Proper planning and training of the FLP is critical, but there are certain events that must be avoided or you could risk invalidating the FLP. If the person or persons transferring assets to an FLP are in a terminal situation, the IRS can invalidate the FLP as it is seen as a way for the transferor to hide assets rather than protect them.

It is equally important not to transfer all of one’s assets to an FLP. A person must maintain sufficient funds to handle daily expenses. Otherwise, it could have adverse tax effects. Also, one cannot use FLP assets to pay for personal expenses without following the terms of FLP. Of course, this refers to distributions from the FLP to the owner. A landlord cannot just take money anytime he chooses to. There are specific circumstances in which distributions can be taken and must be listed in the FLP agreement.

The FLP must not make excessive distributions to a homeowner to pay living expenses. Upon the owner’s death, the FLP is not required to pay estate expenses or estate taxes. That must be handled with the owner’s personal funds or through a life insurance policy. Distributions to certain partners and not to others can spell tragedy for an FLP.

An FLP is a legal business entity and should be treated as such. The correct transfer of assets must be handled legally. If a home is being transferred, then a real estate deed must be drawn up and filed with the appropriate government entity. The same is true for a vehicle. The title and registration must be transferred through the Department of Motor Vehicles. The other assets that have property title must be disposed of in the same way. Other assets can be transferred by deed of sale stating the date, the name of the transferor and what was transferred. A nominal purchase price must be made. In addition, the FLP must keep proper books and records as any business would. If there are no changes in the FLP’s business or investment strategies, the IRS can challenge the validity of the business.

No active involvement of younger family members
When any of the limited partners are not actively involved in business decisions and are not aware of the operations, then the FLP may be in jeopardy. All family members should be able to get advice from an independent lawyer or hire an appraisal expert; otherwise, the IRS may not allow tax benefits.