Chapter 13- Direct Participation Programs 5-12 Questions

Question 1

Definition of a Direct Participation Program

Answer 1

Illiquid investment that pass income, gains, losses and tax benefits directly to limited partners

Limited partnerships are one of the most common

Only pass through entity for losses

Question 2

Limited partnerships

Answer 2

Allow economic consequences of an investment to flow through to investors

Offer share of income, losses, gains, deductions and tax credits

Enjoy limited liability, investment management and flow through income and expenses

Greatest disadvantage is lack of liquidity

Master limited partnerships (MLPs) are traded on exchange/otc

Question 3

Tax reporting

Answer 3

Limited partnerships flow income and losses to partners

SCorps flow through to shareholders

Double taxation is avoided through this process

Both still report their income to IRS but DPPs send K-1s to participants

Only receive passive losses (only be used on passive income)

Question 4

Abusive DPPs

Answer 4

Investors can be subject to:
Back taxes
Recapture of tax credits
Interest penalties or 
Prosecution of fraud

Established without a profit motive

Question 5

Partnership classification

Answer 5

Must provide a service or product to be classified as partnership

Must avoid corporation characteristic like:
Continuity of life (most partnerships have a set end date at beginning), easiest to avoid

Transfer of shares is second easiest to avoid

Centralized management is the hardest characteristic to avoid for a DPP

Question 6

Purchasing an LP

Answer 6

Either sold through private placement or public offering

Limited partners must be accredited investors, and usually make large contributions in a private placement

Public offering however has many LPs and most positions are 1-5 thousand

Sold by a syndicator (fee limit of 10% of gross amount sold)

Main purpose of purchasing should be to make a profit

Question 7

Required documentation for an LP

Answer 7

Certificate of limited partnership- Provides creditors with info regarding an LPs term and member contributions

Must be filed in home state of partnership

Material changes must be noted in 30 days-

Question 8

General Partners role as defined by partnership agreement

Answer 8

Has right to change management fee

Authority to bind partners to contract

Right to determine who should be included in partnership

Right to determine cash distributions

Question 9

Recourse vs non recourse loan

Answer 9

Recourse- investor can be forced to repay partial amount of a loan

Nonrecourse- GPs are in charge of repayment, except for in real estate partnerships where LP may have partial liability

Question 10

Dissolving of a partnership

Answer 10

LPs usually liquidate themselves or dissolve upon the partner group selling off assets or disposing them

GP must cancel certificate of LP and settle accounts in order:
Secured loans
Other creditors
LPs: first for claim to profits and second for claims to return of contributed capital
Gps: first for fees and claims not providing profit
Second for profits
Third for capital return

Question 11

Limited partnerships become effective when

Answer 11

The certificate of limited partnership is filed

Question 12

General partners

Answer 12

Unlimited liability, personal liability for business debts

Responsibility of management

Fiduciary responsibility

Can make legally binding decisions

Buy and sell property for partnership

Maintain financial interest (1% minimum)

Cannot:
Borrow from partnership
Compete against
Commingle funds with personal fund
Continue partnership after loss of a GP

Question 13

Limited partners

Answer 13

Limited liability; can lose only investment and portion of recourse debt

May not participate in management

May sue the GP

Vote on new GPs

Vote on sale or refinancing of partnership

Receive income

Cannot:
Act on behalf of partnership or participate in management
Knowingly sign a false certificate
Have name appear in partner name

Question 14

Real Estate Partnerships

Answer 14

Provide investors with benefit of:
Capital growth potential

Cash flow

Tax deductions from interest expense and depreciation

Tax credits for government assisted housing

Question 15

5 types of Real Estate partnerships

Answer 15

1. Raw Land- Bought for appreciation of a lot, has no income distributions or tax deductions, not considered a tax shelter, speculative
2. New Construction- Minimal maitenance costs, purchase for appreciation of property. Could run into cost overruns in construction. Riskier than existing property. Depreciation and deductions after income is generated
3. Existing property- immediate cash flow, greater maintenance expense, low risk, deductions for mortgage interest and depreciation
4. Gov assisted housing- low income and retirement housing, get tax credits and rent subsidies, but low appreciation potential, tax credits and losses are benefit
5. Historic Rehab- tax credits for preserving structure, possible cost overruns and inability to deduct current expenses during construction

Question 16

Oil and Gas Partnerships unique tax breaks

Answer 16

1. Intangible Drilling Costs (IDCs)- First year of drilling intangible costs can be 100% deducted, any cost that has no salvage value
2. Tangible Drilling Costs (TDCs)- Deducted over a series of years, have a salvage value
3. Depletion Allowance- tax deduction for sale of oil or gas based on loss of asset, only allowed after product is actually sold

Question 17

3 types of oil and gas programs

Answer 17

1. Exploratory- Locating undiscovered reserves of oil and gas, high risk, high IDCs for immediate tax shelter
2. Developmental- Drilling near existing fields to discover new, medium IDCs
3. Income- existing, income shelter from depletion allowances
4. Combination- split between exploratory and income

Question 18

Oil and Gas sharing arrangements

Answer 18

Overriding Royalty Interest- Receive interest from rights but no partnership risk

Re visionary working interest- GP bears no cost and receives no income until LPs recover capital

Net operating profit interest- LP bears all deductible and non deduct costs, only available in private placement

Disproportionate share- GP bears small expense but high rev

Carried interest- LPs receive share of Drilling Costs but no IDCs

Functional Allocation- shared revenues, LP receives the IDCs which immediately deduct

Question 19

Equipment Leasing Program

Answer 19

Purchase leased equipment to get lease pay income

Also get share of write offs for op expenses, interest deductions and depreciation

No longer receive tax credits

Question 20

Economic Viability of an investment

Answer 20

Measured by IRR and cash flow analysis

Question 21

Deductions from an LP

Answer 21

Include the following expenses:
Salaries
Interest payments
Management fees
Depreciation write offs
Depletion allowance

Principal payments on property are not deductible

Depreciation and depletion can only be claimed when there is income and when the product can be no longer used at end of life usually

Question 22

Credits related to LPs

Answer 22

Most are attributed to gov assisted housing programs and historical restoration

Question 23

Crossover point

Answer 23

When a program begins to generate taxable income instead of losses

Generally occurs after a few years

Question 24

Cost basis of an LP

Answer 24

LP Cost Basis consists of:
Cash contributions
Property contributions
Recourse debt
And non recourse for real estate

Allowed to make deduction up to cost basis

Cost basis is the full investment regardless of the commission

Unused losses can be subtracted from a sale of an LP

Question 25

Blind pool

Answer 25

Less than 75% of assets have been specified for use

Question 26

Cash flow

Answer 26

Net income or loss plus added back non cash changes

Depreciation is just added back to the Net gain or loss

Question 27

The partnership agreement-

Answer 27

Outlines roles of general partner and LPs

Right of GP include:
Right to charge a management fee

Authority to bind partnerships into contract

Right to determine which partners should be included

Right to determine cash distribution

Question 28

The subscription agreement (Passive investors only)-

Answer 28

Passive investors only

Appoints one or more GPs who act on behalf of LPs

Only effective once GP signs it

tells net worth of investor

acknowledgment of risk

power of attorney for the GP as the agent of the partnership

Question 29

Agreement (certificate) of limited partnership-

Answer 29

Provides creditors with information regarding an LPs term and member contributions

Must be filed in home state of the partnership

Establishes basic identification of company

Includes:
Partnership name
Partnership business
Amount of time partnership expects to be in business
Size of LP investments
Share of compensation
Whether death of GP destroys partnership or not

Any material change require 30 day update

LP becomes effective once Certificate is filed

Question 30

Partnership Democracy

Answer 30

Allows LPs to vote on major decisions, but not on day to say operations

Question 31

Basis

Answer 31

Share of company that can be lost by a specific shareholder

Investment in partnership + share of recourse debt - cash distributions

Basis is unaffected by commission

Would still have 50,000 basis if had to pay a commission

Question 32

Depreciation Recapture

Answer 32

Depreciation deductions must be taken back if overdone