Family investment partnerships: all the perks.

• Author: Nevius, Alistair M.

Family investment partnerships (IPs) are frequently used to manage and control multigenerational family wealth. Aggregating family assets in an IP may also result in significant economic and tax benefits. Accomplishing a family's investment goals, however, requires understanding its investment objectives, the nature of its underlying investments, and the degree of investment flexibility sought by participating family members or entities. Although these entities appear complex, they are now much easier to administer because technology helps to reduce the burden of tracking sophisticated global investment products and complying with U.S. tax reporting requirements.

A well-conceived IP structure and investment strategy could provide the following benefits:

1. Access to leading money managers who are available to institutional or wealthier investors;

2. Larger asset blocks achieved by pooling family assets, thus providing a more efficient size for trading purposes and lower proportionate investment advisory and banking fees;

3. Fewer managed accounts and account fees;

4. Opportunities to reduce the tax cost of wealth transfer among generations;

5. Ability to accommodate various asset classes ranging from liquid cash equivalents and marketable securities to illiquid private equity and real estate;

6. Ability to rebalance investment portfolios in a cost-and tax-efficient manner for family members with differing investment needs and objectives;

7. Co-investment by family members who individually may have access only to costlier retail investment products; and

8. Ability to compensate family office executives in a manner that is directly aligned with their performance.

An IP structure is typically comprised of one or more partnerships through which a family may invest in marketable securities or illiquid alternative investments. The characteristics of these partnerships, such as allocations of income and distribution of cashflow, vary greatly depending on the asset classes in which the partnerships invest.

Accounting for the movements of capital in these entities also can be complex, but rules permitting the aggregation approach of tracking "reverse" Sec. 704(c) gain or loss help manage the allocation of taxable income or loss among the partners. If the IP invests in marketable securities and meets the definition of an investment partnership under Regs. Sec. 1.704-3(e)(3)(iii)(B)(2) (90% of its assets must be actively traded property), then partnership...