Learn about the details of what makes a limited partnership and find out how it compares to other types of partnerships in business.
What Is a Limited Partnership?
General partners own and operate a business, while limited partners invest in the business but do not make operational decisions or carry any personal liability for company debt. One or more of each type of partner can come together to create a limited liability partnership.
Limited partnerships are often used for firms in which the professionals involved want to turn over management of the business to the general partner. Real estate investors, for example, might use a limited partnership.
Another common use of a limited partnership is in a family business, called a family limited partnership. Members of a family may pool their money, designate a general partner, and watch their investments grow.
How Limited Partnerships Work
There is at least one general partner in a limited partnership who is responsible for the day-to-day management of the business. The general partner may be an individual person or an entity, like a corporation. These types of partners make decisions that affect the business and are therefore fully liable for debts and lawsuits taken on by the business.
A limited partnership also has one or more limited partners. These individuals are sometimes called "silent partners" because they don't have to do anything except invest in the business to get a share of the profits. They are passive owners who don't participate in the management of the business. Their liability is limited to their investment in the partnership, like owners (members).
For tax purposes, limited partnerships are pass-through business entities: The income tax of the business is passed through to the individual partners. Like other types of partnerships, the income taxes are paid by the individual partners according to their share of the business. This share, called a distributive share, is passed through to the owner's personal tax return, and income taxes are paid at the individual's personal tax rate.
When the limited partnership has a loss, there's a difference in how the general partner and limited partners are treated for tax purposes. The general partner can take the loss even if the individual has no other income to offset it.
A limited partner has a passive income because they don't materially participate in the running of the partnership. This means they can't take a loss to reduce income taxes if there is no other income to offset this loss.
How to Form a Limited Partnership
Like most businesses, you can form a limited partnership by registering with your state and paying a filing fee.
In addition to the registration, you will need to create a partnership agreement that spells out all of the responsibilities of the partners. The agreement also details how the profits of the partnership are divided among the partners. It should also include provisions that answer the question, "What if something happens to the general partner?"
Pros and Cons for Limited Partnerships
A limited partnership has the same advantages as other types of partnerships with the option of limited partners: These partners can limit their liability while still benefiting monetarily from the growth of the business.
The major disadvantage to the limited partnership is that the general partner must bear all legal liability for their management decisions. This person will usually require adequate compensation to offset these risks.
Alternatives to Limited Partnerships
The limited partnership differs from a general partnership, which has only partners who participate in the management of the business. All general partners have liability and they all can share in both profits and losses.
A limited liability partnership combines the characteristics of a partnership and a corporation. In this type of partnership, all partners are considered to be limited partners with limited liability. However, all of them can participate in the management of the business.
A business can form a limited liability company (LLC) that serves as the general partner and takes on all liability instead of having individuals take personal responsibility.
- A limited partnership (LP) is a type of business that's owned by two types of partners: general partners and limited partners.
- The general partners in an LP make business decisions and take on full liability for the company.
- The limited partners in an LP invest their money but don't make any business decisions or take on any liability for the company.