Entity that passes all income and expenses directly to the owners, but is not taxed itself. Passive losses can only be offset by passive income, not earned income.
Direct Participation Program (DPP)
What are the different types of DPP's?
- General Partnership
- Limited Partnership
- Subchapter S Corporation
DPP where all partners are fully liable for all activities and obligations of the DPP.
DPP that has a partner who is fully liable and another partner who has limited liability. This DPP is only liable to the amount invested and to the extent of any recourse financing. One of the partners is silent and does not make management decisions. Benefits of this setup are limited liability and avoidance of double taxation.
DPP that is a closely held corporation and all income and expenses pass through to shareholders. It has some limited liability characteristics. Maximum pemissible number of shareholders is 100.
Subchapter S Corporation
DPP that avoids taxation by passing income and expenses through to the owners. Owners are exposed to limited liability.
Limited Liability Company (LLC)
What are the corporate characteristics that a DPP must avoid in order to maintain its unique status?
- Group of Associates
- Gathered to achieve a profit
- Centralized management
- Freely transferable interest
- Limited liability
- Continuity of life
As a manager of the partnership, this person has fiduciary responsibility to act in the best interest of other partners. Must avoid activities that present a conflict of interest which includes borrowing from partnership and competing with parthernship. This person cannot sell personally owned assets to the partnership.
As owner of the partnership, this person has the right to inspect the books and can sue other partner if they willfully mismanage partnership assets or breaches agreement.
Form used for limited partnership informational tax filing where partnerships determine each investor's reportable share of gains and losses
What are PIGs and PALS and how do they work?
PIG - Passive Income Generator
PAL - Passive activity loss
Tax code says PALs can be offset by PIGs, not ordinary income
Accounting methods whereby enterprises recognize the cost of capital assets against their revenues. The enterprise purchases an asset, then recognizes a portion of that purchase price in each year of the asset's life.
Cost Recovery System
Cost recovery method that allows enterprise to write off large portions of asset's cost during early years of asset's life. This is advantageous due to the time value of money. In addition, this method allows owners to depreciate the full cost of the asset, leaving no residual value, or even allow for the write off of more than the cost of the asset.
Accelerated Cost Recovery Method (ACRS)
Risk when a partnership sells a piece of equipment on which it has used an ACRS, which lowers the book value. If the asset is sold for fair market value, the partnership experiences a capital gain and is taxed on it. The prior tax advantage is cancelled due to capital gain tax.
Deprectiation used for real property improvements such as office towers, apartment complexes, or shopping centers. An equal amount of the asset's cost is expensed during each year of the asset's life, which differs from ACRS, where larger expenses are taken during the early years of the asset's life.
Straight Line Depreciation
Cost recovery system taken on irreplaceable natural resources, such as oil, natural gas and coal. The different types are percentage, and cost. Percentage benefits small oil and gas.
What affects an LP's cost basis?
- Established by initial investment
- Recourse debt is added to cost basis
- Depreciation and depletion reduce cost basis
Potential debt for which the LP is liable upon partnership liquidation. If liquidation proceeds do not extinguish all debt, the LP is liable for remaining debt. LP assumes this when in need of financing.
Recourse Debt or Financing
Measurement commonly used to determine the value of a limited partnership, which considers current value or net present value, tax deductions, and cash flow from the investment.
Internal Rate of Return (IRR)
For a DPP, this is actual money left over after all expenses are paid, which is calculated by deducting money paid out from revenues.
Income reportable to IRS, calculated using IRS permitted depreciation and depletion methods. This is lower than cash flow during early years of LP.
Point at which taxable income exceeds cash flow. The investor is taxed on greater reportable income than the cash flow actually received. Before this point is reached, the LP often has positive cash flow and yet reports a loss to the IRS because of ACRS.
Income that the investor is taxed on, but was not received in cash flow
What is the maximum permissible sales charge on limited partnership interests?
10% plus 1/2% for due diligence expenses
Process when a limited partnership changes its status to a Master Limited Partnership (MLP), which is a freely transferable partnership either on exchange or OTC, or a corporation. This benefits the GP, which is a conflict of interest and must be disclosed to LP and requires LP votes.
Trade ticket used by registered reps for assessing customer suitability, that contains a detailed financial questionnaire which the investor must complete and sign. This document is carefully reviewed and approved by the GP before the investor is accepted as an LP.
When a partnership starts, this document is filed with the Secretary of State. This document is important becuase it creates limited liability for the LPs and unlimited liability for the GP.
Certificate of Limited Partnership
How are Limited Partnership interests distributed?
- Public offering with prospectus
- Private placement or offering with offering memorandum
How are DPPs sold?
Reg D Private Placement or Public Offering
What are the three types of limited partnerships?
- Real Estate Partnership
- Oil and Gas Venture
- Equipment leasing programs
Parternship that emphasizes either depreciation deductions, income from existing rental properties, or growth from new development.
Real Estate Partnership
Limited partnership that varies from risky wildcat or exploratory deals, to less profitable but more reliable developmental programs, to more conservative income programs.
Oil and Gas Ventures
Limited partnership structured to provide income because there is little or no capital appreciation potential.
Equipment Leasing Program
Real Estate partnership with highest risk and greatest potential return, has long investment time horizon, provides no expenses because land doesn't depreciate and there is no resource depletion. However, if the land is purchased at the right price and held for a long time, it can appreciate substantially.
Raw Land Partnership
Real Estate partnership with second highest level of risk, whose objective is capital appreciation. The general partner buy, develops and sells land at a profit. Commercial property value is determined by rental income, which is produced by quality tenants.
New Construction Partnership
A safer real estate partnership that buys and manages existing property. This is the safest type because it invests in an established real asset with existing income stream, historical occupancy rate and known tenant base.
Rental Income Partnership
Tax credit that is used by purchasing and restoring old property. The property must be listed on a national registry, and at least 75% of the original structure must exist before the partnership starts restoration.
Historical Rehab Credit
The best tax credit that offers very limited capital apprecation because there is no ptential to improve the rental income stream; the rents are fixed at a low rate. This credit is designed to attract investor capital to this otherwise unattractive market sector.
Low-Income Housing Projects
Oil and Gas drilling program that is in an unproven area. This is the riskiest drilling program because of the high percentage of dry wells, but do offer the greatest potential return if successful.
Drilling program done in an area with proven reserves. Developing these proven reserves is less risky than exploratory drilling.
Drilling program that is less risky and also offers better potential returns
Oil and Gas program that purchases and manages producing wells. This is the safest program because it invests in established, measurable production.
Oil and gas program that has high depletion write-offs, incurs intangible drilling costs (expenses for consumables such as labor and equipment rental).
Limited Partnership Program that is designed to provide income to the investors. An example is a partnership that owns and leases planes to an airline. Airlines frequently lease, rather than own, their planes. They use ACRS, which creates larger expense write-offs in early years.
Equipment Leasing Program