Introduction to Limited Partnerships

By John Hamilton, CNE

My experience with Limited Partnerships was primarily to purchase real estate investment property in the late 1980s.  I was one of three general partners that mainly arranged for the purchase and the closing of the residential investment properties.  One of the general partners was an estate planning attorney, and most of the limited partners were his clients. My job was to find and negotiate the properties.

One of the reasons that limited partnerships are used in the purchase of real estate is that often times individuals would like to benefit from the pooling of investment capital in order to purchase larger investment properties that produce better cash flows as well as better potential for appreciation.  By forming a limited partnership, the limited partner investors limit their liability to their investment, and only the general partners have liability in managing the investment.  Also, if a limited partner wants to leave the partnership, he can be bought out without terminating the partnership.  The general partners are responsible for the management, operations and debt of the partnership, as well as potential legal liability of the partnership.

Because of this limited liability of the limited partners, it is less risky and thus easier to attract investors.  The danger of putting your investment money in a limited partnership is in giving up control to the general partners.  Even those with a track record of previous success, may not be reliable in the future.  I have always liked to be in control of my real estate investments, and you only have yourself to blame if things go wrong.

Typically, in structuring a limited partnership, the investing partners have a priority return of their investment along with a reasonable interest rate, prior to any profits being shared with the general partners.  And there are any number of ways the profits may be shared, and of course all of the profits are passed through to the partners who then report these profits on their tax returns.

One other point, inasmuch as the general partners would have liability from the investment, many times the general partners are structured as a Limited Liability Company (LLC) or as a corporation, in order to protect all of the partners.

Another use that has become popular for the use of the limited partnership structure is the “Family Limited Partnership”, where most of the time the parents become the general partners and the children and/or grandchildren are limited partners.  The parents can transfer assets into the limited partnership and the children are granted an ownership interest in a specific amount of the assets.  Those assets do not have to be distributed to the children, the parents can retain control, and yet that portion of the income attributable to the children will be taxed at the lower tax rate of the children, and therefore lower the total tax liability of the family.