Other Packaged Products
Which of the following statements are TRUE regarding investments in a real estate limited partnership? I Real estate limited partnership investments are considered passive investments II Real estate limited partnership investments are illiquid III Tax deductible losses are obtained through depreciation deductions, while positive cash flow is generated IV When the real estate is sold, capital gains may be generated A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV
D. Limited partnership interest are not liquid - most partnership agreements place restrictions on transfer. The ideal structure for a partnership is to generate losses for tax purposes (in a real estate program, through mortgage interest and depreciation deductions), yet show positive cash flow (since depreciation is a "paper" write-off). Since real estate is considered a passive investment, any losses can only be offset against passive income - not earned income. The structure of partnerships generates higher losses in the early years, and lower losses in the later years. This gives people with "tax problems" the incentive to buy such a program, since the deductions are "front loaded," and the potential purchaser needs those deductions today. Finally, when the real estate owned by the partnership is sold, there is the potential for capital gains.
Regarding investments in limited partnerships, which of the following statements are TRUE? I Net taxable gain or loss is computed at the limited partnership level II Net taxable gain or loss is computed at the individual partner's level III The partnership is a taxable entity IV The partnership is not a taxable entity A. I and III B. I and IV C. II and III D. II and IV
D. Partnerships are not taxable entities; all items of income and loss "flow through" to the tax returns of the partners. Tax liability only exists at the partner level - not at the partnership level.
Which of the following statements are TRUE regarding the tax status of limited partnerships? I Partnerships are taxable entities II Partnerships are not taxable entities III Tax liability exists at the partnership level IV Tax liability exists at the partner level A. I and III B. I and IV C. II and III D. II and IV
D. Partnerships are not taxable entities; all items of income and loss "flow through" to the tax returns of the partners. Tax liability only exists at the partner level - not at the partnership level.
REITs can invest in all of the following EXCEPT: A. mortgages B. real estate C. government securities D. direct participation programs
D. REITs do not invest in direct participation programs (limited partnerships), which are tax shelter vehicles. This makes sense because REITs cannot pass losses to their shareholders. They invest primarily in real estate and mortgages; excess funds can be invested in securities (however, under the tax code, at least 75% of the REIT's assets must be invested in real estate or mortgages). Therefore, a REIT may put up to 25% of its assets in "cash assets" (such as Treasury Bills) to earn interest income during periods when the trust is not fully invested in real estate.
Fixed UITs offer all of the following benefits EXCEPT: A. negotiability B. redeemability C. diversification D. low expenses
A. A fixed UIT is an investment company structure where the sponsor assembles a fixed portfolio of securities that is transferred into trust, and then $1,000 units of the trust are sold to investors. For a relatively small investment amount, the buyer gets a piece of a diversified portfolio. Once the portfolio is assembled, it does not change. There is no ongoing management and no management fees - which is the largest expense of running any investment company type. The trust sponsor makes a market in the units and will buy them back from the initial purchaser at current NAV. Then the sponsor will resell these "slightly used" trust units to another investor for their current NAV. Note that there is no trading of UITs - they are non-negotiable. If the portfolio consists of bonds (a very popular type of fixed UIT), then the portfolio self-liquidates as the bonds mature. If the portfolio consists of stocks (such as an Energy Trust consisting of various oil and gas stocks), then there is a fixed life set on the trust (say 10 years) at which point the stocks in the portfolio are sold and the proceeds distributed to the unit holders.
Which of the following statements are TRUE regarding oil drilling programs? I These programs incur intangible drilling costs which are 100% deductible in the year the drilling takes place II These programs incur intangible drilling costs which are deductible over a 27 1/2 year period III These programs give an immediate deduction IV These programs only give a deduction once oil is found A. I and III B. I and IV C. II and III D. II and IV
A. Oil drilling programs incur heavy intangible drilling costs, which are 100% deductible in the year the drilling takes place. Thus, this type of oil and gas program gives the greatest immediate deduction.
Which statement is TRUE about forming a limited partnership? A. All partners must be limited partners B. There must be at least 1 general partner and 1 limited partner C. More than 50% of the partners must be limited partners D. No more than 99 partners can be limited partners
A. A limited partnership consists of at least one General Partner and one Limited Partner. There can be multiples of each. The General Partner is the manager of the venture and assumes unlimited liability. The Limited Partner is the passive investor whose liability is limited to his or her investment.
An oil and gas program that provides high initial deductions and low mineral rights cost would be a(n): A. exploratory program B. developmental program C. income program D. combination program
A. In an exploratory program, "wildcat" wells are drilled in unproven areas. Because the odds are finding oil are low, the mineral rights cost is low. As with all drilling programs, the IDCs (intangible drilling costs - basically the cost of drilling holes!) are 100% deductible as drilled, so there are large up-front deductions. These are high risk, high return programs.
All of the following are depletable EXCEPT: A. Real Estate B. Coal C. Timber D. Gravel
A. Only natural resources, such as coal, timber, oil, gas, gravel, etc., are depletable. Machinery and real estate are depreciable assets.
Which type of real estate limited partnership offers a deferred depreciation benefit? A. New Construction B. Raw Land C. Existing Housing D. All of the above
A. Raw land is not depreciable; only the building on the land is depreciable. Existing housing is immediately depreciable. New construction is only depreciable after the building is completed - during the building phase, no depreciation deductions are permitted.
The advantage of a limited partnership business structure as opposed to a corporate business structure is: A. flow-through of gain and loss B. centralized management C. lower risk of audit D. limited liability
A. The advantage of the partnership form of business is that the partnership itself is not a taxable entity; income and loss from the partnership "flows-through" onto the individual partners' tax returns. Thus, any net income is taxed once; and any net loss is included on the partner's tax return. In contrast, a corporation must compute net income or loss at the corporate level; and must pay tax on any income. The only way for the shareholder to receive a portion of the net income is for the corporation to pay a dividend, which must be included on the shareholder's tax return; and which is taxed again! Any net losses remain at the corporate level - they cannot be distributed to shareholders. Both corporations and limited partnerships have centralized management; and both shareholders and limited partners have limited liability. Partnerships have a higher risk of audit than corporations, making this a real disadvantage to the partnership form of business.
The manager of an unregistered hedge fund is typically compensated by a fee based on a: I percentage of assets under management II percentage of net investment income III performance fee based on profits IV performance fee based on exceeding a benchmark index A. I and III B. I and IV C. II and III D. II and IV
A. The typical hedge fund fee is "2 and 20" - a 2% annual management fee as a percent of assets under management, plus 20% of profits. Hedge fund managers are not subject to the Investment Company Act of 1940 that limits manager's compensation to a percentage of assets under management - no performance fees are allowed. They are structured as private placement limited partnerships that are only available to wealthy accredited investors. They are exempt from securities regulation since the general public cannot invest, except for the anti-fraud rules. Hedge funds started in the 1990s and the managers produced superior returns and were able to charge high fees. Nowadays, most hedge funds are not doing much better than the overall market, and managers are moving towards a performance fee based on return achieved over a benchmark index, as opposed to a fee based on absolute profits (which might be achieved not because of superior investment choices, but because the market simply went up). However, the majority of hedge funds still charge a performance fee based on profits, not a performance fee based on exceeding a benchmark index.
A customer wishes to invest in an oil and gas program that provides both an immediate tax benefit, as well as a reasonable chance of continuing tax benefits. The best recommendation is a(n): A. exploratory program B. developmental program C. income program D. wildcat program
A. This customer desires an immediate tax benefit, which would only be provided by the intangible drilling cost deduction that provides that 100% of IDC's can be deducted as drilling occurs. Thus, the appropriate oil and gas program must involve drilling, eliminating an income program. (In an income program, proven reserves are purchased and extracted, with the sales partially tax sheltered by the percentage depletion allowance. No drilling occurs.) The customer also wishes to have a reasonable chance of getting continuing tax benefits. Thus, an exploratory (or "wildcat") program is not appropriate, since these programs drill in unproven areas and have a high risk of dry holes. The best choice is a developmental program, where drilling takes place near an existing field. Here, there is a greater chance of finding oil, which, when extracted and sold, would provide tax shelter in the form of the depletion allowance
A customer has heard from a relative that he should invest money in a "hedge" fund. The customer asks you to tell him about this type of investment. Which statement about hedge funds is FALSE? A. Hedge funds are only suitable for wealthy investors that meet the "accredited investor" definition B. Hedge funds are regulated as "mutual funds" under the Investment Company Act of 1940 C. Hedge funds typically allow withdrawal of funds once per year D. Hedge funds use aggressive investment strategies that entail a high level of risk
B. Hedge funds are set up as private placements, open only to accredited investors. They are illiquid, since money can only be withdrawn once per year (and usually only with general partner approval). They use sophisticated aggressive investment strategies that are high-risk (but these can also be high-reward). Most hedge funds are now registered with the SEC (as investment advisers), but they are not "regulated" and are not subject to the 1940 Act rules.
In a developmental oil and gas program which of the following statements are TRUE? I There is lower risk than an exploratory program II There is higher risk than an exploratory program III The cost of drilling is not deductible IV The cost of drilling is 100% deductible A. I and III B. I and IV C. II and III D. II and IV
B. In a developmental program, a well is drilled near an existing field. The cost of drilling is an "Intangible Drilling Cost" (IDC) and is 100% deductible as drilled. This drilling program has lower risk than an exploratory program, since there is a higher probability of finding oil near an existing field.
A 22-year old, unmarried, new customer contacts you, explaining that he just inherited $10,000,000 and wishes to invest the money aggressively to produce superior returns. He is risk-tolerant and understands the use of leverage and shorting as ways of enhancing returns. For this client, the best recommendation would be a: A. hedge fund B. fund of hedge funds C. growth fund D. value fund
B. Well, you can get this one down to 50/50 pretty quickly. This guy is rich and is looking for a rich man's investment. So it's either the hedge fund or the fund of hedge funds. You can argue this one either way, but we go with the "fund of hedge funds." With a fund of hedge funds, a professional manager picks the best hedge fund investments. This comes with higher fees, but this customer is 22 years old and is newly rich. A little professional guidance would be helpful until this guy gets some experience. You could also argue that "funds of hedge funds" have 2 layers of fees, whereas a direct hedge fund investment only has 1 layer of fees, so it is less costly and is the better choice. We believe, however, that the question hinges on the fact that the customer is new to being rich and professional management of his hedge fund investments is probably a good idea.
Real Estate Investment Trusts are not suitable as tax advantaged investments because they: A. have too many corporate characteristics B. do not qualify for conduit tax treatment under Subchapter M C. are not allowed to pass operating losses to shareholders D. are not allowed to pass capital gains to shareholders
C. REITs are not tax shelter vehicles because they cannot distribute losses to shareholders through conduit tax treatment; they can only distribute income and capital gains through conduit tax treatment to shareholders.
What does a BDC invest in? A. Publicly-held small-cap companies B. Publicly-held mid-cap companies C. Privately-held small-cap and mid-cap companies D. Privately-held large-cap companies
C. A BDC is a Business Development Company. It is a registered investment company under the 1940 Act that is listed and trades like any other stock. Instead of investing in securities, it makes "private equity" investments in privately-held start-up companies, and also mid-size companies.
A Real Estate Limited Partnership would most likely invest in: A. Single family homes B. Airport revenue bonds C. Strip malls and apartment houses D. Real estate investment trusts
C. An "existing housing" RELP (Real Estate Limited Partnership) invests in office buildings, shopping centers, apartments building, etc, for rental income. The RELP uses mortgage financing to buy the properties, so there are interest deductions, as well as depreciation deductions. RELPs do not buy single family homes (too hard to manage) and do not invest in securities such as bonds and REITs.
Which of the following are types of oil and gas direct participation programs? I Exploratory II Income III Balanced IV Combination A. I only B. II and III only C. I, II, and IV D. I, II, III, IV
C. Exploratory oil and gas programs drill for oil in unproven areas. Developmental programs drill near existing fields. Income programs simply buy proven oil reserves in the ground, and sell them using the depletion allowance as a partial tax shelter. Combination programs combine all three types. There is no such thing as a "balanced" oil and gas program. This term only applies to investment company portfolio descriptions.
Which of the following statements are TRUE regarding oil and gas limited partnership interests? I The primary tax benefit of an exploratory program is the depletion deduction II The primary tax benefit of an income program is the depletion deduction III The primary tax benefit of an exploratory program is the intangible drilling cost deduction IV The primary benefit of an income program is the intangible drilling cost deduction A. I and III B. I and IV C. II and III D. II and IV
C. Exploratory programs drill in unproven areas, and are high risk; high reward ventures. The cost of drilling the holes is 100% deductible as drilled under the Intangible Drilling Cost deduction provisions in the Tax Code. This is the primary tax benefit of any drilling program. Income programs buy proven reserves in the ground. No drilling is performed. As the oil is extracted and sold, the partnership may take the depletion deduction. This deduction theoretically allows the partnership to recover the cost of the reserves that are extracted from the ground and sold.
An oil and gas program that is designed to take advantage of the depletion allowance, without immediate deductions is a(n)? A. exploratory program B. developmental program C. income program D. combination program
C. In an income program, proven reserves in the ground are purchased. No drilling is required - this work is already complete. All that is left to the program is to extract the oil from the ground and sell it. As the oil is sold, the depletion allowance shelters income.
A tax shelter that invests in raw land offers which benefit? A. Depletion B. Depreciation C. Appreciation D. Tax credits
C. Raw land is neither depreciable nor depletable. Nor are tax credits allowed on raw land purchases. The only reason to buy and hold raw land is for appreciation potential.
Which type of real estate limited partnership offers an immediate depreciation benefit? A. New Construction B. Raw Land C. Existing Housing D. All of the above
C. Raw land is not depreciable; only the building on the land is depreciable. Existing housing is immediately depreciable. New construction is only depreciable after the building is completed - during the building phase, no depreciation deductions are permitted.
All of the following statements are true for both limited partnerships and corporations EXCEPT both limited partnerships and corporations: A. limit liability for the business owners B. have centralized management C. allow for "flow-through" of gain and loss D. are formed with business intent
C. The advantage of the partnership form of business is that the partnership itself is not a taxable entity; income and loss from the partnership "flows-through" onto the individual partners' tax returns. Thus, any net income is taxed once; and any net loss is included on the partner's tax return. In contrast, a corporation must compute net income or loss at the corporate level; and must pay tax on any income. The only way for the shareholder to receive a portion of the net income is for the corporation to pay a dividend, which must be included on the shareholder's tax return; and which is taxed again! Any net losses remain at the corporate level - they cannot be distributed to shareholders. Both limited partners and corporate shareholders have limited liability; both have centralized management; and both are formed to operate a business.
REITs may be organized as: A. general partnerships B. management companies C. trusts D. limited partnerships
C. Usually, REITs are formed as "Trusts," which is why they are called "Real Estate Investment Trusts." However, they trade on an exchange or OTC; and are similar in manner to closed end investment companies
A fund of hedge funds: A. must invest at least 75% of its assets in hedge funds B. must invest at least 90% of its assets in hedge funds C. must invest in at least 10 different hedge funds D. can invest in any number o
D. A "fund of hedge funds" is a registered investment company that invests in hedge funds. There is no limit on how the manager allocates invested monies into hedge fund investments in a "fund of hedge funds."
An equity REIT would most likely invest in all of the following EXCEPT: A. apartments B. office buildings C. shopping malls D. industrial parks
D. An equity REIT invests in income producing real estate. These include apartment buildings, shopping centers, and office buildings. The key here is that these have a large, diverse tenant pool. If any one tenant moves out, that will not have a great impact on the income stream. Industrial parks usually have only a few large tenants, not a lot of smaller tenants.
All of the following are types of real estate direct participation programs EXCEPT: A. New Construction Real Estate Limited Partnership B. Existing Housing Real Estate Limited Partnership C. Raw Land Real Estate Limited Partnership D. Mortgage Real Estate Investment Trust
D. Direct participation programs allow the partners to directly participate in income and loss. Types of RELPs (Real Estate Limited Partnerships) are: New Construction; Existing Housing; Raw Land: and Condominium investments. Real Estate Investment Trusts (REITs) are not direct participation programs. These are stock companies that invest in real estate in a closed-end investment company form. These investment companies do not allow for "flow-through" of loss to shareholders.
When comparing a mutual fund to a hedge fund, which statement is FALSE? A. Hedge funds are less regulated B. Hedge funds are more risky C. Hedge funds are only available to qualified purchasers D. Hedge funds are liquid
D. Hedge funds are "lightly regulated" partnership investments only open to accredited (wealthy, sophisticated) investors. The fund manager uses aggressive investment strategies that are risky in order to generate higher returns. Hedge funds' investments are completely illiquid. Usually, the limited partner investor can only "cash out" at year end. For the rest of the year, the investor is locked into the investment.
When discussing hedge funds with customers, the registered representative should make the customer aware that hedge funds: I often hold illiquid investments II use leverage and other speculative practices III place limitations on withdrawal of funds IV are not regulated and offer much less investor protection A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV
D. Hedge funds are set up as private placements, open only to accredited investors. They are not regulated as investment companies and are subject to minimal regulatory oversight. They are illiquid, since money can only be withdrawn once per year (and usually only with general partner approval). They use sophisticated aggressive investment strategies that are high-risk (but these can also be high-reward), including short selling, using large amounts of leverage, and speculating in futures, commodities, and foreign currency markets. Many of these are illiquid investments. Because of their aggressive trading tactics, high levels of risk, and the fact that there is minimal regulatory oversight, they are only suitable for sophisticated, wealthy investors that are able to bear risk.
