Limited Partnerships
Now that you understand the pass-through concept, let's examine how direct participation programs (DPPs) are actually structured. The limited partnership is the most common DPP structure, and the exam heavily tests the roles and rights of each partner type.
Partnership Structure
A limited partnership has two types of partners with very different rights and responsibilities:
| Feature | General Partner (GP) | Limited Partner (LP) |
|---|---|---|
| Liability | Unlimited personal liability | Limited to amount invested |
| Management | Manages all business decisions | No active management role |
| Day-to-day operations | Runs the business | Passive investor only |
| Fiduciary duty | Owes fiduciary duty to LPs | No fiduciary obligations |
| Tax form | Receives K-1 | Receives K-1 |
| Removal | Requires majority LP consent | Can withdraw per agreement |
Exam Tip: Gotchas
Both partner types receive a K-1, not a 1099. Expect a distractor that puts LPs on a 1099-DIV; that form is for C corporations, not pass-through entities.
General Partner Responsibilities
The general partner is the one running the show:
- Manages day-to-day operations of the partnership
- Makes all business and investment decisions
- Has a fiduciary duty to act in the best interests of limited partners
- Bears unlimited personal liability for partnership debts and obligations
- Cannot be removed without consent of a majority of limited partners
Exam Tip: Gotchas
The general partner bears unlimited personal liability for partnership debts. This is the price of controlling business decisions. A GP cannot be removed unilaterally; it takes a majority vote of the limited partners.
Limited Partner Characteristics
Limited partners are passive investors who provide capital:
- Cannot participate in management decisions
- Liability is limited to the amount invested plus any recourse debt
- Receive a K-1 tax form annually showing their share of income, losses, and deductions
- Are passive investors; losses can generally only offset other passive income (passive activity rules)
Exam Tip: Gotchas
Limited partner losses are passive and can only offset other passive income. Expect a distractor claiming DPP losses offset ordinary wages or portfolio income; they do not.
The Management Boundary
This is one of the most tested concepts in this unit:
- If a limited partner participates in management, they risk being treated as a general partner
- Being treated as a GP means they take on unlimited personal liability
- The line between passive investing (LP) and active management (GP) is a key exam distinction
Exam Tip: Gotchas
A limited partner who starts making business decisions doesn't just lose their "limited" label; they gain unlimited liability for partnership debts. Remember: LPs invest money, GPs make decisions.
Limited partners have LIMITED liability and LIMITED management rights. These two always go together. General partners have UNLIMITED liability but also UNLIMITED management authority.
Next, let's look at another DPP structure: tenants in common.