Limited Partnerships (LPs) have their specific uses in the world of family planning and investments. There is one limitation to the LP that, when studied carefully can be a key advantage in smart asset management.

Limited Partnership Definition

A limited partnership by definition must have at least two partners – a general partner, who is personally responsible for everything, and a limited partner, whose exposure is limited to their contribution (money) to the LP.

Unlike an LLC, S corp or C corp, to gain complete protection we need to form two entities. First, the LP itself and second a corporation or LLC to be the protected general partner. The advantage comes with the general partner exercising complete control over the LP, even with as little as 2% ownership. Thus, mom and dad can gift away 98% limited partnership interests to the kids and still maintain control of the investment with their 2% general partnership interest. Having multiple general partners can add complexity that should be dealt with through proper structuring of entities.

LPs are taxed as partnerships and are used to hold real estate and other appreciating assets. Many states afford LPs the charging order protection, thus providing excellent asset protection benefits.

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Limited Partnership Definition

Advantages of Limited Partnerships

  • LPs allow for pass-through taxation for both the limited partner and the general partner.
  • Limited partners are not held personally responsible for the debts and liabilities of the business, although the GP, if an individual, may be personally responsible.
  • The general partner(s) have full control over all business decisions, which can be useful in family situations where ownership – but not control – has been gifted to children.
  • Estate planning strategies can be achieved with LPs.
  • Limited partners are not responsible for the partnership’s debts beyond the amount of their capital contribution or contribution obligation. So, unless they become actively involved, the limited partners are protected.
  • As a general rule, general partners are personally liable for all partnership debts. But as was mentioned above, there is a way to protect the general partner of a limited partnership. To reduce liability exposure, corporations or LLCs are formed to serve as general partners of the limited partnership. In this way, the liability of the general partner is encapsulated in a limited liability entity.
  • Because by definition limited partners may not participate in management, the general partner maintains complete control. In many cases, the general partner will hold only 2 percent of the partnership interest but will be able to assert 100 percent control over the partnership. This feature is valuable in estate planning situations where a parent is gifting or has gifted limited partnership interests to his children. Until such family members are old enough or trusted enough to act responsibly, the senior family members may continue to manage the LP even though only a very small general partnership interest is retained.
  • The ability to restrict the transfer of limited or general partnership interests to outside persons is a valuable feature of the limited partnership. Through a written limited partnership agreement, rights of first refusal, prohibited transfers, and conditions to permitted transfers are instituted to restrict the free transferability of partnership interests. It should be noted that LLCs can also afford beneficial restrictions on transfer. These restrictions are crucial for achieving the creditor protection and estate and gift tax advantages afforded by limited partnerships.
  • Creditors of a partnership can only reach the partnership assets and the assets of the general partner, which is limited by using a corporate general partner which does not hold a lot of assets.
  • Also, with proper planning, transfers of family assets from one generation to the next can occur at discounted rates. As a general rule, the IRS allows one individual to give another individual a gift of $14,000 per year (at this writing). Talk with your advisors on how using a limited partnership for the management and gifting of family assets, gifting can be accelerated with an IRS-approved discount.
  • The limited partnership provides a great deal of flexibility. A written partnership agreement can be drafted to tailor the business and family planning requirements of any situation. And there are very few statutory requirements that cannot be changed or eliminated through a well-drafted partnership agreement.
  • Limited partnerships, like general partnerships, are flow-through tax entities. The limited partnership files an informational partnership tax return (IRS Form 1065, “U.S. Return of Partnership Income,” the same as a general partnership), and each partner receives an IRS Schedule K-l (1065), “Partner’s Share of Income, Deductions, Credits, etc.,” from the partnership. Each partner then files the K-l with their individual IRS 1040 tax return.

Form your LP now. Call 1-800-600-1760

Get the Book! For more information on this topic, please read, How to Use Limited Liability Companies & Limited Partnerships.

You might be wondering why having to form an extra LLC to provide the asset protection needed in an LP would be a good thing. Why not just form a single LLC in the first place and be done with it? But there are reasons this entity choice may be best for you and that is that the second type of limited partnership partner is a limited partner.

By definition, a limited partner is “limited” to his contribution of capital to the partnership and may not become actively involved in the business of the partnership. A limited partner may then be an owner but have absolutely no say in how the entity operates. This was exactly what a client of mine, Jim, wanted.

Case Study: When a Limited Partnership is Best

Jim is the proud father of three boys. Aaron, Bob, and Chris are active, athletic, and creative boys almost ready to embark upon their own careers. The problem was that they were sometimes too active, too athletic, and too creative.

At the time Jim came to see me, Aaron was seventeen years old and every one of the seemingly unlimited hormones he had was shouting for attention. He loved the girls, the girls loved him, and his social life was frenetic and chaotic.

Bob was sixteen years old and sports were all that mattered. He played sports, watched sports, and lived and breathed sports.

Chris was fifteen years old and the lead guitarist in a heavy metal band. When they practiced in Jim’s garage the neighbors did not confuse them with the Beatles.

Jim has five valuable real estate holdings that he wants to go to the boys. His wife had passed on several years before and he needed to make some estate planning decisions. But given the boys’ energy level and lack of direction he did not want them controlling or managing the real estate.

Jim knew that if he left the assets in his own name, when he died the IRS would take 55 percent of his estate, which was valued at over $10 million. And while estate taxes were supposed to be gradually eliminated, Jim knew that Congress played politics in this arena and no certainty was guaranteed. Jim had worked too hard, and had paid income taxes once already before buying the properties, to let the IRS’s estate taxes take away half his assets. But again, he could not let his boys have any sort of control over the assets. While the government could squander 55 percent of his assets, he knew that his boys could easily top that with a 100 percent effort.

I suggested that Jim place the five real estate holdings into five separate limited partnerships.

I further explained to Jim that the beauty of a limited partnership was that all management control was in the hands of the general partner. The limiteds were not allowed to get involved in the business. Their activity was “limited” to being passive owners.

It was explained that the general partner can own as little as 2 percent of the limited partnership, with the limited partners owning the other 98 percent of it, and yet the general partner can have 100 percent control in how the entity was managed. The limited partners, even though they own 98 percent, cannot be involved. This was a major and unique difference between the limited partnership and the limited liability company or a corporation. If the boys owned 98 percent of an LLC or a corporation they could vote out their dad, sell the assets, and have a party for the ages. Not so with a limited partnership.

The limited partnership was perfect for Jim. He could not imagine his boys performing any sort of responsible management. At least not then. And at the same time he wanted to get the assets out of his name so he would not pay a huge estate tax. The limited partnership was the best entity for this. The IRS allows discounts when you use a limited partnership for gifting. So instead of annually gifting $14,000 tax free to each boy he could gift $16,000 or more to each boy. Over a period of years, his limited partnership interest in each of the limited partnerships would be reduced and the boys’ interest would be increased. When Jim passes on, his estate tax will be based only on the amount of interest he had left in each limited partnership. If he lives long enough he can gift away his entire interest in all five limited partnerships.

Except for his general partnership interest. By retaining his 2 percent general partnership interest, Jim can control the entities until the day he dies. While he is hopeful his boys will straighten out, the limited partnership format allows him total control in the event that does not happen.

Jim also liked my advice that each of the five properties be put into five separate limited partnerships. I explained to him that the strategy today is to segregate assets. If someone gets injured at one property and sues, it is better to only have one property exposed. If all five properties were in the same limited partnership, the person suing could go after all five properties to satisfy his claim. By segregating assets into separate entities the person suing can only go after the one property where they were injured.

Jim liked the control and protections afforded by the limited partnership entity and proceeded to form five of them.

Take Action: Should You Hire Help When Setting Up an LP?

When is it worth it to hire an expert to set up your entity? It’s best to look at it from a cost benefit analysis approach. Should you spend $750 on an accountant to save $5,000? It’s your choice. Because certain laws and tax regulations are downright and annoyingly complex, it is really not worth your time to deal with them. You likely have a business to run and a family to raise. You don’t need to be spending your weekends learning the arcania of the recapture rules for depreciable assets. Pay someone who does it for a living to do it for you. And remember, while our laws can be complex, in complexity comes advantage. Working with a professional to take advantage of complexity can be very worthwhile. The rich have done so for a very long time.

Form your LP now.  Contact Corporate Direct at 1-800-600-1760.

Get the Book! For more information on this topic, please read, How to Use Limited Liability Companies & Limited Partnerships.