Direct Participation Programs
Advantages to Limited Partners of DPPs
-An investment managed by others -Limited Liability -Flow-through of income and certain expenses
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. B) 20,000. C) 30,000. D) 50,000.
A) 70,000. Generally, nonrecourse debt does not add to basis because the limited partner is not responsible (at risk) for the repayment of the debt. However, in real estate partnerships, the at-risk rules do not apply, and therefore, add to basis in this type of partnership.
A limited partnership brought to market through a private placement may be sold to all of the following EXCEPT: A) an unlimited number of unaccredited investors. B) 35 unaccredited investors. C) an unlimited number of accredited investors. D) an investor with over $1 million net worth.
A) an unlimited number of unaccredited investors. *The primary sale of a limited partnership through a private placement is covered by Regulation D. Sales of the issue may be made to 35 individuals, which need not meet any financial standards. If, however, sales are made to more than 35 individuals, any other purchasers must meet certain standards of financial accreditation, known as accredited investors. An accredited investor would include an investor with $1 million or more in net worth not including net equity in a primary residence, or an individual who has earnings of $200,000 in the current year and $200,000 in the previous 2 years, or is an officer or insider of the offering. Also, any large financial institution, such as a bank, an insurance company, a savings and loan, etc., would be considered an accredited investor.
Partnership Democracy
ALLOWS the LP to vote on major decisions but not day-to-day operations -vote under special circumstances, such as permitting the GP to act contrary to the agreement, to contest a judgement against the partnership, or admit a new GP
A customer bought a 10% interest in a real estate limited partnership by investing $100,000. The partnership buys a $4 million property with the funds, making a down payment of $800,000 and financing the balance with a nonrecourse mortgage of $3.2 million. Subsequently, the partnership cannot meet the mortgage payment; the lender forecloses when the remaining mortgage balance is $3 million, auctioning off the property for $1 million. How much of the investment will the customer recover? A) 100,000. B) 0. C) 10,000. D) 32,000.
B) 0. The real estate limited partnership raised only $1,000,000 (10% interest equals $100,000). The partnership incurred excess liabilities. While the customer isn't liable for any of the excess liabilities, as a limited partner the customer is liable for the entire $100,000 invested. Because the customer is liable for the entire $100,000 invested, none of it will be recovered.
A working interest in an oil and gas partnership entitles the holder to: I. a portion of the revenue. II. responsibility for part of the expense of extraction. III. royalty interest in the revenue. IV. royalty interest in revenue after deducting certain expenses. A) III and IV. B) I and II. C) I and III. D) II and IV.
B) I and II. *A working interest is a right to revenues from production, but it also carries the responsibility for extraction costs. A royalty interest carries no responsibility for extraction costs.
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.
B) principal repayment on recourse debt. *Principal repayments are not deductible for tax purposes. The interest is deductible.
The term "wildcatting" refers to: A) limiting your investment portfolio to IPOs. B) small-cap mutual fund diversification. C) drilling for oil or gas where none has occurred previously. D) buying new-construction real estate for speculative appreciation value.
C) drilling for oil or gas where none has occurred previously. *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).
All of the following are types of oil and gas direct participation programs EXCEPT: A) combination. B) developmental. C) minimum guarantee wildcat. D) income.
C) minimum guarantee wildcat. Exploratory programs drill wildcat wells in areas where there are no proven reserves of oil and gas. The chances of success are relatively slim, so there are no guarantees. The other three choices describe types of oil and gas programs.
A nonleveraged direct participation program has all of the following risks EXCEPT: A) legislative risk. B) liquidity risk. C) rate risk. D) management risk.
C) rate risk. *If debt is not used by the partnership, rate risk does not exist. Nonleveraged DPPs do not use debt
All of the following are primary objectives in a DPP EXCEPT: A) deferment of taxes. B) deductions against other income. C) short-term capital gains. D) long-term capital gains.
C) short-term capital gains. *DPPs are used to defer present income into the future and take advantage of time.
In real estate limited partnerships, the general partner has:
C) unlimited liability and an active role. *In partnerships, whether real estate or not, the general partner is the active partner managing the business and taking on unlimited liability.
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) a loss. B) $1.4 million. C) $3 million. D) $1.6 million.
D) $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.
A customer has an investment of 10% of a leasing partnership, giving him a cost basis of $100,000. If the DPP operator fails, leaving $1 million to pay for a $2 million non-recourse loan, what is the maximum liability of the investor? A) 10,000. B) 20,000. C) 200,000. D) 100,000.
D) 100,000. $2 million of the debt is unpaid. However, the investor has no liability beyond the original investment of $100,000. The loan is non-recourse so the customer's basis is $100,000, which represents his maximum liability. Limited partners are not liable for non-recourse debt.
All of the following statements are true of the risks of investing in an oil and gas limited partnership EXCEPT: A) wells may not have sufficient reserves to return drilling costs. B) income programs have fewer tax benefits than exploratory programs. C) development programs may involve acquisition of expensive leases. D) development programs have higher risk than exploratory programs.
D) development programs have higher risk than exploratory programs. *Exploratory programs have the highest risks, rewards, and tax benefits. Development wells are drilled to develop a reserve that is already known to be present.
Profit Motive
DPP w/o a profit motive or w/ the intention of only producing losses for investors may be deemed abusive and subject to - back taxes, recapture of tax credits, interest penalties, or prosecution/fraud
Intangible Drilling Costs
Definition- Any cost that after being incurred, has no salvage value. Include costs associated with drilling- wages, supplies, fuel costs, and insurance. Write-offs for the expenses of drilling are 100% deductible in the first year of operation
Tangible Drilling Costs
Definition- Costs incurred that have salvage value, such as- storage tanks and wellhead equipment. *These costs are not immediately deductible; rather they are deducted (depreciated over several years)
A registered representative must obtain written verification of an investor's net worth for which of the following investments?
Direct participation program. *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 subscription agreement.
3 Types of Oil and Gas Programs
Exploratory (wildcatting)- riskiest Developmental Income- least risky
What might happen if a limited partner begins making business decisions for the partnership?
He might jeopardize his limited liability status. *If a limited partner has control over the partnership operation (i.e., he makes partnership decisions), he could be judged a general partner and, thus, have unlimited liability.
From first to last, which of the following sequences reflects the priority of payments made when a limited partnership is liquidated? I.General partners. II. Limited partners. III. General creditors. IV. Secured creditors.
IV, III, II, I. *Creditors are paid first in a liquidation, with priority given to the secured lenders; general partners are the last to get paid.
All of the following statements are true with respect to a limited partnership subscription agreement EXCEPT:
NOT TRUE- the general partner's signature grants the limited partners power of attorney to conduct the partnership's affairs. *A limited partner's signature on the subscription agreement grants the general partner power of attorney to conduct the partnership's affairs. The subscription agreement for a limited partnership is deemed accepted when the general partner signs the subscription agreement.
DPP Cash Flow Calculation. Why add depreciation?
Net income or Loss + noncash changes (depreciation) Depreciation is added back because it is a NONCASH change and this is a CASH flow calculation
Nonrecourse Loans
Partnerships frequently borrow money through nonrecourse loans **GPs have responsibility for repayment of nonrecourse loans (LPs do NOT)
DPPs passive losses shelter which type of income? Ordinary Income Passive Income
Passive Income only
All of the following are required by limited partnerships EXCEPT: A) partnership agreement. B) SEC approval. C) certificate of limited partnership. D) subscription agreement.
SEC Approval *The SEC does not approve limited partnerships or any other securities. In public offerings of limited partnerships (as opposed to private placements), federal registration and a prospectus are required.
Recourse Loans
Subscribers may assume responsibility for the repayment of a portion of a loan made to the partnership, in addition to a cash contribution
Which of the following registers the securities and packages the program for a limited partnership?
Syndicator * handles the registration of the limited partnership units.
The certificate of limited partnership contains
The amount of Time the partnership expects to be in business AND all conditions of Dissolution *The certificate contains, among other information, the limited partnership's name and business, the amount of time the partnership intends to be in business, and the conditions of dissolution. It does not contain each partner's net worth nor is there a market-out clause like those generally associated with underwriting agreements for new issues.
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?
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).
Programs allowing for the direct pass-through of losses and income to investors include all of the following EXCEPT: A) REITs. B) S corporations. C) oil and gas drilling direct participation programs. D) new construction real estate direct participation programs.
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.
The rights and liabilities of general and limited partners are listed in the: A) agreement of limited partnership. B) certificate of partnership. C) Uniform Limited Partnership Act. D) partnership title.
A) agreement of limited partnership. *The agreement is the contract between the general and limited partners, and contains each entity's rights and duties.
An individual who invests in an undeveloped land limited partnership would be most interested in: A) appreciation. B) depreciation. C) depletion. D) operating expense deductions.
A) appreciation Investors seek appreciation when investing in undeveloped land limited partnerships.
A limited partner assisting the general partner to solicit new investors. A) could jeopardize his limited partner status. B) is permitted if stated in the partnership agreement. C) is permitted if no compensation is paid. D) is permitted if done within 90 days of his acceptance as limited partner.
A) could jeopardize his limited partner status. *If limited partners, either individually or as a group, become too involved with the business of the partnership, they could be considered to be general partners and lose their limited liability.
The managing partner of a limited partnership has responsibility for all of the following EXCEPT:
A) providing unlimited capital for the partnership business. *The general partner organizes and manages the partnership; he assumes unlimited liability, paying all partnership debts. However, it is the limited partners who provide the bulk of the capital.
Depletion allowances apply to all of the following EXCEPT: A) real estate. B) oil and gas. C) copper mining. D) timber.
A) real estate. *Real Estate can't be "used up" -Depletion is applicable to natural resources such as mining or timber. It is not applicable to real estate. However, buildings can be depreciated.
Which of the following would NOT require an amendment to a certificate of limited partnership? A) A change in partnership sharing arrangements. B) A net loss incurred in the current year. C) The discovery of an error in the certificate currently on file. D) An increase in contribution by any partner, general or limited.
B) A net loss incurred in the current year. *The certificate would not be amended unless the information provided in the certificate changes. The certificate contains no operating information.
All of the following are characteristics of both oil and gas, and real estate limited partnerships, EXCEPT: A) deferral of benefits. B) depletion. C) limited liability. D) depreciation.
B) 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.
Once the IRS determines that a tax shelter is abusive, it may do all of the following EXCEPT: A) charge the taxpayer with intent to defraud. B) sentence the abuser to a prison sentence. C) disallow all deductions. D) charge interest on back taxes.
B) sentence the abuser to a prison sentence. *The IRS does not have the authority to hand out prison sentences.
When analyzing a DPP investment, a method that takes into account the revenues and expenses is: A) technical analysis. B) fundamental analysis. C) cash flow analysis. D) liquidity analysis.
C) cash flow analysis. Revenues and expenses are cash items and would be analyzed by cash flow analysis.
Advantages of owning a real estate DPP program include all of the following EXCEPT: A) depreciation. B) appreciation. C) depletion. D) cash flow.
C) depletion. It is impossible to deplete (use up) real estate; depletion only applies to natural resources, such as oil or gas.
Which of the following real estate limited partnerships allows tax credits to the investor? A) Existing property. B) Raw land. C) New construction. D) Historic rehabilitation.
D) Historic rehabilitation. Raw land partnerships seek appreciation. Existing property and new construction partnerships seek passive income and tax deductions from business operations. Historic rehabilitation partnerships allow not just deductions but actual tax credits.
In the partnership agreement of a limited partnership, all of the following would be disclosed EXCEPT: A) how the operating profits will be distributed. B) how the general partners will be compensated. C) what matters the limited partners can vote on under the democracy provisions. D) the procedures for the annual election of general partners.
D) the procedures for the annual election of general partners. *Limited partners have limited liability. General partners have unlimited liability. Only in specific situations can the limited partners elect a new general partner. Such situations would include the resignation, death, incapacity, or removal of the general partner.
Limited Partnership Disadvantages
Illiquidity -Extremely limited secondary market, investor who wish to sell frequently cannot find investors. - The shareholder's interest is NOT freely transferable
Depletion Allowances
Tax deductions that compensate the partnership for the decreasing supply of oil or gas (or any other resource or mineral) *May only be taken once the oil or gas is sold
All of the following are common to both DPPs and REITs EXCEPT
pass-through of losses. *Both DPPs and REITS are professionally managed pools that pass through income and capital gains distributions to participants. REITS, unlike DPPs, do not pass through losses. Common to both- -pass-through of income. -centralized management. -capital gains distributions.
DPPs
-Structured as Limited Partnerships or Subchapter S Corps -Report only income and losses to IRSP -Partners/ Shareholders- responsible for reporting income and losses individually -Flow-Through means that the income and losses and tax responsibilities go straight to the investor with no taxation to the business entity.
A taxpayer's most advantageous tax benefit is: A) a tax deduction. B) straight-line depreciation. C) a depletion allowance. D) a tax credit.
A tax credit reduces a person's tax liability dollar for dollar. Deductions, depreciation and depletion reduce taxable income.
As a requirement of investing in a particular investment, your customer has just signed a statement attesting to his annual income, net worth and affirming that the risks associated with the investment are understood. Which of the following investments would have such a requirement? A) A direct participation program B) A collateralized mortgage obligation C) A hedge fund D) A variable annuity
A) A direct participation program *Investors purchasing limited partnership participations or DPPs are required to sign a subscription agreement. In part the investor would be attesting to annual income, net worth and that they understand the risks associated with the type of program they are investing in. While suitability would be a factor for each of the investments listed, they do not require this type of statement be signed by the customer.
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) An oil and gas drilling program. B) An oil and gas income program. C) Raw land. D) Existing housing.
A) 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.
Investing in undeveloped land satisfies which of the following primary objectives? A) Appreciation. B) Investment tax credits. C) Deductible interest expense. D) Tax-deferred income.
A) Appreciation. The primary reason to invest in raw land is the appreciation in value.
When a certificate of limited partnership is required to be rerecorded or amended, the general partner must file: A) within 30 days of the change. B) before the change. C) within 5 business days of the change. D) within 60 days of the change.
A) within 30 days of the change. *Refiling must occur within 30 days of any significant change to partnership information on file
Depletion allowances in oil and gas programs are based on the amount of oil: A) lost to shrinkage. B) sold. C) in reserve. D) extracted.
B) sold. Depletion allowances are allowed to compensate for a mineral resource, which is considered accomplished when it is sold.
Which of the following are part of the depreciable basis of a limited partner in a real estate DPP? Land. Buildings. Architect's fees incurred in designing the buildings. Air conditioning equipment.
Buildings AND Air conditioning equipment. *Only fixed plant (buildings) and equipment can be depreciated. Land as well as any up-front costs charged to the limited partners cannot be depreciated. Those non-depreciable costs, however, are part of the limited partner's beginning basis but not part of the depreciable basis.
Regarding the use of the term "direct participation programs" when referring to tax-sheltered investments, which of the following is NOT a DPP? A) A real estate limited partnership. B) An equipment leasing limited partnership. C) A real estate investment trust. D) An oil and gas limited partnership.
C) A real estate investment trust. *DPPs include any form of business that allows for the direct pass-through of tax consequences to participants. REITs do not allow for the pass-through of losses.
A method of analyzing limited partnerships by identifying the sources of revenues and expenses is known as: A) capital analysis. B) technical analysis. C) liquidity analysis. D) cash flow analysis.
D) cash flow analysis.
An investor in an oil and gas limited partnership program is subject to the economic consequences of all of the following EXCEPT: A) depreciation on tangible assets. B) operating losses. C) recourse loans. D) nonrecourse loans.
D) nonrecourse loans. *Nonrecourse loans only have economic consequences for investors in real estate programs.
Written verification of the financial status of the customer is needed for all of the following EXCEPT: A) oil and gas limited partnerships. B) real estate limited partnerships. C) equipment leasing limited partnerships. D) real estate investment trusts.
D) real estate investment trusts. *Real estate investment trusts (REITs) do not require proof of financial status for investment. Limited partnerships and other DPPs do.
Which of the following would NOT be a valid use of the partnership democracy?
Deciding which partnership assets should be liquidated to pay creditors. *Deciding which partnership assets should be liquidated to pay creditors involves limited partners in the active management of partnership affairs. This would result in their being treated as general partners with respect to liability, and possible loss of limited partner status.
Which of the following govern the sale of a publicly offered direct participation program?
FINRA & Securities Act of 1933 *The sale of a publicly registered DPP, like any other newly issued nonexempt security, is governed by the Securities Act of 1933, FINRA, and any applicable blue-sky (state) securities laws. While IRS tax code is applicable to DPPs, the IRS does not govern the sale of the securities.
Which of the following statements regarding limited partnerships are TRUE? I. Maximum commission in selling partnership offerings is 5%. II. Maximum commission in selling partnership offerings is 10%. III. Commissions taken are deducted from the original investment to determine beginning basis. IV. Commissions taken are not deducted from the original investment to determine beginning basis.
II. Maximum commission in selling partnership offerings is 10%. IV. Commissions taken are not deducted from the original investment to determine beginning basis. *Under FINRA rules, the maximum compensation that can be taken by sponsors selling direct participation programs is 10%. Up-front costs, such as commissions taken and accounting costs, do not reduce the beginning basis.
DPPs are the only investment opportunity to-
offer a pass-through of losses to the investor.
When conducting a discussion with a client about the merits of investing in a DPP, all of the following could be tax advantages EXCEPT: accelerated depreciation. depletion allowances. recapture of depreciation. tangible drilling expenses.
recapture of depreciation. tangible drilling expenses. Depreciation is the deduction against income representing the cost recovery of certain fixed assets. When one of those assets is sold for more than the straight-line depreciated value, the excess is recaptured as ordinary income. Only intangible drilling expenses benefit the limited partner.
If your client's real estate limited partnership goes bankrupt, which of the following are paid before your client?
-Bank that holds the mortgage on the property. -Bank that holds the unsecured loans on the property. *Creditors, both secured and unsecured, have priority over partners. Your client's fellow limited partners are paid at the same time as your client; the general partner receives his money last.
Losses from direct participation programs can be used to offset: A) none of these. B) income from limited partnerships. C) earned income from salary or commissions. D) portfolio income.
B) income from limited partnerships. *Passive losses can be used only to offset passive income, which is earned from direct participation programs and rental real estate.
A blind pool offering: A) is one in which the properties are purchased on a lottery basis. B) is one in which 25% or more of the properties are not specified. C) is connected with oil and gas leases. D) generates nonallocated income.
B) 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.
Which of the following best describes the advantages of an oil and gas income program as compared with other types of oil and gas programs? A) No depletion allowances. B) Greatest risk of capital. C) Lowest risk of capital. D) Highest tax write-off.
C) Lowest risk of capital. Oil and gas income programs own producing wells and pass through their depletion allowances. There is little risk compared to other programs, such as exploration.
If a limited partnership interest is sold, the gain or loss in the sale is the difference between the sales proceeds and the: A) total of the deductible losses taken by the investor. B) total of tax preference items allocated to the investor. C) adjusted basis. D) original basis.
C) adjusted basis. he adjusted basis is a limited partner's cost basis at any point in time. Gain or loss on the sale of the partnership is determined by comparing the sales proceeds to the adjusted basis.
All of the following are oil and gas program sharing arrangements EXCEPT: A) functional allocation. B) disproportionate sharing. C) reversionary working interest. D) all or none underwriting arrangement.
D) all or none underwriting arrangement. *Functional allocation, disproportionate sharing, and reversionary working interest are all types of oil and gas sharing arrangements. All or none is a type of best efforts underwriting agreement.
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?
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.
Which statements regarding oil and gas limited partnerships are TRUE? I. Developmental programs are more risky than exploratory programs. II. Exploratory programs are more risky than developmental programs. III. Successful developmental programs provide higher returns than exploratory programs. IV. Successful exploratory programs provide higher returns than developmental programs. A) II and IV. B) I and III. C) I and IV. D) II and III.
A) II and IV. *Exploratory oil and gas direct participation programs drill in areas where there are no proven oil reserves. While the chances of success are relatively small, successful exploratory wells provide large returns to investors. Developmental programs drill in areas adjacent to sites where proven oil reserves exist; while the probability of success is favorable, the returns will not be as great as a successful exploratory program.
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? The investor's tax basis will be $10,000. The investor's tax basis will be $50,000. The investor's maximum loss will be $10,000. The investor's maximum loss will be $50,000. A) II and IV. B) I and III. C) I and IV. D) II and III.
A) II and IV. 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.
Which of the following oil and gas programs would be associated with the least risk? A) Income. B) Exploratory. C) Developmental. D) Raw land.
A) Income. For oil and gas programs, ranking from least to most risk would be as follows: Income, Developmental and Exploratory. Raw land is a type of real estate program.
Which of the following statements describes an oil and gas blind pool offering? A) Money is raised without a specific property being stated, and the GP selects the investments. B) The oil exploration occurs in an area that is not adjacent to any known oil reserves. C) The income from producing wells is purchased at a discount from the present value of the projected future flows. D) An unknown number of representatives participates in the sale of known partnership units.
A) Money is raised without a specific property being stated, and the GP selects the investments. *A blind pool offering, also known as a nonspecified program, involves an investment in a program without specific prospects or properties being identified.
If an investor expects to have a large amount of passive income over the next 2 years, which of the following programs will most likely lead to the largest amount of shelter? A) Oil and gas drilling. B) Equipment leasing. C) Undeveloped land purchasing. D) Real estate income.
A) Oil and gas drilling. *Passive income can only be sheltered by passive loss. Oil and gas drilling programs allocate the majority of investment dollars to drilling. These are intangible drilling costs (IDCs), which are 100% deductible when drilling occurs.
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. B) income $1.6 million. C) income $2.7 million. D) loss $3 million.
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.
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) 75,000. B) 55,000. C) 0. D) 35,000
B) 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.
Which of the following types of oil and gas limited partnership programs is the riskiest? A) Existing property. B) Exploratory. C) Developmental. D) Income.
B) Exploratory. For oil and gas partnerships, exploratory programs are considered most risky because they involve drilling new wells in areas where oil has not yet been discovered. These programs would be followed by developmental and finally income programs being the least risky. Existing property is a type of real estate program.
In discussing a direct participation program with your customer, she notes investment characteristics that are important to her and some that are not. For a DPP to be considered suitable for the customer, rank the following items in order of those that should be most important to least important. I. Tax write-offs II. Liquidity and marketability III. Potential for economic gain IV. SEC approval
B) III, I, II, IV *In the eyes of the IRS, a program's economic viability should be the most important aspect of the investment for a limited partner and the first priority in the assessment of the DPP. While the IRS considers programs designed solely to generate tax benefits abusive, they do allow for some in terms of writing off passive income and allowable tax credits so these factors would be the next concern for an investor. Because there is a very limited secondary market for DPPs, liquidity and marketability should be a low priority, and because there is no SEC approval of any investment it would be of no concern.
Which of the following best describes an intangible drilling cost? A) Exploratory well drilling. B) Labor, fuel, or drilling rig rental. C) Proven reserve of oil or gas. D) Tax liability.
B) Labor, fuel, or drilling rig rental. *Intangible drilling costs are the noncapital costs of putting in a well. They are currently deductible expenses, like fuel, wages, and rent. An intangible drilling cost is one which, after expenditure, has no salvage value.
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) Oil and gas income program. C) Exploratory oil and gas drilling program. D) New construction real estate limited partnership.
B) 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.
A general partner may do all of the following EXCEPT: A) act as an agent for the partnership in managing partnership assets. B) borrow money from the partnership. C) make general management decisions regarding the partnership. D) sell property to the limited partnership.
B) borrow money from the partnership. *All these situations offer the potential for conflicts of interest. However, the general partner is not forbidden by law to engage in any of these acts, except for borrowing money-the general partner may never borrow money from the partnership.
All of the following documentation is necessary for a publicly subscribed limited partnership EXCEPT: A) subscription agreement. B) cash flow analysis. C) Certificate of Limited Partnership. D) partnership agreement.
B) cash flow analysis. *The certificate gives public information about the partnership and is filed in the home state. The partnership agreement spells out the roles of the general and limited partners. The subscription agreement is the instrument by which the limited partners invest.
Limited partners have all of the following rights EXCEPT the right to: A) receive their pro rata share of income or loss. B) decide which properties the partnership purchases. C) monitor the partnership. D) sue the general partner for violating the partnership agreement.
B) decide which properties the partnership purchases. *The limited partners have the right to inspect partnership records and to sue a general partner who acts outside the partnership agreement. The general partner normally sets his own compensation in the original agreement and makes all management decisions relative to the partnership's interests.
A general partner is considered to have a conflict of interest with the business of a limited partnership if he:
Borrows money from the business. *The general partner manages the business and acts as agent for the business. The general partner may loan money to the partnership at a reasonable rate of interest, but may not borrow from the partnership.
If a limited partner in a real estate direct participation program becomes involved in the management of the office building acquired by the partnership, which of the following is TRUE? A) The limited partner's participation is disallowed and the program continues as before, but the remaining partners are required to prorate the remaining unit. B) This is allowed, but only with a majority vote of the other limited partners and written approval of the sponsor. C) That limited partner's limited liability is jeopardized. D) There are no adverse consequences if, in performing management functions, the limited partner's expertise benefits the program.
C) That limited partner's limited liability is jeopardized. *While the limited partners usually have limited liability, that benefit can be lost if a limited partner engages in certain activities, including (1) the day-to-day management of the property, (2) representing himself as a general partner, and (3) financial control of the partnership.
Limited partnership programs are categorized as direct participation programs. The term "direct participation" refers to the A) general partners directly participating in the day to day management of the partnership B) ability of any partner, limited or general, to participate in the running of the partnership C) flow-through of profits and losses of the partnership to the individual limited partners D) ability, through partnership democracy, for each partner to have his vote flow through to the general partner
C) flow-through of profits and losses of the partnership to the individual limited partners *Understanding the flow-through concept is critical with DPPs. Only DPPs allow flow-through of losses.
In the case of a real estate direct participation limited partnership program, nonrecourse financing will: A) have no effect on a limited partners original cost basis. B) be added to a limited partners sales proceeds at the time the partnership is dissolved. C) increase a limited partners original cost basis. D) decrease a limited partners original cost basis.
C) increase a limited partners original cost basis. *For real estate limited partnerships, nonrecourse loans are included in the limited partners cost basis. In this way, the loans increase the partners original cost basis by the amount of the partner's debt liability for the loan.
Which of the following is least likely to be part of an equipment leasing partnership? A) Railroad cars. B) Aircraft. C) Computers. D) Oil well casing and piping.
D) Oil well casing and piping. *Casing and piping are materials used in oil and gas well drilling programs.
The principal tax benefit of investing in an exploratory oil and gas drilling program is derived from: A) depreciation expenses. B) capital appreciation. C) recapture. D) intangible drilling costs.
D) intangible drilling costs. Intangible drilling costs (IDCs), which are a significant portion of all drilling costs, are a major tax advantage to a limited partner and are tax deductible in the year in which they are incurred. IDCs are costs that, after incurred, hold no salvage or ongoing value. Examples are labor and geological survey.
In a DPP, a general partner is all of the following EXCEPT A) one who appoints the property manager B) a key executive who makes day to day business decisions C) one who buys and sells the program's property D) one who has limited liability
D) one who has limited liability *A general partner of a limited partnership is a key executive of the program who purchases and sells the property and/or appoints someone to manage the property. The general partner does not have limited liability. By not allowing the general partner to have limited liability, the program is able to rule out limited liability as a corporate characteristic.
The document attesting to the formation of a limited partnership, filed with designated authorities, is called: A) the subscription agreement. B) the registration statement. C) the offering memorandum. D) the certificate of limited partnership.
D) 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.
A sharing arrangement in which only deductible costs are apportioned to the investor with the sponsor bearing all capitalized costs is called a(n): A) functional allocation. B) carried interest. C) overriding royalty arrangement. D) reversionary sharing arrangement.
Functional allocation is a sharing arrangement in which the general partner pays for all tangible drilling costs (capitalized costs) and the limited partners pay for all intangible drilling costs (deductible costs).
An investor acquires limited partner status in a direct participation program when:
He and the general partner have both signed the subscription agreement. *The investor must sign a copy of the subscription agreement, but he is not considered a limited partner until the agreement is also signed by the general partner indicating acceptance of the limited partner.
An investor in a limited partnership generating passive losses can offset these against: I.passive income from other partnerships. II.rental income from direct investments in real estate. III.dividends received from listed securities. IV.capital gains from sale of unlisted securities.
I.passive income from other partnerships. II.rental income from direct investments in real estate. *Passive losses can be deducted from passive income and income from certain real estate investments; it cannot be deducted from active or portfolio (investment) income.
Intangible drilling costs would include all of the following EXCEPT: A) wages. B) fuel. C) land surveys. D) 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
A limited partner (LP) invests $100,000 in a limited partnership with a nonrecourse note for $300,000. The partnership liquidates and the LP receives $100,000. His loss for tax purposes is: A) 0. B) 100,000. C) 200,000. D) 300,000.
Limited partners are liable for their investments and any shares of recourse debt. They are not liable for nonrecourse debt. Because the limited partner received the full amount of his original investment at the liquidation of the partnership, he has no loss to declare.
Which of the following could an analyst use to establish the rate of return on a direct participation program? Present value. Internal rate of return. Yield to maturity. First in, first out.
Present value. Internal rate of return. *Analysts use both present value and internal rate of return to establish a DPP's rate of return. Both involve assumptions based on future cash flows generated by the program.
In a functional allocation oil and gas program, which of the following statements are TRUE? The general partner picks up all tangible drilling costs. The general partner picks up all intangible drilling costs. The limited partners pick up all tangible drilling costs. The limited partners pick up all intangible drilling costs. A) III and IV. B) I and IV. C) I and II. D) II and III.
The general partner picks up all tangible drilling costs The limited partners pick up all intangible drilling costs. B) I and IV. *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.
