When a partner dies, the question of how to value that partnership interest for estate and gift tax purposes is rarely straightforward. IRC Section 712 provides the statutory framework — but the real complexity lies in how it interacts with family limited partnerships (FLPs), minority interest discounts, and the IRS's ongoing scrutiny of valuation strategies.

This article breaks down what IRC 712 actually says, how it applies in practice, and what Autarky's CPA- and EA-led team looks for when reviewing a client's estate plan that includes partnership interests.

IRC § 712 establishes that when a partner dies, the fair market value of the partnership interest is included in the decedent's gross estate under IRC § 2033. The valuation is determined as of the date of death (or the alternate valuation date under IRC § 2032, if elected).

The key phrase is fair market value — defined under Treasury Regulation § 20.2031-1(b) as the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell, and both having reasonable knowledge of the relevant facts.

For publicly traded partnership interests, this is straightforward. For closely held or family partnerships, it is anything but.

Family limited partnerships (FLPs) and family limited liability companies (FLLCs) are commonly used estate planning vehicles. A senior family member transfers assets — typically real estate, investment portfolios, or operating business interests — into a partnership, retaining a general partner interest while gifting or selling limited partner interests to heirs.

The estate planning benefit comes from valuation discounts applied to those limited partner interests:

• Lack of marketability discount (LOMD): A limited partner interest in a closely held FLP cannot be easily sold on the open market. Courts and appraisers routinely apply discounts of 15–35% for this restriction.
• Minority interest discount: A limited partner typically has no control over distributions, management decisions, or liquidation. This lack of control supports an additional discount of 15–40%.

Combined, these discounts can reduce the taxable value of transferred interests by 30–50% compared to the underlying net asset value — a significant estate and gift tax savings.

IRC § 712 does not itself authorize or prohibit valuation discounts. It simply requires that the fair market value of the partnership interest — not the underlying assets — be included in the estate. The discounts flow from the nature of the interest itself under general valuation principles.

This distinction matters. The IRS has repeatedly challenged FLP arrangements under several theories:

If the decedent retained the right to income from the transferred assets, or retained control over the partnership, the IRS may argue the underlying assets (not the discounted partnership interest) should be pulled back into the gross estate under § 2036(a). Courts have sided with the IRS in cases where:

• The decedent commingled personal and partnership funds
• The FLP was formed on the deathbed with no legitimate business purpose
• The decedent continued to use partnership assets as personal property

Partnership agreements that restrict transferability or set below-market buyout prices may be disregarded under § 2703 unless the restriction meets a three-part test: it is a bona fide business arrangement, not a device to transfer property to family members for less than full consideration, and comparable to arm's-length arrangements.

Certain restrictions on liquidation that lapse at death, or that are more restrictive than state law default rules, may be disregarded when valuing the interest. Proposed regulations under § 2704 (though not yet finalized as of this writing) would significantly curtail the use of artificial restrictions to inflate discounts.

Under IRC § 2032, the executor may elect to value estate assets as of six months after the date of death if doing so reduces both the gross estate and the estate tax liability. For partnership interests, this election can be valuable when:

• The partnership holds publicly traded securities that declined after death
• A real estate partnership experienced a market correction post-death
• The partnership was in the process of liquidating and the interest's value changed materially

The election applies to all assets in the estate — you cannot cherry-pick which assets to value at the alternate date.

A critical benefit of holding partnership interests at death is the step-up in basis under IRC § 1014. The heir's basis in the partnership interest is stepped up to its fair market value as of the date of death (or alternate valuation date). This eliminates the built-in gain that accumulated during the decedent's lifetime.

For partnerships holding highly appreciated real estate or securities, this step-up can be worth more than the estate tax savings from valuation discounts — particularly for estates below the federal exemption threshold (currently $13.99 million per individual in 2025, scheduled to sunset to approximately $7 million in 2026 under current law).

Planning implication: For estates unlikely to owe federal estate tax, holding appreciated assets in a partnership until death to capture the § 1014 step-up may be more valuable than lifetime gifting strategies that preserve the carryover basis.

For estate and gift tax returns reporting partnership interests, a qualified appraisal by a qualified appraiser is required under IRC § 6695A and the regulations thereunder. The appraisal must:

• Be conducted no earlier than 60 days before the gift or no later than the due date of the return
• Use a recognized valuation method (income approach, market approach, or asset approach)
• Document the discount methodology and comparable transactions
• Be signed by an appraiser meeting the IRS's credentialing requirements

Failure to obtain a qualified appraisal can result in penalties under § 6662 for substantial valuation misstatements (20% of the underpayment) or gross valuation misstatements (40%).

1. Stale appraisals. Using an appraisal prepared for a prior gift to support the date-of-death value. Market conditions change; a new appraisal is required.

2. Ignoring § 2036 exposure. Forming an FLP without a legitimate non-tax business purpose — asset protection, centralized management, facilitating gifts to heirs — invites IRS challenge. The partnership must function as a real business entity.

3. Commingling assets. Paying personal expenses from the partnership account, or failing to maintain separate books, undermines the entity's legitimacy and the discount argument.

4. Overlooking state estate taxes. Twelve states and the District of Columbia impose their own estate taxes with lower exemption thresholds. Valuation discounts that reduce the federal taxable estate may not apply identically under state law.

5. Failing to coordinate with the income tax basis rules. The § 1014 step-up applies to the partnership interest, not directly to the underlying assets. A § 754 election allows the partnership to adjust the inside basis of its assets to reflect the stepped-up outside basis — but the election must be made timely and documented properly.

IRC § 712 is not a planning tool in isolation — it is the starting point for understanding how your partnership interest will be valued when you die. The real planning happens in the structure of the partnership agreement, the timing of transfers, the quality of the appraisal, and the coordination with income tax basis rules.

If your estate plan includes an FLP or FLLC, or if you are considering transferring business or investment assets into a partnership structure, the interaction of §§ 712, 2036, 2703, 2704, and 1014 deserves careful attention from a CPA and attorney working together.

Autarky's team includes former IRS agents who have reviewed these structures from the government's perspective. We know what the IRS looks for — and how to build a defensible position before a return is ever filed.

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