Limited Partnerships: A Complete Guide for Business Owners and Investors

Most business owners never consider a limited partnership—they default to LLCs or corporations without realizing that for certain situations, a limited partnership offers unique advantages neither structure can match. If you're raising capital from passive investors, structuring a family business, or entering real estate development, an LP might be exactly what you need.

A limited partnership combines the flexibility of a partnership with built-in protection for investors who want ownership without management responsibilities. It's the structure behind many private equity funds, real estate syndications, and venture capital firms—yet remains misunderstood by everyday entrepreneurs.

This guide breaks down how limited partnerships work, when they make sense, and how to decide if this structure fits your situation.

What Is a Limited Partnership?

A limited partnership (LP) is a business structure that requires at least two types of partners: one or more general partners who manage the business and bear full liability, and one or more limited partners who contribute capital but don't participate in management and enjoy limited liability.

This division creates a clean separation between operators and investors—something that's difficult to achieve with other business structures.

General Partners (GPs):

• Manage day-to-day operations
• Make business decisions
• Have unlimited personal liability for partnership debts
• Share in profits according to the partnership agreement

Limited Partners (LPs):

• Contribute capital to the business
• Cannot participate in management decisions
• Liability is limited to their investment amount
• Receive returns based on their contribution

The key principle: limited partners trade control for protection. They can't lose more than they put in, but they also can't direct how the business operates.

How Limited Partnership Liability Works

Limited liability is the defining feature that makes LPs attractive to passive investors.

When a limited partner invests $100,000 in a partnership, their maximum exposure is that $100,000. If the business fails with $5 million in debt, creditors cannot pursue the limited partner's personal assets—their house, savings accounts, or other investments remain protected.

General partners, however, face unlimited liability. They're personally responsible for all partnership obligations. If the business can't pay its debts, creditors can pursue the general partner's personal assets.

Important caveat: Limited partners lose their liability protection if they take an active role in management. Courts have ruled that limited partners who participate in business decisions become effectively general partners and assume the accompanying liability. This is why the line between investor and operator must remain clear.

Limited Partnership vs. Other Business Structures

Understanding how LPs compare to other options helps clarify when they make sense.

Limited Partnership vs. General Partnership

A general partnership is simpler—two or more people agree to go into business together, and they're done. No state filings required. But every partner has unlimited liability and equal management authority unless specified otherwise.

An LP requires state registration and formal documentation, but offers liability protection to passive investors that a general partnership cannot provide.

Limited Partnership vs. LLC

Limited liability companies (LLCs) protect all members from personal liability, not just passive investors. Any member can participate in management without losing protection.

However, LPs offer specific advantages:

• Tax treatment for limited partners: LPs can avoid self-employment tax on their share of profits, while LLC members often owe self-employment tax on all business income
• Clear investor structure: The GP/LP distinction creates a formal hierarchy that's well-understood in investment communities
• Established legal precedent: LP structures have decades of case law, particularly in real estate and private equity

Many LLCs work well for operating businesses where all owners are active. LPs work better when you need to clearly distinguish between operators and investors.

Limited Partnership vs. Corporation

Corporations offer liability protection to all shareholders and can issue stock to raise capital. However, C corporations face double taxation—the corporation pays taxes on profits, then shareholders pay again on dividends.

LPs are pass-through entities. Profits flow directly to partners and are taxed only once on individual returns. This makes LPs more tax-efficient for many investment structures.

Tax Advantages of Limited Partnerships

Limited partnerships offer several significant tax benefits:

Pass-Through Taxation

LPs don't pay entity-level taxes. Instead, profits and losses "pass through" to individual partners who report them on personal tax returns. This avoids the double taxation that affects C corporations.

Self-Employment Tax Savings for Limited Partners

Limited partners generally don't pay self-employment tax (15.3% in 2025) on their share of partnership income because they're not actively engaged in the business. General partners do pay self-employment tax. This distinction can mean thousands of dollars in annual tax savings for passive investors.

Qualified Business Income Deduction

As pass-through entities, LPs typically qualify for the 20% qualified business income (QBI) deduction. Partners may be able to deduct up to 20% of their share of partnership income, effectively reducing their tax rate.

Depreciation and Loss Allocation

Real estate LPs can allocate depreciation deductions to partners, reducing taxable income even when the property generates positive cash flow. Losses can often offset other income, though passive activity loss rules may limit this benefit.

When to Use a Limited Partnership

Limited partnerships excel in specific situations:

Real Estate Investment

Real estate syndications commonly use LP structures. A developer or experienced operator serves as general partner, managing property acquisition, development, and operations. Investors contribute capital as limited partners, receiving returns without management responsibilities.

This structure lets developers leverage investor capital while maintaining control. Investors get exposure to real estate deals they couldn't access individually, with liability limited to their investment.

Private Equity and Venture Capital

Most private equity and venture capital funds are structured as limited partnerships. The fund manager serves as general partner, making investment decisions and managing portfolio companies. Institutional investors and high-net-worth individuals invest as limited partners.

This structure has become industry standard because it clearly separates management (GP) from capital (LP) and aligns incentives through carried interest arrangements.

Family Businesses

Limited partnerships can facilitate wealth transfer and business succession. Parents might serve as general partners managing the family business while transferring limited partnership interests to children. This allows:

• Gradual wealth transfer with retained control
• Estate tax benefits from discounted valuations
• Clear distinction between active and passive family members

Professional Investment Groups

Groups of investors pooling capital for specific projects often choose LP structures. One member with relevant expertise serves as general partner, while others contribute capital as limited partners.

When NOT to Use a Limited Partnership

LPs aren't right for every situation:

Small operating businesses: If all owners will actively participate in management, an LLC usually makes more sense. Everyone gets liability protection without the GP's unlimited exposure.

Equal partners: When partners contribute equally and share management equally, the GP/LP distinction creates unnecessary hierarchy. A general partnership or LLC works better.

Businesses needing maximum liability protection: The general partner's unlimited liability is a significant drawback. Some businesses mitigate this by using an LLC or corporation as the general partner (more on this below).

Simple ventures: The formation complexity and legal costs of an LP may not be justified for straightforward businesses.

How to Form a Limited Partnership

Formation requirements vary by state, but typically include:

1. Choose a State

You can form an LP in any state, regardless of where you operate. Delaware is popular for its business-friendly laws and established legal precedent. However, if you'll operate primarily in one state, forming there usually makes sense.

2. Select a Business Name

Your partnership name must be available in your formation state. Most states require including "Limited Partnership," "LP," or similar designation in the name.

3. File a Certificate of Limited Partnership

Submit formation documents to your Secretary of State. Filing fees range from $50 to $1,000 depending on the state. The certificate typically includes:

• Partnership name and address
• Names of general partners
• Registered agent information
• Purpose of the partnership

4. Create a Partnership Agreement

While not always required by law, a comprehensive partnership agreement is essential. This document should cover:

• Capital contributions from each partner
• Profit and loss allocation
• Management responsibilities and authority
• Distribution schedules
• Procedures for admitting new partners
• Buyout provisions and exit procedures
• Dissolution terms

Have a lawyer review this agreement. State-specific requirements vary significantly, and mistakes in partnership agreements lead to expensive disputes.

5. Obtain Necessary Licenses and Permits

Depending on your industry and location, you may need business licenses, professional certifications, or regulatory approvals.

6. Set Up Partnership Accounting

Establish systems to track partner capital accounts, allocate profits and losses, and generate K-1 tax forms for each partner. This becomes complex quickly with multiple partners and varying contribution amounts.

Protecting the General Partner

The general partner's unlimited liability is the most significant drawback of LP structures. Several strategies can mitigate this risk:

Use an LLC or Corporation as General Partner

Many modern limited partnerships use a separate entity—typically an LLC or corporation—as the general partner. This creates a two-layer structure where:

• The LLC/corporation serves as general partner and makes management decisions
• The LLC/corporation's owners gain liability protection from their entity structure
• Limited partners retain their LP liability protection

This approach has become standard practice in real estate and private equity. It provides the benefits of the LP structure while addressing the general partner liability concern.

Adequate Insurance

General liability insurance, errors and omissions coverage, and other appropriate policies can protect against many risks. Insurance won't cover all liabilities, but it's an essential component of risk management.

Careful Contract Drafting

Structuring contracts to limit partnership liability, requiring personal guarantees only when absolutely necessary, and using indemnification clauses appropriately can reduce exposure.

Understanding LP Economics

Limited partnership economics often follow established patterns, particularly in investment contexts:

Capital Contributions

Limited partners typically provide 80% to 95% of total capital. General partners contribute 5% to 20%, often investing in earlier, riskier phases of projects.

Preferred Returns

Many LPs guarantee limited partners a "preferred return"—a minimum return on their investment before the general partner receives any profit share. Common preferred returns range from 6% to 10% annually.

Profit Splits and Waterfalls

After the preferred return, remaining profits are typically split according to a "waterfall" structure:

• First tier: Profits split 80/20 (LP/GP) until a certain return threshold
• Second tier: Profits split 70/30 or 60/40 at higher return levels
• Final tier: At exceptional returns, GPs may receive larger shares

These structures align incentives—general partners earn more by delivering stronger returns to limited partners.

Management Fees

In investment LPs, general partners often charge annual management fees of 1% to 2% of committed capital. This covers operational expenses and provides baseline GP compensation.

Limited Partnership Ongoing Requirements

After formation, LPs have continuing obligations:

Annual Reports

Most states require annual or biennial reports with updated partnership information. Failure to file can result in penalties or administrative dissolution.

Tax Filings

LPs file Form 1065 (U.S. Return of Partnership Income) annually. The partnership issues Schedule K-1 to each partner showing their share of income, deductions, and credits.

Maintaining Records

Partnerships should maintain:

• Current partnership agreement
• Records of all partner contributions and distributions
• Financial statements and tax returns
• Meeting minutes for significant decisions
• Partner contact information

Capital Account Tracking

Each partner has a capital account reflecting their contributions, allocated profits/losses, and distributions. Accurate tracking is essential for tax compliance and partner relations.

Keep Your Partnership Finances Organized

Whether you're forming a new limited partnership or managing an existing one, clear financial records are essential. Partner capital accounts, profit allocations, and distribution tracking quickly become complex, especially with multiple partners and varying ownership percentages.

Beancount.io provides plain-text accounting that makes partnership finances transparent and auditable. Track capital contributions, allocate profits according to your partnership agreement, and maintain the clear records partners expect—all in version-controlled text files you fully control. Get started for free and bring clarity to your partnership accounting.