Very few investment structures permit investors to claim tax deductions associated with their investment. One of these investments, flow-through shares, was discussed in an earlier edition of this feature. In this issue, we consider investments in limited partnerships. Unlike flow-through shares, limited partnerships can generate tax deductions in any business sector, not just natural resources.
A limited partnership is a form of partnership which provides limited liability for its limited partners, who do not carry on the partnership’s business. Most partnerships are structured as limited partnerships in order to provide limited liability for investors.
Partnerships are generally not taxpayers under Canadian income tax law. Instead, the income or loss of the partnership for each fiscal year is calculated for tax purposes and then allocated to the partners at the end of the fiscal year, which for most partnerships is December 31. There is no tax payable on distributions made to partners, per se. Rather, the taxable income of the partnership is allocated to the partners and the partners must pay tax on that allocated income, regardless of whether or not they actually receive a distribution from the partnership.
New businesses often suffer start-up losses, since their expenses initially exceed their income. Businesses who expect this result may structure themselves as limited partnerships in order to pass on the tax deductions associated with those start-up losses to investors. If the business were structured as a corporation or a trust, this flow-through of losses would not be possible.
The amount of tax deductions that can be claimed by a limited partner of a limited partnership is generally limited to the limited partner’s at-risk amount. The at-risk amount is a complex calculation designed to reflect the amount that the limited partner is at risk of losing by virtue of the investment.
On the sale of a limited partnership interest, an investor will generally realize a capital gain or loss based on the difference between the proceeds of disposition and the adjusted cost base of the partnership interest. The adjusted cost base of a partnership interest varies over time based on amounts invested in, and withdrawn from, the partnership as well as allocations of profit and loss by the partnership to the investor.
If you are looking for an investment which provides the potential for tax deductions, consider investing in a limited partnership.
End of Tax-Assisted Investing Series.