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Editorial 12 MIN READ

The limited partnership at the start of 2022, reviewed

Still the right vehicle for real-estate syndications and private fund sponsors, now with a FinCEN filing waiting at the end of the year

The Editors
Staff, Incorporator.org
12 min read Updated
Contents 5 sections
  1. The Delaware statute, unchanged
  2. The tax story is still Subchapter K
  3. The CTA overlay, which is the part that is new
  4. The LP's remaining domain in 2022
  5. Sources

limited partnership in February 2022 is a form the LLC never displaced, because the people who actually use it (real-estate sponsors and private fund general partners) never asked the LLC to replace it. The statute has not moved since our June 2020 field report. What has moved is FinCEN. A Delaware LP formed this week is a reporting company under 31 U.S.C. § 5336, and a sponsor papering a fund this quarter is papering for a beneficial-ownership regime whose proposed rule sits open in the Federal Register until next Monday.

The LP's two natural habitats still drive the population. Real-estate syndications and pooled private investment funds do most of the LP formation volume in the United States, and both use the form for the same reason they used it in 1998 and in 2008: a built-in separation of control from capital that the LLC can replicate in its operating agreement but has never been able to replicate in its vocabulary.

The Delaware statute, unchanged

Delaware's Revised Uniform Limited Partnership Act sits at 6 Del. C. Chapter 17 and has since 1983. The Act's short title is in § 17-1102. Formation runs through § 17-201: file a Certificate of Limited Partnership with the Division of Corporations naming the partnership, its Delaware registered office and registered agent, and the name and business address of each general partner. That is the entire public record. The partnership agreement, which governs economics and control, never enters the file.

The filing fee for the Certificate is $200. The annual tax under § 17-1109 is a flat $300, due June 1 every year, on every domestic LP whether or not it has had a day of activity, with a $200 late penalty and 1.5 percent monthly interest running on unpaid amounts. The 2019 series amendments added a separate $75 tax per registered series. None of that has moved in the last year. The Division of Corporations runs LPs through the same back office that handles Delaware LLCs, and the filing times that stabilized after the pandemic push to online filing have held.

Section 17-303 is the limited-partner liability rule and the reason sophisticated money sits on the limited-partner side of the ledger. A limited partner is liable for partnership obligations only if the partner is also a general partner or if the partner participates in the control of the business in a way that causes a third party reasonably to believe the limited partner is a general partner. Section 17-303(b) is a long safe harbor: consulting with the GP, serving on a committee, guaranteeing partnership debt, voting on major matters (dissolution, sale, admissions, removals, amendments) all sit inside the harbor, and § 17-303(f) makes clear that frequency of any listed activity does not matter. In practice the control rule bites almost never, which is why the LP still works for passive investors who nonetheless want voting rights on the big events.

Section 17-403(b) is the general-partner liability rule and the reason you never see a natural person as the named GP of a fund. The general partner has "the liabilities of a partner" under Delaware's partnership law, which is to say unlimited personal exposure for partnership obligations. Every fund counsel in the country translates that into the same structural fix: the named GP is an LLC, the individual sponsors sit behind the LLC's own shield, and the fund has two liability wrappers instead of one. The same trick is available to a real-estate sponsor with a handful of deal-by-deal LPs; the GP of each deal is a special-purpose LLC that winds up with the deal, and the sponsor's operating company sits above all of them.

Delaware also lets an LP elect to be a limited liability limited partnership under § 17-214, which confers an LLP-style shield on the general partner directly. Fund sponsors rarely bother, because the GP-is-an-LLC structure already delivers the shield the LLLP election would provide and the LLLP adds a second statement to the state file without buying much that is not already there.

The tax story is still Subchapter K

The default federal tax classification of a Delaware LP is a partnership, and unless the LP files Form 8832 it stays one. Treas. Reg. § 301.7701-3(b)(1) sets the default: a domestic eligible entity with two or more members is classified as a partnership unless it elects to be an association. A Delaware LP is a domestic eligible entity; it has at least two members by definition (one GP and one LP, minimum); and nobody with a fund sponsor as a client ever files the election. Partnership status flows from doing nothing.

That default carries three provisions of Subchapter K that make the LP work for its constituencies. IRC § 704(b) lets a partnership allocate items of income, gain, loss, deduction, and credit among the partners on any basis the partnership agreement specifies, as long as the allocation has substantial economic effect. Waterfall distributions, preferred returns, promote structures, catch-up tranches, and clawbacks all live inside § 704(b). No corporate form has an analog; an S-corp must allocate pro rata and a C-corp runs on a single class of stockholder economics. IRC § 752 adds partnership debt to a partner's outside basis (recourse debt to the partners who bear the economic risk of loss, nonrecourse debt pro rata under the § 752 regulations), which is the mechanical hinge of real-estate tax strategy. A real-estate LP's limited partners can take depreciation and interest deductions against basis that includes their share of the partnership's mortgage, which is how a thirty-percent equity investor picks up her share of one hundred percent of the economic leverage for deduction purposes. IRC § 701 makes the partnership transparent for income-tax purposes, so all of this flows onto partner K-1s rather than triggering entity-level tax.

IRC § 469 then takes most of what came off the K-1 and filters it through the passive-activity rules. Section 469(h)(2) says that except as provided in regulations, "no interest as a limited partner in a limited partnership shall be treated as an interest with respect to which a taxpayer materially participates." For a passive real-estate LP investor this is fine, because her allocated losses are passive anyway and she has passive income to offset. For the GP and for an investor with no other passive income, it matters, and the real-estate professional rules under § 469(c)(7) are the route through.

The self-employment-tax treatment of limited partners is the corner of the LP's tax story that has been unsettled for three decades and is about to get less settled, not more. IRC § 1402(a)(13) excludes a limited partner's distributive share from net earnings from self-employment "other than guaranteed payments described in section 707(c) to that partner for services actually rendered to or on behalf of the partnership." The statute is clean in concept. The practice is not. The Tax Court held in Renkemeyer, Campbell & Weaver, LLP v. Commissioner, 136 T.C. 137 (2011), that the three attorney partners of a Kansas LLP were not limited partners for § 1402(a)(13) purposes because their distributive shares arose from legal services they performed, not from returns on invested capital. The court read the legislative history of § 1402(a)(13) as intending to exclude only the earnings of partners "akin to passive investors."

Renkemeyer addressed an LLP and left state-law LP questions aside, but the reasoning reaches further. A general partner who draws a distributive share (as opposed to a § 707(c) guaranteed payment) has never had an argument for the carveout, because § 1402(a)(13) applies only to limited partners. A passive limited partner in a traditional real-estate LP still fits the "akin to passive investors" description cleanly; the LP's distributive share is a return on committed capital, the GP is doing the work, and the statute's exclusion operates as it was written. The harder case is the service partner who sits on the LP side of a structure for capital-account reasons but actually works for the business. Renkemeyer's functional reading says that partner's distributive share is self-employment income under § 1402(a), and the IRS has pursued that reading in examinations of state-law LPs since Renkemeyer came down.

For a 2022 fund formation, the practical guidance is the same as it has been: passive LPs are outside SE tax, the GP entity earns guaranteed payments for services that are inside SE tax at the principals' level (net of the employer-equivalent offset through the management-company structure), and the LP agreement names who is what so that the character of each partner's share is not a question an examiner has to resolve from the books alone.

The CTA overlay, which is the part that is new

The Corporate Transparency Act, enacted at § 6403 of the National Defense Authorization Act for Fiscal Year 2021, Pub. L. 116-283 (January 1, 2021), adds 31 U.S.C. § 5336 to the Bank Secrecy Act architecture. Section 5336(a)(11)(A) defines a "reporting company" as a corporation, LLC, or "other similar entity" that is "created by the filing of a document with a secretary of state or a similar office under the law of a State or Indian Tribe," plus a foreign entity registered to do business by a similar filing. A Delaware LP is formed by filing a Certificate of Limited Partnership under 6 Del. C. § 17-201. The LP is a reporting company. Every statement from FinCEN since the Act was signed has treated LPs as within the "similar entity" language; our June 2021 read of the ANPRM walked through the scope analysis that got the agency there.

FinCEN's Notice of Proposed Rulemaking on the reporting rule was published at 86 Fed. Reg. 69920 (December 8, 2021). The comment window runs sixty days and closes February 7. The proposed rule treats the LP as a reporting company directly, lists the LP alongside the corporation and the LLC in its discussion of covered entities, and does not create a carveout for fund-industry uses. A Delaware LP formed in the typical fund structure (a GP that is itself a reporting company, a fund LP that is a reporting company, often a parallel LP or a feeder that is another reporting company) will file a BOI report for each separate filing entity once the final rule is in force, naming each beneficial owner who exercises substantial control or holds 25 percent or more of the ownership interests.

The 23 exemptions in § 5336(a)(11)(B) do some work here. Registered investment advisers, SEC-registered broker-dealers, registered investment companies, pooled investment vehicles advised by a registered investment adviser, and "large operating companies" (more than 20 full-time U.S. employees, more than $5 million in prior-year gross receipts or sales, physical office in the U.S.) are all outside the rule. A large buyout fund whose general partner is a registered investment adviser and whose fund vehicle meets the "pooled investment vehicle advised by" formulation under § 5336(a)(11)(B)(xviii) qualifies for the pooled-investment-vehicle exemption for the fund itself, though the reporting line for the GP and related entities still has to be walked. A venture fund whose adviser is an exempt reporting adviser (not a registered adviser) does not qualify, and the fund LP reports. A real-estate syndicator running deal-by-deal LPs on an adviser-of-one structure is a reporting company at the fund level and at the GP level, with no exemption.

The operational consequence for an LP formed in 2022 is that the general partner who files the Certificate will be the "company applicant" under § 5336(a)(2) and is on the initial report. Every beneficial owner gets named. Changes to substantial control or ownership get updated. The final rule's effective date is a function of when FinCEN promulgates the final regs, and the NPRM contemplates an effective date one year after final publication for new entities with a longer phase-in for existing ones. For funds being launched this spring, the prudent drafting approach is the one that makes the CTA report mechanical: a schedule inside the LP agreement that tracks substantial control and 25-percent-or-more ownership, a covenant obligating each partner to supply the information the partnership will need when the rule goes live, and a contact at the GP who owns the filing.

The LP's remaining domain in 2022

Nothing about the CTA changes the calculus for the two groups that actually use the form. A real-estate syndicator running a $40 million value-add multifamily deal still forms a Delaware LP with a special-purpose LLC as GP, because her investor base has signed into a dozen of these and the investor subscription documents are built around an LP. The § 752 debt-basis treatment still matters for the depreciation story. A growth-equity fund raising its fourth vintage still forms a Delaware LP for the vehicle and parallel LPs for non-U.S. and tax-exempt investor classes, because the LP framework is what every institutional LP's counsel, ERISA compliance officer, and state-unitary-return preparer expects to receive. The LP is a Schelling point that the LLC would take a decade and a dozen institutional policy committees to displace, and there is no pressure to try.

For an operating business that is not a fund and not a real-estate deal, the LP remains the wrong form. The GP's residual exposure is a cost the LLC does not charge. The fund-industry vocabulary adds nothing to a consulting partnership's economics. The LP's Subchapter K flexibility is available through the LLC on the same default classification. A two-person operating firm reaching for the LP in 2022 is usually reaching for it because a template said so, not because the form solves anything an LLC does not.

The form that survives here is the form that exists for particular jobs and declines to expand. A Delaware LP formed this quarter for a new fund is a familiar instrument with a new attachment: the BOI report filed with FinCEN once the rule is final. The instrument still plays.

Sources

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