Family LLC and Valuation Discounts in New York Estate Tax Planning

Putting family assets into an LLC and giving away non-controlling units lets you transfer more value per dollar of exemption. This page explains the discounts, the arithmetic, the IRS attack points, and the New York angles.

A share of something nobody can sell and nobody can control is worth less than its proportionate share of the whole. That is common sense to any minority owner, and it is also the law of gift and estate tax valuation. A family LLC takes advantage of it. Parents contribute investment real estate, a portfolio or a business to a limited liability company, keep the managing interest, and give non-managing units to children or trusts for them. Each unit is appraised at a discount from its share of the underlying assets, so more value moves for the same gift.

For a New York family the structure does double duty. Every discounted dollar that leaves the estate is a dollar further from the $7,350,000 exclusion and the $7,717,500 cliff, and the discount applies again at death to whatever the parents still hold. For a nonresident, an LLC also turns New York real estate into an intangible that New York does not tax at all. The technique is well established, but the IRS litigates it often, and it only works if the family runs the entity as a real business.

What a family LLC is

A family LLC (or a family limited partnership, which works the same way with general and limited partners) is an ordinary New York limited liability company owned by members of one family. The operating agreement usually creates two classes of interest: a small managing or voting class held by the parents, which controls investments, distributions and the sale of assets, and a large non-managing class that has an economic interest but no say. The parents take all the units for their contribution, then transfer non-managing units by gift or sale. Our page on why to form a New York family LLC covers the non-tax reasons: centralized management, creditor protection, and keeping property in the family.

How the discounts work

A gift is valued at what a willing buyer would pay a willing seller. A buyer of a 10% non-managing interest cannot force a distribution, compel a sale, or vote out the manager, and cannot easily resell because the operating agreement restricts transfers and there is no market. A qualified appraiser accounts for this with two discounts:

Lack of control (minority) discount

Reflects the holder’s inability to direct distributions, management or liquidation. Larger when the operating agreement concentrates authority in the manager and requires a supermajority to dissolve.

Lack of marketability discount

Reflects the absence of a ready market and the transfer restrictions. Larger for an entity holding illiquid real estate or an operating business than for one holding marketable securities.

Combined, the discounts commonly fall in the 20%–40% range, depending on the assets, the agreement and the appraiser’s analysis. A formal qualified appraisal is required; a discount the family picks itself will not survive an audit. We go into the appraisal factors on our page on the discount for lack of marketability and control in a New York family LLC.

A worked example

A New York couple contributes $10,000,000 of investment real estate to a family LLC. They keep the managing units. An appraiser concludes that non-managing units carry a 30% combined discount. They give 40% of the units to a trust for their children.

The children’s trust now owns 40% of an entity holding $10,000,000 of real estate, plus 40% of all future appreciation and rents, and the gift cost the parents $2,800,000 of exemption rather than $4,000,000. The same discount reaches the parents’ retained 60% at death. If the parents die still holding those units and the appraisal then supports a similar discount, the units enter their estates at about $4,200,000 rather than $6,000,000. For a couple whose other assets already approach $7,350,000 each, that difference can be the difference between paying nothing and paying on every dollar. The discount at death survives only if the parents actually gave up control of the economics; see the § 2036 discussion below.

New York real estate and nonresidents

New York taxes a nonresident’s estate only on real property and tangible personal property located in New York. Intangibles, including an interest in an LLC or partnership that itself holds New York real estate, are generally not taxed under current guidance. A Florida or New Jersey resident who owns a Manhattan apartment or a Long Island rental directly has a New York taxable estate; through an LLC, generally not. For nonresidents this is often the most valuable thing a family LLC does, and it works without any gifting. The deed must actually be transferred and the LLC respected.

Pairing the LLC with other techniques

• Annual exclusion gifts. Non-managing units worth $19,000 per child per year, or $38,000 with gift-splitting, can be given every year without a taxable gift and without any New York add-back exposure. Because of the discount, $19,000 of units represents more than $19,000 of real estate. The units must carry a present interest, so the agreement cannot let the manager indefinitely defeat the donee’s economic rights.
• SLATs. A spousal lifetime access trust funded with discounted units moves more underlying value for the same use of exemption while the beneficiary spouse keeps indirect access.
• GRATs. A GRAT funded with discounted units combines the discount with the growth transfer; the annuity can be paid back in units, and defining it as a percentage of the finally determined value protects against a revaluation.
• Dynasty trusts. Units given to a dynasty trust with GST exemption allocated leverage the $15,000,000 GST exemption by the same discount and keep the real estate out of the children’s and grandchildren’s estates. New York has no GST tax of its own.

Where the IRS attacks

The IRS does not dispute that discounts exist; it argues that a particular family did not really give anything up. The main weapon is IRC § 2036(a), which pulls an asset back into the estate if the decedent transferred it but kept the possession, enjoyment or income, or the right to say who enjoys it. In Estate of Powell v. Commissioner, 148 T.C. 392 (2017), the Tax Court applied § 2036(a) to bring the full undiscounted value of a partnership’s assets back into the estate where the decedent, acting with her family, could control distributions and dissolution. Estate of Strangi reached a similar result. The recurring facts in the IRS’s wins are:

• No non-tax business purpose. An LLC formed solely to generate a discount, holding a single passive account, with no management activity to speak of.
• Deathbed formation. An entity created weeks before death, often by an agent under a power of attorney, with units immediately gifted out.
• Commingling. The LLC paid the decedent’s personal bills, or nearly all of the decedent’s assets went in, leaving nothing to live on outside the entity.
• Ignoring the operating agreement. Distributions that were not pro rata, no meetings, no books, no separate account, no tax returns.
• Sole control over distributions retained by the donor. A parent who alone decides when and whether anyone gets money has kept the enjoyment of the units given away. Distribution decisions should follow a fiduciary standard and, ideally, involve an independent manager or a vote.

The withdrawn regulations deserve a mention. In 2016 the Treasury proposed regulations under IRC § 2704 that would have disregarded many of the restrictions that support lack-of-control discounts in family entities. They were withdrawn in 2017 and never took effect; discounts remain available. Chapter 14 (§§ 2703 and 2704) still requires that transfer restrictions be comparable to what unrelated parties would agree to, which is a drafting point, not a bar.

Form 709 and adequate disclosure

Any gift of units above the annual exclusion, and any gift of units to a trust, must be reported on a Form 709 by April 15 of the following year. Even when it is not required, we file. A return that meets the adequate-disclosure rules (Treas. Reg. § 301.6501(c)-1(f)), by attaching the appraisal, describing the entity and the discounts, and identifying the transfer, starts the three-year statute of limitations on the value of the gift. Without adequate disclosure, every unit gift can be reopened at death with no time limit, and a family that gave units away over twenty years could face twenty years of revaluations at once. Gift-splitting under § 2513, if used, also requires both spouses to sign the return. Our Form 709 page lists the disclosure elements.

Income tax and basis

Gifted units take the donor’s basis under IRC § 1015. They get no step-up at the donor’s death under § 1014 because they are no longer in the estate (Rev. Rul. 2023-2 confirms this for grantor trusts). If the family plans to sell the real estate, the children will pay capital gains tax on the parents’ historic basis: up to 23.8% federally and, for a New York City resident, a combined federal, state and city rate of roughly 38.5%. Retained units, by contrast, get a step-up in basis at death, but only to their discounted value, so the discount that saves estate tax also shrinks the step-up.

The practical rule is to give away high-basis or cash-like assets and appreciating assets, and to think hard before gifting units in a building the family bought decades ago for a fraction of its value. Where the estate tax saved clearly exceeds the capital gains cost, as it usually does near the $7,350,000 line, the gift makes sense; well under that line with low-basis property, holding until death may be better. Our pages on step-up and carryover basis and capital gains versus estate tax work through the comparison. The LLC is usually taxed as a partnership, so rents and gains pass through to the members.

New York-specific points

• No gift tax. New York imposes no tax on the gift of units. The discounted value is what counts for federal purposes, and nothing is due to the state.
• Three-year add-back. If a New York resident donor dies within three years of a taxable gift of units, the gift is added back to the New York gross estate (Tax Law § 954(a)(3)). The add-back uses the gift’s value as reported, which is the discounted value, so even a failed three-year test preserves the discount. Annual exclusion gifts are never added back.
• Publication requirement. New York requires a newly formed LLC to publish notice of its formation in two newspapers designated by the county clerk and to file a certificate of publication. The cost varies widely by county and is much higher in Manhattan; it is a one-time expense.
• Annual filing fee. An LLC treated as a partnership pays New York an annual filing fee that scales with its New York-source income, in addition to the members’ own income tax on the pass-through income.

Management and operating agreement terms

The operating agreement is where the discount is earned and where the § 2036 defense is built. We draft for both:

• A manager with a fiduciary duty to all members, not a parent with unfettered discretion. Consider an independent co-manager or a requirement that distributions be pro rata and made under a stated standard.
• Transfer restrictions that require consent for transfers outside the family, with a right of first refusal, comparable to what unrelated investors would accept.
• Dissolution and amendment requiring a supermajority of all units, so no single member, including the parents, can unwind the entity.
• Separate books, a separate account, annual meetings and a partnership tax return.
• Enough assets kept outside the LLC for the parents to live on.

Who it is for

• Good fit: families with substantial investment real estate, a closely held business or a large portfolio; parents who will actually manage the entity; nonresidents who own New York real estate; and families using SLATs, GRATs or dynasty trusts that want to stretch exemption.
• Poor fit: a single passive brokerage account with no management to do, a parent who cannot bear to give up control of distributions, a family that will not keep books and hold meetings, or a residence, which should not go into a family LLC.

Related Estate Tax Planning Topics

• GRAT – Funding a GRAT with discounted units to move growth without a taxable gift.
• SLAT – Discounted units in a trust for your spouse and children.
• Form 709 – Adequate disclosure and the three-year statute on unit gifts.
• Tax Basis: Step-Up and Carryover – What gifting low-basis real estate costs later.
• New York Estate Tax in 2026 – The exclusion, the rate table and the add-back.

Talk to us about a family LLC

We form family LLCs, draft operating agreements that support the discount and withstand § 2036, coordinate the appraisal, and prepare the Form 709 with adequate disclosure. Call Albert Goodwin at 212-233-1233 or email [email protected] to discuss whether a family LLC fits your assets.