Limited Partner: Definition, Role, and Tax Treatment

A limited partner is an investor in a limited partnership (LP) who contributes capital but does not participate in day-to-day management. Their liability for the partnership’s debts is generally limited to the amount they have invested.

Key characteristics

• Must be part of a limited partnership, which by definition has at least one general partner and at least one limited partner.
• Limited voting power on ordinary business matters; may have voting rights on major structural issues (e.g., removing a general partner, terminating the partnership, amending the partnership agreement, or selling most assets) depending on state law and the partnership agreement.
• Not involved in daily operations or management.
• Liability limited to the invested capital unless the limited partner takes on an active role and is treated as a general partner.

Role and limitations

Limited partners function primarily as passive investors:
* They provide capital and share in profits and losses according to the partnership agreement.
* They do not make operational decisions, sign contracts, or bind the partnership in ordinary business affairs.
* If a limited partner becomes actively involved—such as performing managerial tasks or participating extensively—they risk being treated as a general partner and losing limited liability protection.

General partner vs. limited partner

• General partner: Manages and controls daily operations, makes business decisions, and is personally liable for partnership debts.
• Limited partner: Invests capital, shares in returns, and is shielded from personal liability beyond their investment as long as they remain passive.

Fast fact: Investors in private equity and many venture funds are typically limited partners.

Liability

A limited partner’s potential loss is generally capped at the amount invested. Creditors seeking repayment of partnership debts normally pursue the partnership and the general partner’s personal assets, not the limited partners’ personal assets—unless a limited partner has acted in a way that converts them into a general partner under law or the partnership agreement.

Tax treatment

• A limited partnership is a pass-through (flow-through) entity: income, gains, losses, deductions, and credits pass through to the partners, who report them on their personal tax returns.
• Income allocated to limited partners is typically treated as passive income, not earned income. As such, limited partners generally are not subject to self-employment tax on partnership distributions.
• Passive activity rules limit how passive losses may be used; under existing rules, passive losses can typically only offset passive income (subject to exceptions and specific rules).
• Significant participation (commonly cited as more than 500 hours in a year) can cause a limited partner’s activity to be treated as nonpassive, with different tax and liability consequences.

Advantages of being a limited partner

• Limited liability exposure—losses generally limited to invested capital.
• Ability to invest in businesses (including private equity, real estate partnerships, and other ventures) without handling management responsibilities.
• Potential tax-advantaged pass-through treatment of income.

When limited partner status can be lost

A limited partner may lose limited liability if they:
* Undertake managerial or operational activities that exceed passive investor behavior.
* Act in a way that causes creditors or courts to treat them as assuming partnership obligations or acting as a general partner.

Bottom line

A limited partner is a passive investor in a limited partnership whose liability is typically capped at their investment and whose share of partnership income is usually treated as passive for tax purposes. This structure suits investors who want exposure to a business or fund without taking on management duties or unlimited personal liability, provided they remain passive.