Entity Restructuring for Estate and Transition Planning in Real Estate Portfolios

Real estate investors rarely think about their entity structure until tax season arrives or a major life event forces the conversation. By then, opportunities may have already slipped away. The way you hold your properties today determines how much of your portfolio actually passes to your heirs, and how much goes to the IRS. For investors with substantial holdings, restructuring your entities before a transition event can preserve significantly more wealth for the next generation.

Understanding the Current Estate Tax Environment

The federal estate and gift tax exemption for 2026 stands at $15 million per individual. Married couples can effectively shelter $30 million from federal estate taxes. According to the IRS, estates exceeding these thresholds face a 40% tax rate on the excess amount.

Real estate portfolios present particular challenges in this context. Unlike stocks or bonds, properties cannot be quickly liquidated to cover tax obligations. Forced sales rarely produce optimal prices, and heirs may find themselves selling assets at a discount simply to satisfy estate tax liabilities within the required timeframe.

Valuation adds another layer of complexity. Properties require professional appraisals, and the IRS can challenge valuations it considers too low. Planning ahead allows investors to take advantage of legitimate strategies that reduce taxable estate values while maintaining control over their investments.

Family Limited Partnerships as a Transfer Vehicle

A family limited partnership creates two classes of ownership. General partners, typically the parents or senior generation, maintain management authority over the partnership assets. Limited partners, usually children or other heirs, hold ownership interests but cannot participate in day-to-day decisions.

This structure offers a significant planning advantage. When you transfer limited partnership interests to family members, those interests carry restrictions that reduce their value for gift tax purposes. Limited partners cannot force distributions, control management decisions or freely sell their interests on an open market. These restrictions support discounts for lack of control and lack of marketability when valuing transferred interests.

A property worth $5 million held in an FLP might allow you to transfer a 10% limited partnership interest valued at $425,000 rather than $500,000 after applying appropriate discounts. This means you can move more value out of your taxable estate while using less of your lifetime exemption. The annual gift tax exclusion for 2026 is $19,000 per recipient, or $38,000 for married couples making joint gifts, allowing families to transfer meaningful value each year without reducing their lifetime exemption.

Choose Between FLPs and Family LLCs

Family limited liability companies accomplish similar goals with some notable differences. Both structures allow for valuation discounts on transferred interests and both keep management authority with the senior generation.

The primary distinction involves liability exposure. In an FLP, general partners bear personal liability for partnership obligations. Limited partners enjoy protection, but the managing partners do not. Many families address this by having an LLC serve as the general partner, adding complexity to the arrangement. A family LLC provides liability protection to all members, including those who manage the company.

Management flexibility also differs between the structures. FLPs require general partners to handle management directly. LLCs can designate specific members as managers or even hire outside management while other members remain passive. For families where the senior generation wants to step back from active involvement while retaining ownership, this flexibility can be valuable.

State law governs formation requirements, annual fees and ongoing compliance obligations for both entity types. The operating documents should include clear provisions addressing transfer restrictions, distribution policies and management succession.

Combine Entity Structures with Trust Planning

Entity restructuring becomes more powerful when coordinated with trust strategies. Transferring FLP or LLC interests to irrevocable trusts provides additional estate tax benefits while offering asset protection for beneficiaries.

A Spousal Lifetime Access Trust allows one spouse to gift assets for the other spouse’s benefit while removing those assets from the taxable estate. The beneficiary spouse can receive distributions, and the grantor spouse benefits indirectly through the marriage. This approach works particularly well with FLP or LLC interests because valuation discounts allow for larger transfers within exemption limits.

The interplay between entity structures and basis step-up rules deserves attention. Assets remaining in your estate at death receive a basis adjustment to fair market value, potentially eliminating capital gains for heirs. Assets gifted during life retain your original basis. Real estate investors who have used 1031 exchanges to defer gains over many years face important decisions about which assets to gift or retain.

Maintain Compliance and Documentation

These structures only work when properly implemented and maintained. The IRS scrutinizes family entity transactions, and arrangements lacking legitimate business purposes or proper formalities may be disregarded.

Your operating documents must clearly define each ownership class. Terms should establish that limited partners or non-managing members cannot withdraw capital unilaterally, force distributions or transfer interests without restrictions. These limitations form the foundation for valuation discounts.

Section 2036 of the Internal Revenue Code can pull assets back into your taxable estate if you retain certain rights over them. You cannot continue using transferred properties rent-free or maintain excessive control over distributions. Ongoing compliance requires annual meetings with documented minutes, separate bank accounts, accurate capital account records and distributions consistent with ownership percentages.

Plan Today for a Smoother Transition Tomorrow

Entity restructuring requires careful planning and ongoing attention, but the benefits for real estate investors can be substantial. The right structure protects your portfolio from excessive taxation, simplifies generational transitions and keeps your family in control of the assets you built. At James Moore, we work with real estate investors and family offices to design entity structures that support their long-term goals. If you are considering how to position your portfolio for the next generation, contact a James Moore professional to discuss your options.

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