03 May What Is a Limited Partnership?
By: Barry E. Haimo, Esq.
May 3, 2016
What Is a Limited Partnership?
A limited partnership (LP) by definition is a form of ownership that can protect limited partners from financial or legal liability. In a limited partnership, you have a partnership consisting of a general partner and limited partner. A general partner manages and operates the business. General partners are personally liable for the debts and obligations of the Limited Partnership. They frequently also apply for and personally guarantee loans on behalf of the Limited Partnership
In contrast to general partners, limited partners cannot participate in the management and operations of the business. As a result, limited partners do not have any personal liability for the debts and obligations of the Limited Partnership.
Through a partnership agreement, both types of partners negotiate their respective limited partnership percentage interests. These amounts are typically based on the amount of contribution to the Limited Partnership and desired distribution and/or allocation of profits and losses to limited partners. Limited partners, however, earn a passive income through these agreements. Importantly, if a lawsuit were filed against the Limited Partnership, the general partner would be liable, whereas limited partners are generally shielded from liability. Similarly, creditors of the limited partners are limited in their ability to levy the limited partners’ interest in the Limited Partnership to satisfy a debt This will be covered in detail later.
Understanding Passive Income
When we say that limited partners receive passive income, we mean that they don’t get active or portfolio income. Another way to look at this is that their income is considered “passive” because they are not materially participating in the partnership.
This kind of income is taxable, but is treated different than active and portfolio income. Having passive income is beneficial because passive losses cannot be offset by active or portfolio income. If, in a tax year, a limited partner reports a passive loss that is higher than his or her passive gain, the remaining loss is carried over into the next tax year.
Protection with Limited Partnerships
Limited partnerships not only provide the best form of legal protection, they also protect your assets. A limited partner is only liable for his or her contribution to the Limited Partnership. As mentioned above, a creditor cannot easily pursue these assets to satisfy judgments.
Families can enter a family limited partnership (FLP) as a way to protect the family’s assets. An FLP is formed under state law, and allows future generations to receive interests. Often these types of limited partnerships are used for estate tax planning; mainly due to their ability to receive discounts for lack of control and marketability.
Example of a Limited Partnership
Want to know what a limited partnership looks like?
Let’s say a group of investors decide to buy and manage an apartment complex. A partnership agreement is drawn up, in which each partner contributes a certain percentage of the investment, and earns a certain amount of revenue from the apartment complex.
The general partners (often comprised of another entity to insulate from liability) are involved with the day-to-day management and operation of the apartment complex, and earn an active income from this investment. The limited partners are not materially involved, but continue to earn a passive income. In a lawsuit against the apartment complex, the general partners can be held liable (but as mentioned above, are limited due to also being a separate business entity), but the limited partners are protected.
As you can see, limited partnerships have many benefits. But your involvement in multiple partnerships and deals can open up the possibilities for having vulnerable assets. If you are considering entering into a limited partnership or forming a family limited partnership, it is important to understand your rights and create the best plan to protect these assets, especially as they relate to your overall estate planning goals
Barry E. Haimo, Esq.