For investors seeking portfolio diversification and access to alternative assets, limited partnerships (LPs) offer a compelling opportunity. While traditional investments like mutual funds and publicly traded stocks are well understood, limited partnerships can be more complex—especially when held in a self-directed IRA. At Mainstar Trust, we provide custodial services that support your ability to include limited partnerships in your retirement account.
Below, we’ll break down what a limited partnership is, how it works, and what to consider before initiating a partnership investment.
What Is a Limited Partnership?
A limited partnership is a type of business entity formed by two or more parties. It consists of:
- General Partners (GPs): These individuals or entities manage the day-to-day operations, assume personal liability, and are responsible for the business debts and obligations of the partnership.
- Limited Partners (LPs): These investors contribute capital, enjoy limited liability, and typically do not participate in the daily management. Their liability is generally restricted to their initial partnership interest.
This partnership structure allows limited partners to benefit from the business's success while minimizing their exposure to risk. In some cases, LPs are referred to as “silent partners” or “passive investors” due to their lack of operational involvement.
Types of Limited Partnerships Held in IRAs
Limited partnerships can span a wide variety of investment opportunities, including:
- Real estate investment partnerships
- Private equity or venture capital funds
- Startups or business ventures
- Broker-dealer sponsored offerings
When held in a self-directed IRA, LPs can provide exposure to alternative investments outside traditional brokerage platforms. However, it's important to perform due diligence and fully understand the partnership agreement, including any distributions, allocation of income, and the potential for early distributions or penalties depending on the terms.
Limited Partnerships and Tax Considerations
Most limited partnerships are treated as pass-through entities for tax purposes. This means that any gains, losses, or income are reported on the partner’s tax return, regardless of whether cash distributions are made.
Each investor typically receives a Schedule K-1, which outlines their share of the partnership’s income, deductions, and credits. This income may be subject to income tax, including self-employment taxes if the investor is considered actively involved.
Keep in mind:
- Traditional IRA contributions to LPs may be tax-deductible, but any distributions taken before age 59½ may be subject to taxes and penalties.
- Required Minimum Distributions (RMDs) still apply to traditional IRAs, even when holding alternative assets like LPs.
- Tax-exempt entities like IRAs are generally shielded from taxes on income from LPs unless the income triggers Unrelated Business Taxable Income (UBTI). If UBTI is due, ensure the Schedule K-1 is being reported under an Employee Identification Number (EIN) for the IRA.
Each taxpayer should evaluate these considerations with a tax professional to understand the implications for their individual situation.
Key Differences Between LPs and Other Business Structures
While limited liability companies (LLCs) and general partnerships share similarities with LPs, there are critical key differences:
- Limited partnerships offer liability protection only to limited partners, not general partners.
- LLCs generally provide liability protection to all members.
- General partnerships expose all partners to unlimited liability for debts and legal obligations.
Investors looking for passive income without exposure to business operations often prefer LPs over these other types of business entities.
Liquidity and Risk Factors
Investors must also consider the liquidity of limited partnership investments. These are typically long-term, illiquid assets, which may lack a public market for resale. Redemption options may be limited or restricted by the partnership agreement.
Additional risks include:
- Market volatility
- Operational risk tied to the general partner
- Inability to exit the investment easily
- Dependence on the fiduciary integrity of the GP
As with any investment strategy, it’s important to match the structure and terms of a limited partnership to your personal assets, net worth, and long-term financial goals.
Who Can Invest?
In many cases, LP investments are limited to accredited investors—individuals who meet certain net worth or income thresholds defined by the IRS. These requirements are often included in broker-dealer documents or the partnership agreement and help determine investor eligibility.
Getting Started with Limited Partnerships in Your IRA
Mainstar Trust enables account holders to hold limited partnerships in their self-directed IRA. While we don’t offer investment advice or endorse specific offerings, our team ensures all required custodial paperwork and recordkeeping is in place for your LP investment.
Whether you're pursuing real estate, startups, or alternative assets, holding a limited partnership in an IRA may offer diversification and tax benefits as part of your retirement planning.
Ready to Open a Limited Partnership IRA?
If you're interested in establishing a limited partnership investment through a self-directed IRA, our experienced custodial team is here to support the process. With decades of experience and a commitment to reliable service, Mainstar Trust can help you maintain compliance and manage your LP documentation.
Contact us today to learn how to set up a limited partnership in your Mainstar Trust IRA account.