What is a Limited Partnership Unit?

A limited partnership unit is a piece of ownership in a limited partnership.

How Does a Limited Partnership Unit Work?

A limited partnership is a business formation that limits the liability of certain owners. Shares of ownership are referred to as units.

A limited partnership is made up of partners. In some partnerships, all the partners are general partners. That is, they are all liable for the debts and obligations of the business. In other partnerships, some of the partners are general partners and others are limited partners. In those cases (called limited partnerships, or LPs), one or a handful of general partners manage the day-to-day operations of the business and are personally liable for the business's debts. They act as the core management team for the business and obligated to keep the limited partners informed about the condition and performance of the business. A master limited partnership (MLP) is a publicly traded limited partnership. MLPs generally operate in the natural resource, financial services and real estate industries. The most distinguishing characteristic of MLP ownership is that it combines the tax advantages of a partnership with the liquidity of a publicly traded stock.

Partnerships are generally not taxable entities; rather, the income is passed in a pro rata fashion to the partners, who pay applicable federal, state and local income taxes. Parternships make distributions, similar to dividends; this is typically done quarterly. It is important to note that cash distributions are not guaranteed, and generally every unitholder is responsible for the taxes on his or her proportionate share of income, even if the partnership does not pay a cash distribution.

Generally, investors can purchase MLP units from brokers. A unitholder's initial tax basis in MLP units is generally the amount he or she pays for the units. The unitholder's basis usually decreases with each distribution and allocation for losses or deductions, and the basis increases for each allocation of income. A portion of a distribution may qualify as a return of the investor's capital, reducing the unitholder's taxable basis.

Why Does a Limited Partnership Unit Matter?

When a limited partnership pays more in distributions than it earns in taxable income, the unitholder's tax basis is decreased by the difference between the cash received and the taxable income. When the unitholder sells his or her units, any gain on the sale is taxed at the unitholder's ordinary income tax rate.

Limited partnerships usually must mail an IRS Schedule K-1 to each of their unitholders every year. Schedule K-1 reports the unitholder's allocated income, gain, loss, deduction and credits. If the unitholder's taxable partnership income for the year is negative, this is considered a passive loss under the tax code and may not be used to offset income from other sources. The passive loss may only be used to offset future income from the same MLP.

Although unitholders are generally limited in their liability, similar to corporation shareholders, creditors typically have the right to seek the return of distributions made to unitholders if the liability in question arose before the distribution was paid. This liability stays attached to the unitholder, even if he sells the units.