Limited Partnership
A limited partnership (LP) is a partnership with at least one general partner and at least one limited partner. For REG, the tax rules largely follow partnership taxation, but the exam often tests the different legal and economic positions of general versus limited partners.
Core legal and tax profile
- Owners: One or more general partners and one or more limited partners.
- Liability: General partners usually have unlimited liability; limited partners generally risk only their investment.
- Federal return: Usually Form 1065.
- Tax character: Pass-through taxation with Schedule K-1 reporting.
Why LPs matter
Limited partnerships are commonly used when passive investors want liability protection without taking on day-to-day management authority. That structure shows up often in real estate, investment, and private fund settings.
Tax rules the exam emphasizes
Formation and contributed property
Like other partnerships, contributions of cash or property are generally nonrecognition events, and contributed property typically carries over into the partnership at its adjusted basis.
Basis and liabilities
A partner's outside basis includes the partner's share of partnership liabilities. On REG questions, limited partners often receive a share of nonrecourse liabilities, while general partners may bear more of the economic risk of recourse liabilities.
Passive activity treatment
A limited partner's share of losses is more likely to be treated as passive, which can restrict immediate deductibility unless the partner has passive income or disposes of the activity.
Self-employment tax distinction
A key exam point is that a limited partner's distributive share of ordinary trade or business income is generally not subject to self-employment tax, although payments for services may be treated differently.
Distributions
Current and liquidating distributions generally follow the same framework used for partnership taxation:
- Usually no gain unless cash exceeds outside basis
- Basis shifts from the partnership interest to distributed assets
- Special attention goes to cash, unrealized receivables, and inventory items
Advantages and disadvantages
| Topic | Limited Partnership |
|---|---|
| Tax regime | Pass-through taxation |
| Liability protection | Better for limited partners than general partners |
| Investor appeal | Useful for passive investors |
| Management | Controlled primarily by general partners |
| Complexity | More formal than a general partnership |
REG quick hits
- LPs still use partnership tax rules.
- General and limited partners can have very different liability outcomes.
- Limited partners are often passive investors for loss limitation purposes.
- Limited partners generally do not pay self-employment tax on their distributive share of business income.
Bottom line
A limited partnership is a partnership tax entity with a split ownership model: managers on one side and passive capital on the other. On the exam, focus on liability, basis from liabilities, passive loss limits, and the self-employment tax distinction.