The primary advantage of a family partnership is a 1 percent interest in a family partnership is not worth 1 percent of the partnership assets. Thus, the unit you give to a child during your life (or that passes to them at your death) is not worth what you would think is its full value. The reason is “the sum of the parts does not equal the value of the whole.”

The key is how we define “fair market value.” The fair market value of an asset that is gifted during life or passed at death is how much a willing buyer would pay a willing seller. Let us say I put a $300,000 piece of property into a partnership with me owning 80 percent and my children owning 20 percent. The property cannot be sold unless a majority of partners agree. I probably will get most of the partnership income as compensation for my services in managing the property. Moreover, the property may be tied up until the partnership dissolves in 30 years.

I offer to sell you 20 percent out of my 80 percent. Would you pay me $60,000 (20 percent of $300,000) to be a partner with me and my children? You simply would not. Your $60,000 would likely be tied up for years. Would you pay me $1,000? Sure! You would willingly tie up $1,000 to get hopefully $60,000 and more in the future. Hence, the “fair market value” of the 20 percent partnership interest lies somewhere between $1,000 and $60,000.

Studies show that your “average” buyer would be willing to buy and your “average” seller would be willing to sell a 20 percent partnership interest in a $300,000 partnership for about $39,000. This is an $21,000 or 35 percent discount. That is the key.

You can give to your family members a 20 percent interest in a $300,000 family partnership during life or at death and it only uses $39,000 (instead of $60,000) of your gift or estate tax exemption. When you pass away your 80 interest is valued for estate value purposes with the discount at $156,000, instead of the undiscounted value of $240,000. This is a value discount of $84,000!