Series 7 Unit 11
Tax Features Applicable to all DPPs
As described, a partnership distributes income, losses, and gains to the LPs because of their flow-through nature. Limited partnership, as with other businesses, are able to apply certain deductions and tax credits to income as described here.
Lesson 11.6
DPP Regulation
Lesson 11.4
DPP Taxation
Lesson 11.2: DPPs and Their Investors
Direct participation programs (DPPs) are investments that pass income, gains, losses, and tax benefits (such as depreciation, depletion and tax credits) directly to the limited partners. There are some unique tax concepts and suitability issues associated with DPPs. Limited partnerships are one of the most common types of DPPs. They can also be set up as an S corporation or limited liability companies (LLCs). Because the exam focuses on the limited partnership, so will we.
Lesson 11.5
Evaluating the DPP
Introduction
In selecting a limited partnership interest to participate in, an investor should first consider whether the partnership matches his investment objectives and has economic viability. Economic viability means that there is potential for returns from cash distributions and capital gains. Although tax benefits may be attractive, they should not be the first consideration in the purchase of an interest in a DPP.
Internal Rate of Return
The internal rate of return (IRR) is the discount rate (r) that makes the future value of an investment equal to its present value. You will not have to do any calculations with IRR. All you need to know is that it takes into consideration the time value of money and is a favorite method of evaluation a DPP.
Lesson 11.3
Types of DPPs
Types of REITS
A real estate investment trust (REIT) (pronounced reet) isa company that mangoes a portfolio of real estate investments to earn profits and/or income for its shareholders. Like many other pooled investment vehicles, REITs offer professional management and diversification. REITs are normally publicly traded and serve as a source of long-term financing for real estate projects. A REIT pools capital in a manner similar to an investment company. There are three basic types of REITS. -Equity REITSs. Own commercial property -They take an ownership position in the properties. They receive rental income and possible capital gains upon a future sale of the properties. -Mortgage REITS. Own mortgages on commercial property. -They make real estate loans (mortgages). Their earnings come from the interest payments on those loans. -Hybrid REITs. Own commercial property and own mortgages on commercial property. -They are, as the name implies, a combination of both mortgage and equity REITs. REITs are organized as trusts in which investors buy and sell shares either on stock exchanges or in the OTC market. They are not redeemable as is the case with mutual funds or UITs, but have the liquidity of listed stocks. REITs do compute a NAV per unit. As you can imagine, the valuation of real estate is not as exact as the price of publicly traded stock. Therefore, the NAV is only an approximation. Because REITs are not redeemed by the issuer, the prices are based on supply and demand. Just as with CEFs, the price an investor pays can be more, less, or the same as the NAV. Take Note: In recent years, there has been substantial growth in the number of nontraded REITs (limited liquidity). However, for exam purposes, assume the REIT is publicly traded unless the question states otherwise. What are the
Tax Basis
An investor's tax basis represents the upper limit on deductibility of losses. LPs must keep track of their tax basis, or amount at risk, to determine their gain or loss upon the sale of their partnership interest. An investor's basis is subject to adjustment periodically for occurrences such as cash distributions and additional investments. Take Note: A LPs basis consists of -cash contributions to the partnership, -non cash property contributions to the partnership, -recourse debt of the partnership, and -non recourse debt for real estate partnerships only. Partners must adjust their basis at year-end. Any distributions of cash or property and repayments of recourse debt (also non recourse debt for real estate only) are reductions to a partner's basis. Partners are allowed deductions up to the amount of their adjusted cost basis. Take Note: With non recourse debt, other than any collateral pledged, the lender has no other option to purse the borrower. With recourse debt, if the pledged collateral is not sufficient to satisfy the obligation, the lender can file a suit to recover the balance. As a lender, you would prefer recourse debt. As a borrower, you would prefer a non recourse loan. Example: If a partner's basis is $25,000 at year-end and the investor has losses of $35,000, only $25,000 of the losses may be used to deduct against passive income. The remaining $10,000 may be carried forward. Computing Tax Basis Tax basis is computed using the following formula: -investment in partnership + share of recourse debt (+ non recourse debt in real estate DPPs)- cash or distributions = basis It is important to note that any up-front costs incurred by the investor will not affect beginning basis. Assume that an LP invests $50,000 in a partnership unit, and the broker-dealer selling the unit takes a commission
Investors in a Limited Partnership
As stated previously, the limited partnership form of DPP involves two types of partners: the GP (s) and the LP (s). Limited partnerships must have at least one of each. Figure 11.2 GPs vs. LPs GPs Unlimited liability: personal liability for all partnership business losses and debts Management responsibility: Assumes responsibility for all aspects of the partnership's operation Fiduciary responsibility: Morally and legally bound to use invested capital in the best interest of the investors. LPs Limited liability: Can lose no more than their investment and proportionate interest in recourse notes. No management responsibility: Provides capital for the business but may not participate in its management; known as a passive investor Attempting to take part in a management role jeopardizes limited liability status May sue the GP: Lawsuits may recover damages if the GP does not act in the best interest of the investors of uses assets improperly. The following tables compare other activities of GPs and LPs Figure 11.3: GPs and LPs: Allowed Activities GPs can: Make decisions that legally bind the partnership, buy and sell property for the partnership, maintain a financial interest in the partnership (must be a minimum of 1%), receive compensation as specified in the partnership agreement LPs can: Vote on changes to partnership investment objectives or the admission of a new GP, Vote on sale or refinancing of partnership property, Receive cash distributions, capital gains, and tax deductions from partnership actives, inspect books and records of the partnership, exercise the partnership democracy (vote under special circumstances, such as permitting the GP to act contrary to the agreement, to contest a judgment against the partnership, or admit a new GP) Figure 11.4 GPs and LPs Cannot: Prohibited Activities GPs
Real Estate Program Taxation
As we know, the tax benefit form all DPPs is that operating losses flow-through to investors. When a corporation loses money, there is no tax benefit to the shareholders. When a DPP shows a loss, that loss can be sued to offset passive income and save on taxes. The exam wants you to know the specific source of those tax losses for each of the programs. In the case of a real estate program, expenses creating the losses are -mortgage interest expense, -depreciation allowances for the "wearing out of the building" and -expenses for improvement to the property In addition, there are two other benefits unique to real estate programs: -Non recourse debt adds to the investor's cost basis. We will get to this shorty. -Tax credits are offered for government-assisted housing and historic rehabilitation projects. The advantage of a tax credit is that is reduces tax liability dollar-for-dollar. Example: An individual in the 30% tax bracket receives a tax deduction of $1,000. By lowering her income by $1,000, she saves $300 in tax. But, if she received a $1,000 tax credit, she lowers her taxes by $1,000.
Introduction
As with so many of the investment products we've discussed, DPPs come in many different "flavors." It is important to recognize that DPPs are one way to structure a business. We commonly see huge corporations and single person sole proprietorships. As we go through the different types of DPPs, remember, these are just businesses using the limited partnership structure as a way to raise capital.
Introduction
As with the other investments we've discussed, there are common and specific regulations relating to the issuance and sale of DPPs.
FINRA Rule 2310
Before participating in a DPP offering, member firms must have reasonable grounds for believing, based on the information provided in the prospectus, that all material facts are adequately disclosed and that these facts provide a framework for customers to evaluate the program. DPP Suitability: Under FINRA Rule 2310, all DPPs must have clearly stated standards of suitability in the prospectus. In recommending a DPP to a customer, a member firm must be certain that the program is consistent with the customer's objectives and that the customer -is in a position to take full advantage of any tax benefits generated by the DPP; and -has a net worth sufficient to sustain the risks of the DPP, including loss of investment. The member, after making a suitability determination, must painting documents in its files describing the basis on which the determination of suitability was made. In addition, no member is permitted to execute a DPP transaction in a discretionary account without the prior written consent of the customer.
Cash Flow
Cash flow is defined as net income or loss plus noncash changes (such as depreciation). Example Revenue: $300,000 less costs: selling $50,000 interest $70,000 Operating $160,000 Depreciation $50,000 _____________________________________ $330,000 Net loss: ($30,00) This example shows a loss of $30,000. However, when we add back in depreciation, the cash flow is a positive $20,000. net income or loss ($30,000) +depreciation $50,000 __________________________________________________ cash flow +$20,000
FINRA Rule 2310 Cont.
DPP Compensation Restrictions The rule places limits on the overall expenses and amount of broker-dealer compensation considered fair and reasonable. Specifically, fi the organization and offering expenses exceed 15% of the gross proceeds, FINRA considers that too high. A subset of those expenses is the compensation to the member firm. That cannot exceed 10% of the gross proceeds. Included in the 10% is any compensation to wholesalers. Example: A DPP offering is sold in units of $10,000. It is prohibited for any member firm to participate in the offering is less than $8,500 is received by the issuer. Member compensation, including all participants in the sales chain, cannot exceed $1,000. Noncash compensation: The rules on noncash compensation are the same as covered previously in Unit 8. For example, gifts cannot exceed $100 per year. An occasional meal or ticket to a sporting event would permitted. DPP Roll-Up: A roll-up is a transaction involving the combination or reorganization of one or more limited partnerships into securities of a successor corporation. The lure to investors is the possibility of turning an illiquid DPP into a more liquid security. Disclosure documents prepared in connection with a proposed roll-up transaction must -disclose all the risk factors; -disclose the GP's belief concerning fairness of the transaction; and -include all reports, opinions, and appraisals received by the GP in connection with the transaction. Failure to provide adequate disclosure of a negative opinion rendered by an investment banker or financial adviser concerning fairness constitutes fraud. Under FINRA rules, members are prohibited from soliciting votes form LPs in connection with a proposed roll-up unless any compensation to be received by the member -is payable and equal in amount regardless of whethe
Issuing Partnership Investments
DPPs may be offered either as private placements, qualifying for an exemption from registration under state and federal law, or publicly registered either with the SEC, the state(s) or both. Most are sold in private placements. When sold privately, they are usually limited to accredited investors. Unlike most securities, sales are conditioned upon acceptance of subscribers. That means that just because the investor wants to buy, he may not be accepted by the GP. Many offerings wholesalers. These are individuals or firms paid to serve as an interface between the issuer and broker-dealers and their sales force. It is legal for them to be compensated for their services. That compensation is usually on the basis of sales of program interests. One of the most important requirements is preforming due diligence. FINRA defines that as "the exercise of reasonable care to determine that the offering disclosures are accurate and complete." This helps the broker-dealer avoid fraud charges. Investigating the background of the management is one action taken in performing due diligence. For those who have a track record, checking it is an important step. Finally, the broker-dealer will evaluate all fees and other distribution of the offering's proceeds. At the end of this unit, we'll go a bit deeper into some of FINRA's rules on offering compensation.
Equipment Leasing Programs
Equipment leasing programs are created when DPPs purchase equipment leased to other businesses. Investors receive income from lease payments and also a proportional share of write-offs form operating expenses, interest expenses, and depreciation. Tax credits were once available through these programs but were discontinued by tax law changes. The primary investment objective of these programs is tax-sheltered income.
Business Deductions
Expenses of the partnership, such as salaries, interest payments, and management fees, result in deductions in the current year to the income of the business. Principal payments on property are not deductible expenses. Compare that to a home mortgage. The interest is deductible, but that portion of the mortgage payments applied to reduce the loan is not. Cost recovery systems offer write-offs over a period of years as defined by IRS schedules. Depreciation write-offs apply to cost recovery of expenditures for equipment and real estate (land cannot be depreciated). Depletion allowances apply to the using up of natural resources, such as oil and gas. Depreciation and depletion allowances may be claimed only when income is being produced by the partnership. Also, recognize that some assets are not depreciable, nor can they be depleted. For example, farm crops fall into this category and are generally known to be renewable assets. Take note: Depreciation may be taken on a straight-line (i.e. the same amount each year) or accelerated basis. Accelerated depreciation, known as a modified accelerated cost recovery systems, increases deductions during the early years and decreases them during the later years. Take note: The crossover point is 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.
FINRA Rules Dealing with DPPs
FINRA Rule 2310 is specifically titled Direct Participation Programs. Many of the requirements placed upon member firms and their representatives have been included where relevant in this unit.
Dissolving a Limited Partnership
Generally, limited partnerships are liquidated on the date specified in the partnerships agreement. Early shutdown may occur if the partnership sells or disposes of its assets or if a decision is made to dissolve the partnership by the LPs holding a majority interest. When dissolution occurs, the GP must cancel the certificate of limited partnership and settle accounts in the following order: -Secured lenders -Other creditors -LPs -First, for their claims to shares of profits -Second, for their claims to a return of contributed capital -GPs -First, for fees and other claims not involving profits -Second, for a share of profits -Third, for capital return Figure 11.1: DPP Life Cycle Diagram Limited partnership: Requires at least one GP and one LP ---> Syndicator (GP) promotes and offers partnership interests to potential LPs ---> Interested parties complete subscription agreement: submit cash and/or interest in recourse/nonrecourse loans as payment ---> GP approves or disapproves completed subscription agreements: approval required for completion of sale ---> partnerships passes through income and losses to partners---> partnership is dissolved or sold and gains/losses are distributed.
Other Evaluation Factors
Here are additional factors that investors should consider in their overall analysis of these investments: -management ability and experience of the GP in running other similar programs -Blind pool or nonspecific program- in a blind pool, less than 75% of the assets are specified as to use; however, in a specified program, at least 75% have been identified. -Time frame of the partnership -Similarity of start-up costs and revenue projections to those of comparable ventures -Lack of liquidity of the interest Partnership interest are not for all investors. Careful consideration must be given to the overall safety and lack of liquidity of these programs before investing. The DPP investor enjoys several advantages, including -an investment managed by others; -flow-through of income and certain expenses; and -limited liability-the most the investors can lose is the amount of their investment plus any funds committed for, but not yet remitted. The exam will probably give more attention to the following disadvantages: -Liquidity risk. The greatest disadvantage for a DPP investor is lack of liquidity. Because the secondary market for DPPs is limited, investors who want to sell their interests frequently cannot locate buyers. -Legislative risk. When Congress changes tax laws, new rules can cause substantial damage to LPs, who may be locked into illiquid investments that lost previously assumed tax advantages. -Leverage risk. It is common for DPPs to use borrowed funds. Although the leverage can boost returns, it can have the same effect on losses. The risk is even higher when partnership uses recourse debt. -Risk of audit. Statistics from the IRS indicate that reporting ownership of a DPP results in a significantly higher percentage of returns selected for audit. -Depreciation renature. One of the tax befits is
Introduction
It is important to understand that a DPP is just a different way to invest in a business rather than buying the company's stock. There are certain tax advantages to being structured as a partnership with the flow-through of income or loss being one of them. That aside, this is merely an investment in a business, whether it be a Real Estate Limited Partnership, an oil and gas drilling program, or a movie production company. Important tax concepts associated with DPPs include the following. -DPPs were formerly known as tax shelters because investors used losses to reduce or shelter ordinary income (by writing off passive losses against ordinary income). -Tax law revisions now classify income and loss form these investments as passive income and loss. Current law allows passive losses to shelter only passive income, not all ordinary income as before. Many programs lost their appeal because of this critical change in tax law. -As we learned in Unit 1, passive income is not considered earned income for the purpose of making an IRA contribution. -The IRS considers programs without any economic viability to be abusive tax shelters. The promoters and investors can face severe penalties.
Issuing Limited Partnership Interests
Limited partnerships may be sold through private placements or public offerings. If sold privately, investors receive a private placement memorandum for disclosure. Generally, such private placements involve a small group of investors, each contributing a large sum of money. These investors must be accredited investors- that is, they must meet certain net worth or income standards. The general public does not meet this description. In a public offering, partnerships are sold with prospectus to a larger number of investors, each making a relatively small capital contribution, such as $1,000 - $5,000. The syndicator oversees the selling and promotion of the partnership. The syndicator is responsible of rate preparation of any paperwork necessary for the registration of the partnership. Syndication or finders fees are limited to 10% of the gross dollar amount of securities sold.
SEC Rules Dealing with DPPs
Most DPPs are private offerings under Regulation D of the Securities Act of 1933. That will be covered in detail in Unit 20. Generally, purchasers must be accredited investors as defined in SEC Rule 501. DPPs that are offered to the public must meet the SEC's registration requirements. We will discuss those in Unit 20.
Oil and Gas Partnerships
Oil and gas programs include speculative drilling programs and income programs that invest in producing wells. We will list them from the most risk to least risk. Three types of oil and gas programs are exploratory, developmental, and income. Some offerings combine two or all three into a combination program. Exploratory (Wildcatting) Partnership objective: locate undiscovered reserves of oil and/or gas Advantages: High rewards for discovery of new reserves Disadvantages: Few new wells produce Tax Features: High intangible drilling costs for immediate tax sheltering Degree of Risk: High; most risky oil and gas program. Developmental partnership objective: drill near existing fields to discover new reserves (called step-out wells) Advantages: less discovery risk than exploratory Disadvantages: Few new wells produce Tax Features: Medium intangible drilling costs, immediate tax sheltering degree of risk: medium to high risk Income Partnership objective: provide immediate income from sale of existing oil Advantages: immediate cash flow Disadvantages: Oil prices; well stops producing Tax Features: Income sheltering form depletion allowances Degree of Risk: Low
REIT Taxation
REITs enjoy a unique hybrid status for federal income tax purposes. A REIt shareholder generally is taxed only on dividends paid by the REIT and on gains upon the disposition of REIT shares. A REIT is a corporation for US tax purposes. The REIT is generally not subject to corporate tax if it distributes to its shareholders substantially all of its taxable income for each year. How much is substantially all? Under the guidelines of Subchapter M of the IRC, a REIT can avoid being taxed as a corporation by receiving 75% or more of its income from real estate and distributing 90% or more of its taxable income to its shareholders. Shareholders receive dividends from investment income. IN most cases, those dividends are taxed at ordinary income rates rather than as qualified dividends. If there are capital gains distributions, they are generally taxed at the favorable long-term capital gains rate. Please note that with the advent of the Tax Cut and JOBS Act of 2017 (TCJA), there are some complex tax issues with REITs and those are not likely to be tested. A tax-related concern for investors is that failure to meet the distribution rules could cause the REIT to be taxed. That would lead to another level of taxation before the income gets to the investor. Test Topic Alert: Important points to remember about REITs: -An owner of REITs holds an undivided interest in a pool of real estate investments. -REITs are liquid because they trade on exchanges and OTC. -REITs are not investment companies (mutual funds). -REITs offer dividends and gains to investors but do not offer flow-through losses like limited partnerships, and therefore are not considered direct participation programs. -REITs are not DPPs (losses do not flow through). -A REIT must receive 75% or more of its income from real estate, have at least 75% of it
Real Estate Partnerships
Real estate DPPs are by far the most popular type. There are five different kinds and, as you will see in the following tables, some offer income, some offer potential growth, and some offer both. The five types of real estate programs and their features are the following. Raw Land Partnership objective: purchase undeveloped land for its appreciation potential Advantages: Appreciation potential of the property Disadvantages: Offers no income distributions or tax deductions Tax Features: No income or depreciation deductions, not considered a tax shelter Degree of Risk: Most speculative real estate partnership New Construction Partnership Objective: Build new property for potential appreciation Advantages: Appreciation potential of the property and structure; minimal maintenance costs in the early years Disadvantages: Potential cost overruns; no established track record; difficulty finding permanent financing; inability to recut current expenses during construction period Tax Features: Depreciation and expense deceptions after construction is completed and income is generated degree of risk: less risky than new land; more risky than existing property Existing Property Partnership Objective: Generate an income stream from existing structures Advantages: immediate cash flow; known history of income and expenses Disadvantages: Greater maintenance or repair expenses than for new construction; expiring leases that may not be renewed; less than favorable rental arrangements Tax Features: Deductions for mortgage interest and depreciation -Degree of Risk: Relatively low risk Government-Assisted Housing Programs Partnership Objective: Develop low-income and retirement housing Advantages: Tax credits and rent subsidies Disadvantages: Low appreciation potential; risk of changing government programs; high mai
Structuring a Limited Partnership
The concept of a partnership for our purposes is based upon tax law. An unincorporated organization with two or more members is generally classified as a partnership for federal tax purposes if its members engage in a trade, business, financial operation, or venture and divide its profits. However, a joint undertaking merely to share expenses is not a partnership. For example, co-ownership of property maintained and rented or leased is not a partnership unless the co-owners provide services to the tenants. In the case of a limited partnership, one of those members is the limited partner (LP) and the other the general partner (GP). We will get into the details of their Roels later in this lesson. An organization is classified as a partnership for federal tax purposes if it has two or more members and is none of the following: -An organization that refers to itself as incorporate or as a corporation -An insurance company -A REIT -An organization classified as a trust or otherwise subject to special treatment under the IRC. To qualify as a parent ship, the business entity must avoid corporate characteristics such as continuity of life. This is the easiest of the corporate characteristics to avoid because partnerships have a predetermined date of dissolution when they are established, whereas corporations are expected to exist in perpetuity. Test Topic Alert: Exam questions may test avoidance of corporate characteristics. For example: 1. Which of these characteristics is the most difficult to avoid? Centralized management-no business can function without it. 2. Which of these characteristics is the easiest to avoid? Continuity of life- there is a predetermined time at which the partnership interest must be dissolved. 3. Which two corporate characteristics are most likely to be avoided by a DPP? Continuity
Flow-Through
The ket tax benefit of DPPs is that they allow the economic consequences of a business to flow-through to investors. Any income or loss to the investor is considered passive because the investor does not take an active role in the management of the business- that is the role of the GP. Unlike corporations, limited partnerships pay no dividends. Rather, they pass income, gains, losses, deductions, and credits directly to investors. While each of the DPPs covered offer flow-through, some of the details are unique to each program. Let's look at them one at a time.
Introduction
The most common example of a packed product is the mutual fund. There are many others, and those are the subject of this unit. A packaged product is an investment that relives the investor or daily decision making. In the case of real estate investment trusts (REITS), investor do not have to find the properties or manage them. That is taken care of for them by the management of the trust. The same is true with a direct participation program (DPP). The program handles the details, not the investors.
Measuring Economic Soundness
There is an old saying in the real estate business. When valuing a property, what are the there most important factors? The answer is location, location, location. When it comes to evaluating a DPP, there are also three factors: economic soundness, economic soundness, and economic soundness. How is the economic soundness or viability measured? Two methods applied to the analysis of DPPs are cash flow analysis and internal rate of return. -Cash flow analysis compares income (revenues) to expenses. -Internal rate of return determines the present value of estimated future revenues and sales proceeds to allow comparison to other programs.
Required Documentation
Three important documents are required for limited partnerships to exist: -The certificate of limited partnership -The partnership agreement -The subscription agreement Certificate of Limited Partnership For legal recognition, the certificate of limited partnership must be filed in the home state of the partnership. It includes -the partnership's name; -the partnership's business; -the principal place of business; -the amount of time the partnership expects to be in business; -the conditions under which the partnership will be dissolved; -the size of each LP's current and future expected investments; -the contribution return date, if set; -the share of profits or there compensation to each LP; -the conditions for LP's assignment of ownership interests; -whether the limited partnership may admit other LPs: and -whether the business can be continued by remaining GPs at death or incapacity of a GP. Partnership Agreement: Each partner receives a copy of this agreement. It describes the roles of the GPs and LPs and guidelines for the partnership's operation. Subscription Agreement All investors interested in becoming LPs (passive investors) must complete a subscription agreement. The agreement appoints one or more GPs to act on behalf of the investors and is only effective when the GPs sign it. Along with the subscriber's money, the subscription agreement must include -the investor's net worth, -the investor's annual income, -a statement attesting that the investor understands the risk involved, and -a power of attorney appointing the GP as the agent of the partnership. In addition to a cash contribution, subscribers may assume responsibility for the repayment of a portion of a lona made to the partnership. This type of loan is called a recourse loan. Frequently, partnerships also borrow money throug
Oil and Gas Program Taxation
Unique tax advantages associated with oil and gas programs include intangible drilling costs (IDCs) and depletion allowances. Intangible Drilling Costs: Write-offs for the expenses of drilling are usually 100% deductible in the first year of operation. These include costs associated with drilling such as wages, supplies, fuel costs, and insurance. Intangible drilling costs (IDCs) can be defined as any cost that, after being incurred, has no salvage value. Tangible Drilling Costs: Tangible drilling costs are those costs incurred that have salvage value (e.g. storage tanks and wellhead equipment). These cost are not immediately deductible; rather, they are deducted (depreciated) over several years. Depletion Allowances: The IRS allows allowances in the form of tax deductions that compensate that partnership for the decreasing supply for oil or gas (or any other resource or mineral). Depletion is only allowed for natural resource programs. That includes timber and mining DPPs. Take Note: Depletion allowances may be taken only once the oil or gas is sold. There are two forms of depletion, cost and percentage. Other than knowing these two terms, we do not expect any detail on these to be on the exam. Oil and Gas Sharing Arrangements: The costs and revenues associated with oil and gas programs are shared in a variety of ways. A description of these arrangements follows: -Overriding royalty interest. The holder of this interest receives royalties but has no partnership risk. An example of this arrangement is a landowner who sells mineral rights to a partnership. -Reversionary working interest. The GP bears no costs of the program and receives no revenue until LPs have recovered their capital. LPs bear all deductible and nondeductible costs. -Net operating profits interest. The GP bears none of the program's costs
