What Is a Unitholder? Meaning, Tax Implications, and Rights

Investing in certain financial entities often involves purchasing “units” rather than traditional shares of stock. Those who hold these units are known as unitholders, and their rights, tax obligations, and income distributions can differ significantly from corporate shareholders.

Understanding what it means to be a unitholder is essential for making informed investment decisions. Voting power, taxation, and income distribution all affect returns and responsibilities, making it important to evaluate these factors before investing.

Entities That Issue Units

Several types of investment vehicles and business structures issue units instead of stock shares. These entities operate under different legal and tax frameworks than corporations, influencing ownership and returns.

Partnerships

Limited partnerships (LPs) and master limited partnerships (MLPs) issue units to investors, called limited partners. Unlike corporate shareholders, limited partners do not have managerial control but receive income distributions based on profits. These entities are structured as pass-through entities for tax purposes, meaning income, deductions, and credits are allocated to unitholders, who report them on personal tax returns.

Taxation of partnership units can be complex, particularly when depreciation recapture or unrelated business taxable income (UBTI) is involved. Publicly traded partnerships (PTPs) must comply with Internal Revenue Code Section 7704, requiring at least 90% of income to come from qualifying sources like natural resources or real estate. Selling partnership units can also trigger ordinary income tax on previously deferred gains, making tax planning essential.

Real Estate Trusts

Real estate investment trusts (REITs) may issue units instead of shares when structured as unincorporated trusts or partnerships. These entities pool capital to acquire and manage income-generating real estate assets. To maintain REIT status under Internal Revenue Code Section 856, at least 90% of taxable income must be distributed to unitholders annually.

Unlike partnerships, REITs do not pass through losses or deductions to unitholders, limiting tax liabilities to distributions received. REIT dividends are typically taxed as ordinary income rather than at the lower capital gains tax rates applied to qualified dividends. Mortgage REITs (mREITs), which generate income from interest on mortgage loans rather than rental income, have different risk exposures and tax treatments compared to equity REITs.

Exchange-Traded Funds

Some exchange-traded funds (ETFs), particularly those structured as grantor trusts or limited partnerships, issue units instead of shares. Commodity-based ETFs, such as those holding gold or oil, use a grantor trust structure where unitholders directly own a proportional interest in the underlying assets. This means unitholders may be responsible for reporting capital gains or losses when assets are sold, even if they receive no distributions.

Limited partnership ETFs, which invest in futures contracts and other derivatives, are subject to the Internal Revenue Code Section 1256 60/40 rule, where 60% of gains are taxed at long-term rates and 40% at short-term rates regardless of holding period. These funds often issue Schedule K-1 tax forms instead of standard 1099-DIV forms, requiring additional tax reporting.

Rights and Voting Powers

Unitholders’ rights depend on the entity’s structure, with governance provisions outlined in a trust agreement, partnership agreement, or offering memorandum. Unlike corporate shareholders, who typically have voting rights tied to stock ownership, unitholders may have limited or no direct influence over management decisions.

Investment funds structured as trusts, such as certain ETFs and REITs, often centralize decision-making authority with a trustee or board of directors. In these cases, unitholders may not vote on routine business matters but may have rights in extraordinary circumstances, such as changes to the fund’s investment mandate or liquidation.

Limited partnerships generally grant voting rights only to the general partner, who manages operations. Limited partners, despite their financial stake, usually cannot participate in day-to-day decision-making but may vote on specific matters, such as removing the general partner or approving a major transaction. Some master limited partnerships (MLPs) allow unitholder votes on structural changes, though these rights are often more restricted than those of corporate shareholders.

Tax Consequences

The tax treatment of unitholders varies based on the entity’s legal structure and jurisdiction. Unlike corporate stockholders, who primarily deal with capital gains and dividend taxation, unitholders often have tax liabilities stemming from the entity’s income, even if no cash distributions are received. This can create phantom income, where tax is owed despite no actual payment being made to the investor.

Certain publicly traded partnerships (PTPs) and grantor trusts require unitholders to report their share of taxable income on personal returns, with tax obligations potentially arising in multiple states if the entity operates across jurisdictions. This can trigger state-specific filing requirements, as some states impose income tax on non-residents earning income within their borders.

Depreciation recapture adds another layer of complexity, particularly when unitholders sell their units. If the entity has previously allocated depreciation deductions, a portion of the gain on sale may be taxed at higher ordinary income rates rather than the lower long-term capital gains rates.

Income Distributions

Unitholders receive income distributions based on the financial performance and policies of the entity. These payments can take different forms, including cash payouts, reinvested units, or allocations of taxable income, each carrying distinct tax and reporting implications. Unlike corporate dividends, which are generally discretionary and subject to board approval, certain entities must distribute a substantial portion of earnings to maintain favorable tax treatment.

The timing and structure of distributions vary depending on the entity’s accounting framework and cash flow management. Some investment vehicles follow a predictable schedule, such as quarterly or monthly payments, while others distribute income based on operational results, leading to fluctuations in payout amounts. Investors relying on these distributions for cash flow should assess the entity’s historical payout consistency, coverage ratios, and reserve policies to gauge sustainability.

Transfer and Redemption

Unitholders looking to exit their investment must navigate the transfer and redemption process, which varies significantly depending on the entity’s structure and marketability of the units. Unlike publicly traded stocks, which can be bought and sold freely on exchanges, some units are subject to restrictions that limit liquidity and impose additional administrative requirements.

Publicly traded units, such as those issued by exchange-listed REITs or master limited partnerships, can typically be sold through brokerage accounts like common stocks, with pricing determined by market supply and demand. However, bid-ask spreads may be wider than those of traditional equities, particularly for thinly traded securities. In contrast, privately held units, such as those in non-traded REITs or private equity funds, often require approval from management before a transfer can occur. Some entities impose lock-up periods, during which units cannot be sold, or require investors to sell back to the issuer at a discount to net asset value.

Redemption policies also differ based on the nature of the investment. Some entities offer periodic redemption windows where unitholders can sell their units back at a predetermined price, while others only allow redemptions under specific conditions, such as death or financial hardship. Certain funds impose exit fees or penalties, reducing the final payout to the investor. Investors should carefully review offering documents to understand liquidity constraints and potential financial impacts.