Real Estate FLP with Retained Management: Legitimate Business or §2036 Trap?

High

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🏢 Client

I'm setting up a family partnership to transfer wealth to my kids while maintaining control of our commercial real estate portfolio. Here's what I'm looking at: I own six apartment buildings worth about $30 million with minimal debt — probably $2 million in mortgages. My plan is to contribute all six properties to a new FLP, keep 100% of the general partner interest for myself, and gift 70% of the…

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Case Summary ▾

Complexity ⓘ High

Fact Pattern 68-year-old donor contributed six apartment buildings ($30M value, $2M debt) to FLP, retained 1% GP and 30% LP interests, and gifted 69% LP interests to three adult children within three months. Partnership pays donor $200k annual guaranteed payment for management services and distributes remaining $1M NOI proportionally quarterly to all partners including children.

Position Taken FLP structure is respected for estate and gift tax purposes with 30-35% valuation discount on gifted LP interests. Donor's retained GP management authority does not trigger IRC § 2036 inclusion because: (1) partnership holds operating real estate requiring professional management rather than passive securities, (2) guaranteed payment under § 707(c) represents market-rate compensation documented and separately stated from partnership distributions, (3) children receive substantial annual cash distributions ($230k each) demonstrating real economic benefit from transferred interests, and (4) partnership operates with arm's-length formalities including quarterly distributions to all partners proportional to interests. Supporting authorities: IRC § 2036(a) requires retained enjoyment or designation power; Treas. Reg. § 25.2511-2 (completed gift standard); § 707(c) (guaranteed payments for services).

IRS Challenge IRC § 2036(a)(2) inclusion of full undiscounted FMV at death. Service will argue three-month contribution-to-gift timeline demonstrates lack of legitimate business purpose beyond tax avoidance, retained GP management authority constitutes power to designate who enjoys property income even with mandatory distribution provisions (GP controls expenses and reserves affecting distributable cash), and donor's continued management of properties identical to pre-contribution activity shows no change in economic substance. Bongard v. Commissioner supports inclusion where donor-GP retains broad management and distribution powers. Guaranteed payment may be recharacterized as disguised retained enjoyment rather than arm's-length compensation. Accuracy-related penalties likely asserted under § 6662(a) for valuation discount on transfers subsequently disregarded.

Authorities

IRC § 2036(a)(1) IRC § 2036(a)(2) IRC § 707(c) IRC § 6662(a) Treas. Reg. § 20.2036-1(b)(2) Treas. Reg. § 25.2511-2 Bongard v. Commissioner, 124 T.C. 95 (2005) Estate of Powell v. Commissioner, 148 T.C. 392 (2017) Rev. Rul. 73-361