A limited partnership is formed when you go into business with one of more other people, and some of you are personally liable for the debts of the business, while others are not. The general partners are all personally liable for the business debts, while the limited partners are not. The limited partners are only liable for the debts of the business up to the amount of their investment in the business, plus their portion of any recourse debts and obligations for making future payments.
A limited partnership can be formed under an informal agreement regarding splitting profits and losses, and identifying any limited partners. It is the standard, however, for a limited partnership to be formed through a formal written partnership agreement. The partnership agreement explains in detail the method and proportion to be used to divide income, deductions, gains, losses, and credits among the partners. Also addressed in the partnership agreement is how the death, retirement, disability, or bankruptcy of any of the partners will be handled.
A partnership is a pass-through entity. That means that the partnership itself does not pay any income taxes. The partnership must file Form 1065, the partnership information return. This form reports the income and deductions of the partnership. Part of Form 1065 is a Schedule K-1 for each partner, which shows that partnerís share of the partnership net income or loss, along with any separately stated items.
The partner uses the Schedule K-1 to report their business income or loss on their Form 1040. This income or loss is reported on Schedule E, Part II, Income or Loss From Partnerships and S Corporations. If the partnership is reporting a loss, there are limits imposed on the amount of loss that can be taken by the partners. The partner cannot claim a loss for more than their partnership basis. The partnerís basis is their interest in the partnership, which is the amount of cash and other property that they contributed to the partnership. If you are a passive investor in the partnership, otherwise known as a silent partner, further limits are imposed due to the passive activity rules. You would only be able to deduct the loss up to the level of your income from passive activities.
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