Estate Planning for Clients with Real Estate, LLCs, and Closely Held Businesses

Real estate portfolios, LLCs, family limited partnerships, and closely held operating businesses create estate planning opportunities that are simply not available for liquid assets. They also create risks that many families do not discover until it is too late. This guide covers the full landscape — entity structure, valuation discounts, basis planning, transfer strategies, and the coordination required to make it all work.

Why Complex Asset Structures Require Different Planning

A client with $10 million in a brokerage account and a client with $10 million in closely held business interests face fundamentally different estate planning challenges — even if the dollar amounts are identical.

The liquid client has a simple valuation problem and a simple transfer problem. The assets can be valued with precision, transferred easily, and if the estate tax bill comes due, the executor has options.

The complex client has a different set of problems and a corresponding set of opportunities. The business interests are illiquid — they cannot be sold in pieces to pay an estate tax bill without destroying value. They are harder to value, which creates audit risk. And they are often growing — which means the estate tax exposure grows with them every year the business increases in value.

But illiquidity and complexity also create planning leverage. Assets that are hard to value can be transferred at discounted values. Assets held in entities can be restructured to create minority interests eligible for those discounts. Business value can be frozen through techniques that cap the owner's estate exposure while transferring all future appreciation to the next generation. The families that capture those opportunities are the ones with coordinated advisory teams that understand how the legal structure, the tax analysis, and the planning strategy interact.

Entity Structure: The Foundation of Complex Asset Planning

The entity in which an asset is held determines nearly everything about how it can be transferred. Real estate held directly by an individual has different transfer characteristics than the same real estate held in an LLC.

For real estate, the most common entity planning involves organizing a portfolio of properties into one or more LLCs or limited partnerships. The reasons include liability protection, operational simplicity, and — most importantly for estate planning — the ability to create minority interests eligible for valuation discounts.

For operating businesses, the entity form — C corporation, S corporation, LLC taxed as a partnership, or sole proprietorship — has dramatic implications for both the income tax treatment of the business and the estate planning strategies available. S corporations have shareholder eligibility rules that constrain trust planning. C corporations are subject to double taxation but may qualify for significant benefits on sale (QSBS exclusion). LLCs taxed as partnerships offer the most flexibility for estate planning purposes.

The design of the operating agreement matters as much as the entity form. Restrictions on transfers, voting rights, distribution policies, and liquidation rights all affect the defensibility of valuation discounts and the mechanics of transfer strategies. The time to design the entity structure with estate planning in mind is before the assets are accumulated, not after.

Valuation Discounts: The Mechanics and the Risks

Valuation discounts are the most powerful and most contested tool in complex asset estate planning. When a minority interest in a closely held entity is transferred for gift or estate tax purposes, the value for transfer tax purposes may be significantly less than the pro-rata share of the entity's underlying assets.

There are two primary categories of discount. Lack of marketability discount (LOMD): a minority interest in a closely held LLC cannot be easily sold. There is no established market. A willing buyer would demand a discount to compensate for the difficulty of liquidating the investment. Courts and the IRS have generally accepted marketability discounts of 15 to 35 percent for closely held entities with appropriate restrictions.

Lack of control discount (minority interest discount): a minority interest holder cannot compel distributions, force a sale, or direct management. The inability to control operations justifies an additional discount. Control discounts of 15 to 30 percent are commonly applied to minority interests.

Combined, these discounts can reduce the transfer tax value of an entity interest by 25 to 45 percent. On a $10 million LLC interest, a 35 percent combined discount reduces the gift tax value to $6.5 million — saving $1.4 million in gift tax at a 40 percent rate.

The risks: the IRS scrutinizes these discounts aggressively, particularly when entities are formed primarily for estate planning purposes rather than legitimate business operations, when the grantor retains effective control despite transferring interests, or when the discount is not supported by a qualified appraisal. Entities need genuine business purpose, documented compliance with operating formalities, consistent treatment of entity assets as separate from the owner's personal assets, and qualified appraisals.

Real Estate-Specific Planning: Basis Step-Up vs. Transfer Tax

Real estate investors face a planning tension more acute than for most other asset classes: the conflict between estate tax efficiency and income tax basis preservation.

The basis step-up at death is enormously valuable for investors who have owned properties for many years and heavily depreciated them. Consider a commercial property purchased for $2 million in 2000, depreciated to an adjusted basis of $500,000, and now worth $8 million. The property carries $7.5 million of built-in gain — $6 million of appreciation plus $1.5 million of depreciation recapture. If transferred to a trust during lifetime at a carryover basis and later sold, the combined tax cost could approach $2 million.

If the same property passes through the estate at death, the basis steps up to $8 million. The entire $7.5 million of built-in gain disappears.

The analysis: for estates comfortably below the available exemption, retaining appreciated real estate for the basis step-up is almost always the right answer. For estates that significantly exceed the available exemption, transferring the real estate to trusts or to the next generation during lifetime is often more valuable, even accounting for the lost step-up. For estate sizes near the threshold, the analysis requires actual modeling of both scenarios.

Family Limited Partnerships: Design, Implementation, and Maintenance

The family limited partnership (FLP) is one of the most widely used estate planning vehicles for families with significant real estate or investment portfolios. It provides liability protection, facilitates annual gifting, creates a vehicle for valuation discounts, and allows parents to maintain management control while transferring economic interests to children and trusts.

A properly designed FLP has a general partner (often an LLC controlled by the parents) that manages the partnership's investments, and limited partners (family members, trusts) that have economic interests but no management rights. This structure supports both the lack-of-control discount and the lack-of-marketability discount.

The IRS has successfully attacked FLPs where: assets were transferred to the partnership but owners never actually ceded control; owners continued to use partnership assets for personal purposes; assets were transferred immediately before death; or the FLP was formed solely to avoid estate tax without legitimate business purpose.

Successful FLP planning requires: genuine transfer of assets at inception; consistent maintenance of partnership formalities; market-rate management fees; distributions made pursuant to the partnership agreement rather than at parental discretion; and clear business purpose independent of the tax savings.

Operating Business Succession: Buy-Sell Agreements

Closely held operating businesses need buy-sell agreements that work — agreements that are properly funded, regularly updated, and drafted to avoid the tax and legal disputes that unfunded or poorly designed agreements routinely create.

A buy-sell agreement that sets the purchase price at a formula value creates an estate tax problem if the formula does not reflect fair market value. The IRS is not bound by a buy-sell agreement's valuation formula for estate tax purposes unless the agreement meets specific requirements: the price must reflect fair market value at the time of transfer, the agreement must have been entered into for legitimate business reasons, and the price must apply to inter vivos transfers as well as transfers at death.

Funding matters. A buy-sell agreement without a funding mechanism — life insurance, a sinking fund, or a financing commitment — is a promise the parties may not be able to keep. An executor required to sell at a fixed price but without a buyer able to pay that price has a legal dispute, not a succession plan.

For S corporations, the buy-sell agreement must account for the eligibility rules. A buy-sell agreement that transfers stock to an ineligible trust can terminate the S election with significant and immediate tax consequences.

Coordination: The Missing Piece

The most consistent observation about estate planning failures in complex asset situations is not that the individual pieces were wrong — it is that the pieces were not coordinated. The real estate attorney restructured the portfolio into LLCs. The estate attorney drafted the trusts. The CPA prepared the returns. No one was responsible for making sure that the LLC operating agreements were compatible with the trust designs, that the valuations were consistent across gift tax returns, and that the annual reporting reflected the underlying structure.

Effective coordination for a complex asset estate plan requires someone — typically the CPA — to own the full picture: the entity structure, the trust design, the transfer strategy, the annual reporting, and the ongoing review. Not just prepare returns, but actively track whether the plan is being implemented as designed, whether the entities are being operated correctly, and whether changing circumstances require adjustments.

For families with multiple entities, multiple trusts, and multiple advisors, that coordination function is the most valuable service any advisor can provide. It is also the one most commonly left to chance.