’s responsibilities, how partnership assets are managed and controlled, how distributions to partners are made, and other necessary legal and operative terms.
FLPs - like standard partnerships - have two types of partners. The first kind is a general partner. If the FLP is set up as a family business, the general partner is usually responsible for the initial funding of the partnership, owns a larger share of the business, and is in charge of the day-to-day management tasks. The general partner may pay themselves a management fee from profits earned by the business. This makes sense since the general partner will be doing most of the heavy lifting when it comes to running the business, plus this will probably be their only job and source of income.
If the FLP is set up as a vehicle to transfer money to other family members, the general partner will usually transfer personal assets to the FLP or use the FPL to purchase income-generating assets, control and manage those assets, and then make distributions to other partners of the interest, dividends or profits generated by the FLP assets. These assets can be money, stocks, bonds, private equity interests, closely-held business interests, real estate, or other income-generating devices.
Strategically, a general partner should include stipulations in the partnership agreement to protect gifted shares from being wasted or mismanaged.
The second type of partner is called a limited partner. Limited partners generally do not have any management responsibilities. Instead, they either buy-in or are gifted shares of the partnership in exchange for dividends, interest earned, and profits generated by the business.
FLPs also provide considerable estate and gift tax advantages to all partners. Every year, an individual can gift FLP interests (i.e., shares) tax-free to other individuals up to the annual gift tax exclusion. In 2019, the gift exclusion is $15,000 for individuals and $30,000 for married couples.
Additionally, once FLP shares are gifted, the value of the shares leaves the gifting individual’s estate, which means that any future returns on those FLP shares are excluded from their estate taxes. The beneficiary of the FLP shares would also benefit from any increase in interest, dividends or profits generated by the FLP assets.Example: An older couple has amassed savings in the millions of dollars and wants to ensure their children and grandchildren receive sizeable inheritances. The couple establishes an FLP and transfers all or a portion of their savings into it. Each year, they gift the gift tax limit of $30,000 worth of FLP shares to each of their children and grandchildren. This means the couple can transfer a large amount of FPL interests gift-tax free, every year, and their children’s and grandchildren’s inheritances will only increase as the FLP assets earn interest, dividends or profits.
Family LLCs and Family Limited Partnerships are real business entities, and they should be treated as such. Meetings should be held on a regular basis to review the conduct of the entity's investment business, the entity should make proportionate distributions to the members or partners, and the entity should never be used as the personal bank account of any member or partner.
Creating a Family LLC or Family Limited Partnership for purposes of real estate investing and/or preservation of generational wealth are complex matters and should not be done without the help of an estate planning professional.
If you want to learn more about setting up a Family LLC or FLP in Florida, please contact me today!