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Unit Questions > Unit 13: Direct Participation Programs > Flashcards

Unit 13: Direct Participation Programs Flashcards

1
Q

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

A

Direct Participation Programs (DPPs)

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2
Q

One of the most common types of DPPs

A

Limited Partnerships (LPs)

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3
Q

Three advantages of Limited Partners

A

1) An investment managed by others
2) Limited Liability
3) Flow-through of income and certain expenses

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4
Q

Main disadvantage of DPPs

A

Lack of liquidity

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5
Q

DPPs are generally structured as _________ or ________. These business forms are not tax-paying entities like corporations; instead they only report income and losses to the IRS and then the partners (in ________) or shareholders (in ___________) have the responsibility to report income and losses individually and pay the taxes due.

A

Limited Partnership or Subchapter S Corporation

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6
Q

How can LPs be sold?

A

Through private placement or public offerings

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7
Q

In a private placement for LPs, investors receive a __________ for disclosure and are involved in a _____ group of accredited investors.

A

Private placement memorandum; small group of accredited investors

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8
Q

Public offerings of LPs are sold with ________ to a larger number of limited partners.

A

prospectus

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9
Q

The _______ oversees the selling and promotion of the partnership.

A

Syndicator

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10
Q

Three important documents are required for a LP to exit:

A

1) The certificate of limited partnership (filed in home state)
2) The partnership agreement
3) The subscription agreement

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11
Q

To dissolve a LP, ______ must cancel the certificate of limited partnership and settle accounts.

A

GP (General Partner)

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12
Q

GP must cancel the certificate of limited partnership and settle accounts in the following order: when dissolving a LP:

A

Secured lenders, other creditors, limited partners, general partners

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13
Q

What are the two methods applied to the analysis of DPPs

A

Cash flow analysis and Internal Rate of Return (IRR)

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14
Q

Compares income (revenues) to expenses

A

Cash Flow Analysis

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15
Q

Determines the present value of estimated future revenues and sales proceeds to allow comparison to other programs

A

Internal Rate of Return (IRR)

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16
Q

Unique investment opportunities that permit the economic consequences of a business to flow through to investors. These programs offer investors a share in the income, gains, losses, deductions, and tax credits of the business entity.

A

Limited partnerships (LPs)

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17
Q

A small number of limited partnership interests are negotiable and trade on the OTC and exchanges

A

Master Limited Partnerships (MLPs)

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18
Q

Means that all of the income and losses and corresponding tax responsibilities go directly to the investors with no taxation to the business entity.

A

Flow-through (or pass-through)

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19
Q

When there is potential for returns from cash distributions and capital gains, it is said to be ________ ________.

A

Economically viable

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20
Q

Applies to the using up of natural resources, such as oil and gas

A

Depletion allowances

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21
Q

Applies to cost recovery of expenditures for equipment and real estate (land cannot be depreciated)

A

Depreciation write-offs

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22
Q

The point at which the program begins to generate taxable income instead of losses. This generally occurs in later years when income increases and deductions decrease.

A

Crossover point

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23
Q

Are the only investment opportunity that you will study that offer a pass-through of losses to the investor. Also ________ passive losses shelter passive income, not ordinary income.

A

Direct Participation Programs (DPPs)

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24
Q

Any DPP established without a profit motive or with the intention of only generating tax losses for investors may be determined as _______

A

Abusive

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25
Q

Which characteristics of a corporation are hard to avoid in a DPP?

A

Centralized management

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26
Q

Which characteristics of a corporation is the easiest to avoid for DPP?

A

Continuity of Life

27
Q

Which two corporate characteristics are most likely to be avoided by a DPP?

A

Continuity of Life and Freely Transferable Interests

28
Q

When considering the purchase of a limited partnership interest, an investor should be most concerned with:

A

Economic Viability

29
Q

LPs are liable for a proportionate share of________ loans assumed by partnerships. LPs have no liability for _________ loans, except in real estate partnerships.

A

recourse

nonrecourse

30
Q

The 2 corporate characteristics that most limited partnerships avoid are

A

continuity of life and free transferability of interest.

31
Q

Depletion allowances on oil & gas partnerships may be taken ____________________

A

only once the oil or gas is sold.

32
Q

A blind pool offering:

A

is one in which 25% or more of the properties are not specified.

Many times, large real estate or oil and gas programs are offered in the form of a blind pool. In a blind pool, 25% or more of the specific properties (in real estate) or sites (in oil and gas) have not been identified at the time of the offering. When investing in a blind pool, the participants are relying on the expertise of the program sponsor to select locations that will prove profitable.

33
Q

In a functional allocation oil and gas program, which of the following statements are TRUE?
I. The general partner picks up all tangible drilling costs.
II. The general partner picks up all intangible drilling costs.
III. The limited partners pick up all tangible drilling costs.
IV. The limited partners pick up all intangible drilling costs.

A

I. The general partner picks up all tangible drilling costs.
IV. The limited partners pick up all intangible drilling costs.

In a functional allocation program, the general partner picks up all tangible drilling costs while the limited partners pick up all intangible drilling costs. As intangible drilling costs are deductible as incurred, this type of program benefits the limited partners. Tangible drilling costs, however, are deductible pro rata over the estimated life of the well.
Reference: 13.2.2.7 in the License Exam Manual

34
Q 
Which of the different sharing arrangements for limited partnerships between the general partners (GPs) and the limited partners (LPs) is generally considered the most common?
A) Carried interest
B) Overriding royalty interest
C) Net operating profits interest
D) Functional allocation
A

D) Functional allocation

While both LPs and GPs share equally in the revenues with a functional allocation arrangement, it is most commonly used because it gives the best tax benefits to each. The LPs receive the immediate tax write-offs from the IDCs, whereas the GPs receive continued write-offs from the tangible costs over the course of several years.
Reference: 13.2.2.7 in the License Exam Manual

35
Q 
Some limited partnership programs provide potential tax credits to partners. Which of the following typically provide potential tax credits?
I. Rehabilitation of historic properties
II. Equipment leasing
III. Developmental oil and gas programs
IV. Government-assisted housing programs
A

I. Rehabilitation of historic properties

IV. Government-assisted housing programs

36
Q

Raw land partnerships seek __________

A

appreciation

37
Q

Existing property and new construction partnerships seek ___________and __________from business operations.

A

passive income and tax deductions

38
Q

Historic rehabilitation partnerships allow not just deductions but actual ________ ________.

A

tax credits.

39
Q

Who registers the securities and packages the program for a limited partnership?

A

Syndicator

40
Q

A customer buys a real estate limited partnership interest by contributing $20,000 and signing a nonrecourse note for $50,000. The customer’s beginning basis is:

A

$70,000

41
Q

Functional allocation, disproportionate sharing, and reversionary working interest are all types of ___________sharing arrangements.

A

oil & gas

42
Q 
All of the following are characteristics of both oil and gas, and real estate limited partnerships, EXCEPT:
A) depreciation.
B) deferral of benefits.
C) depletion.
D) limited liability.
A

C) depletion.

A depletion allowance makes up for the using up of a natural resource. Real estate limited partnerships do not have depletion allowances. Both real estate and oil and gas partnerships offer limited liability, depreciation allowances, and deferred receipt of income and capital gains.

43
Q

Money is raised without a specific property being stated, and the GP selects the investments. This describes what?

A

An oil and gas blind pool offering?

A blind pool offering, also known as a nonspecified program, involves an investment in a program without specific prospects or properties being identified.

44
Q 
All of the following would flow through as a loss to limited partners EXCEPT:
A) accelerated depreciation.
B) principal repayment on recourse debt.
C) depletion.
D) interest payments on recourse debt.
A

B) principal repayment on recourse debt.

Principal repayments are not deductible for tax purposes. The interest is deductible.
Reference: 13.2.6 in the License Exam Manual

45
Q

If a customer subscribes to a $20,000 public limited partnership interest, which of the following is the maximum underwriting compensation that may be charged?

A

$2,000

The FINRA rules for limited partnership offerings limit underwriting compensation to 10% of the total money raised (10% of $20,000 is $2,000).
Reference: 13.1.2 in the License Exam Manual

46
Q

A taxpayer’s most advantageous tax benefit is:

A

a tax credit.

A tax credit reduces a person’s tax liability dollar for dollar. Deductions, depreciation and depletion reduce taxable income.
Reference: 13.2.4.2.2 in the License Exam Manual

47
Q

A customer invests $20,000 in a DPP and signs a recourse note for $50,000. During the first year of operation, the customer receives a cash distribution from the partnership of $15,000. At year end, the customer receives a K-1 statement reporting his share of partnership losses of $75,000. How much of the loss may the customer deduct from passive income?

A

$55,000

A limited partner can only deduct partnership losses to the extent of his basis. To determine basis, add the original investment ($20,000). to any recourse debt assumed by the investor ($50,000). Recourse debt adds to basis as the partner is liable for this amount. Cash distributions received reduce basis ($15,000). At year end, the investor’s basis and the amount he can deduct from passive income is $55,000.
Reference: 13.2.4.2.1 in the License Exam Manual

48
Q

Drilling for oil or gas where none has occurred previously

A

wildcatting

In an oil and gas drilling program, the term “wildcatting” is used to describe the most speculative type of program, which is drilling where none has occurred before (i.e., in an unproven location).

49
Q

The document attesting to the formation of a limited partnership, filed with designated authorities, is called:

A

the certificate of limited partnership.

The Uniform Limited Partnership Act requires that two or more persons sign and swear to a certificate of limited partnership. It is filed with the state and is a public document available for review.

50
Q

Programs allowing for the direct pass-through of losses and income to investors include all of the following EXCEPT:
A) REITs.
B) oil and gas drilling direct participation programs.
C) S corporations.
D) new construction real estate direct participation programs.

A

A) REITs.

REITs allow for the direct pass-through of income but not losses. The other choices are forms of business which allow for pass-through of income and losses.

51
Q

Analysts use both __________ and ____________to establish a DPP’s rate of return. Both involve assumptions based on future cash flows generated by the program.

A

present value and internal rate of return

52
Q

The ___________ gives public information about the partnership and is filed in the home state.

A

Certificate

53
Q

The ___________ agreement spells out the roles of the general and limited partners.

A

Partnership

54
Q

The____________ agreement is the instrument by which the limited partners invest.

A

subscription

55
Q

A direct participation program shows the following operation results:

Revenues: $3 million
Operating expense: $1 million
Interest expense: $200,000
Management fees: $200,000
Depreciation: $3 million

Cash flow from program operation is:

A

$1.6 million

Cash flow for a partnership is calculated in the following fashion:

Gross revenue $3 million
Less operating exp -$1.2 million
Less debt interest -$200,000
Less depreciation $3 million

= Net income -1.4 million (loss)

To complete the cash flow calculation add back in depreciation of $3 million

= Cash flow = $1.6 million.

56
Q

Before an investor can become a limited partner, the investor must provide a written verification of net worth. The investor is accepted as a limited partner only when the general partner signs the __________________.

A

Subscription Agreement

57
Q

Investors seek ______________ when investing in undeveloped land limited partnerships.

A

appreciation

58
Q

A customer with a moderate income from a secure job is in the 28% tax bracket. She has a small diversified portfolio and has $10,000 she would like to invest in a limited partnership. If she is willing to accept only a moderate amount of risk, which of the following limited partnerships would be the most appropriate recommendation?

A) Raw land real estate limited partnership.
B) New construction real estate limited partnership.
C) Oil and gas income program.
D) Exploratory oil and gas drilling program.

A

C) Oil and gas income program.

The customer is not in a high tax bracket and would not be able to take full advantage of the tax benefits produced by an exploratory oil and gas program or by new construction real estate limited partnerships. A raw land real estate partnership is usually speculative. Of the answers listed, the income and moderate risk from an oil and gas income program would be of greatest benefit to this investor.

59
Q

A client invests $100,000 in a tax shelter as a limited partner, giving him a 10% interest in the program. However, the general partners cannot meet the program’s expenses. A mortgage balance remains of $3 million, and the property of the program is liquidated for $1 million. How much does the investor get back from his original investment?

A

$0

The limited partner will not receive any return of his investment. In a failed program, the partnership’s creditors are paid first with any sale proceeds, before the limited partners receive any money. Because the limited partners had not signed a recourse agreement, even though the partnership still owes $2 million on the mortgage, the limited partners are not liable for any money beyond their original investments.
Reference: 13.1.3 in the License Exam Manual

60
Q 
Intangible drilling costs would include all of the following EXCEPT:
A) wages.
B) casing.
C) fuel.
D) land surveys.
A

B) casing.

Intangible drilling costs are the costs of drilling a well other than the costs for capital equipment (e.g., pumps, casing). They are incidental to and necessary for the drilling activity and include wages, fuel, repairs, hauling, supplies, surveys, tests, and drilling mud.

61
Q

An investor purchased an interest in a limited partnership, paying $10,000 in cash and signing a recourse note to the partnership under a letter of credit for $40,000. Which of the following statements are TRUE?
I. The investor’s tax basis will be $10,000.
II. The investor’s tax basis will be $50,000.
III. The investor’s maximum loss will be $10,000.
IV. The investor’s maximum loss will be $50,000.

A

II. The investor’s tax basis will be $50,000.
IV. The investor’s maximum loss will be $50,000.

A recourse note means that the limited partner agrees to pay the note no matter what happens. He is legally liable for the $40,000, which makes both his tax basis and maximum loss potential $50,000.
Reference: 13.2.6 in the License Exam Manual

62
Q

A direct participation program shows the following operations results:

Revenues: $3 million.
Operating expense: $1 million.
Interest expense: $200,000.
Management fees: $200,000.
Depreciation: $3 million.

Profit or loss for the year is:

A

loss $1.4 million

Taxable income for a partnership is determined as follows:

Gross revenue $3 million.
Less operating expense -$1.2 million.
Net revenue $1.8 million.
Less interest -$200,000.
Less depreciation $3 million.
Taxable loss = $1.4 million.
Reference: 13.2.6 in the License Exam Manual
63
Q

An investor with a large salary as well as unearned investment income is two years from retirement. If he wants to shelter a portion of his income, which of the following programs would provide him with substantial initial write-offs?

A) Existing housing.
B) An oil and gas drilling program.
C) Raw land.
D) An oil and gas income program.

A

B) An oil and gas drilling program.

Oil and gas drilling programs pass through IDCs (intangible drillings costs), which the partners may use to reduce passive income.
Reference: 13.2.2.1 in the License Exam Manual

Unit Questions (18 decks)

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