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 Planning

LIMITED PARTNERSHIPS

The term "limited partnership" as generally understood and as used in this section refers to a variety of investment products structured to provide a combination of economic and tax benefits to the investor.  The limited partner is precluded from participating in the management of the partnership's affairs; however, the investor's liability is limited to the amount of his or her investment.

Prior to the Tax Reform Act of 1986, most limited partnerships were structured to maximize the use of tax incentives provided by Congress. Tax savings were generated basically in three ways, including deferral of tax liability until a later time, utilization of tax credits, and conversion of ordinary income to capital gains.  TRA eliminated or severely reduced these tax savings opportunities. Although some tax savings are available under the TRA, they are generally less valuable to investors due to a reduction in individual tax rates. 

The well structured, economically feasible limited partnership serves a legitimate purpose in the portfolio of many investors. The limited partnership structures in and .of itself is appropriate for certain individuals, regardless of the tax characteristics of the underlying business activity. 

Investment sponsors are continuously designing and offering new limited partnerships which must be evaluated by investors. 

Client Suitability Considerations

All limited partnerships provide client suitability criteria in one of the first few pages of the offering memorandum. 

The fact that a client meets the suitability criteria as stated in the partnership prospectus (generally a specified net worth and gross income) does not mean that the client should invest in that program. More important suitability criteria are:

a. the liquidity needs of the client
b. the control the client likes to have over an investment
c. the client's personal risk profile; and
d. the client's current investment portfolio diversification. 

Liquidity

Most limited partnership investments are long‑term investments that require a commitment by the clients to forego a return of principal for anywhere from 3 to 25 years. With the exception of master limited partnership interests, there is no broad market for limited partnership investments. There have been some steps to create an after‑market for sale of publicly registered limited partnership interests, but clients should not count on the after market as a way out of a limited partnership investment. Before investing in most limited partnerships, the clients should understand that they may have to forego cash flow for several years and may not see return of capital for five to ten years.

Cash Flow Planning

The lack of liquidity of most limited partnerships discussed in the previous paragraphs and the fact that many of these investments require cash investments by the investor over a period of years, increases the need for long‑term cash flow planning. Before recommending a limited partnership investment, the planner should analyze the effects on the clients' cash flow for at least the periods during which the clients must provide cash through stated capital contributions or via note payments. In addition, the planner should review the provisions of the agreement related to capital calls and review guarantees and other contingent liabilities for their possible cash requirements. Cash flow planning should, of course, be coordinated with tax planning to arrive at after tax cash flow. Often overlooked in cash flow planning are the large additional taxes in the years that the partnership produces "phantom income" or passive losses which are not deductible by the investor. Appendix 5C of Chapter 5 provides a form that may be useful in cash flow planning.

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