Series 7 Chapter 5

The following dividends were received by a husband, his wife, and both of them jointly: husband-$160; wife-$160; joint-$100. Indicate the amount of dividends that would be subject to taxation if they filed a joint tax return.

$160 + $160 + $100 = $420. This would all be taxable as ordinary income.

A taxpayer's most advantageous tax benefit is:

A tax credit reduces a person's tax liability dollar for dollar. Deductions, depreciation and depletion reduce taxable income.

If a limited partnership interest is sold, the gain or loss in the sale is the difference between the sales proceeds and the:

Adjusted Basis

A direct participation program shows the following operation results: Revenues: $3 millionOperating expense: $1 millionInterest expense: $200,000Management fees: $200,000Depreciation: $3 millionCash flow from program operation is:

Cash flow for a partnership is calculated in the following fashion:Gross revenue $3 millionLess operating exp -$1.2 millionLess debt interest -$200,000Less 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.

Depletion allowances in oil and gas programs are based on the amount of oil:

Depletion allowances are allowed to compensate for a mineral resource, which is considered accomplished when it is sold.

A sharing arrangement in which only deductible costs are apportioned to the investor with the sponsor bearing all capitalized costs is called a(n):

Functional Allocation 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).

Which of the different sharing arrangements for limited partnerships between the general partners (GPs) and the limited partners (LPs) is generally considered the most common?

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

A limited partner assisting the general partner to solicit new investors.

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.

All of the following would flow through as a loss to limited partners EXCEPT:

Principal repayments are not deductible for tax purposes. The interest is deductible.

In the partnership agreement of a limited partnership, all of the following would be disclosed EXCEPT:

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.

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?

$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.

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?

$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.

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?

0

One of your customers, age 52, wishes to open an IRA. His annual income is over $200,000 and consists entirely of income from rental real estate and income from a trust fund. What amount may your customer contribute this year to his IRA?

0 To open an IRA, a person needs earned income. Income from rental real estate is passive income while income from a trust fund is portfolio income. This customer has no earned income.

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:

70000 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.

Which of the following is least likely to be part of an equipment leasing partnership?

Casing and piping are materials used in oil and gas well drilling programs.

Depletion allowances apply to all of the following EXCEPT:

Depletion is applicable to natural resources such as mining or timber. It is not applicable to real estate. However, buildings can be depreciated.

If a book author receives royalty payments from a publisher, the payments will be taxable as which of the following types of income?

Earned Income The author received royalties as a result of an active trade or business, therefore the payments are considered earned income.

In the case of a real estate direct participation limited partnership program, nonrecourse financing will:

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 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.

I and II 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.

An investor in a limited partnership generating passive losses can offset these against: passive income from other partnerships. rental income from direct investments in real estate. dividends received from listed securities. capital gains from sale of unlisted securities.

I and II 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.

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.

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.

If your client's real estate limited partnership goes bankrupt, which of the following are paid before your client? Fellow limited partners. Bank that holds the mortgage on the property. Bank that holds the unsecured loans on the property. General partner.

II and III 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.

Which of the following statements regarding limited partnerships are TRUE? The maximum commission in selling partnership offerings is 5%. The maximum commission in selling partnership offerings is 10%. Commissions taken are deducted from the original investment to determine beginning cost basis. Commissions taken are not deducted from the original investment to determine beginning cost basis.

II and IV 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 cost basis.

The principal tax benefit of investing in an exploratory oil and gas drilling program is derived from:

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.

Which of the following best describes an intangible drilling cost?

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 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:

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.

The rights and liabilities of general and limited partners are listed in the

Partnership Agreement The agreement is the contract between the general and limited partners, and contains each entity's rights and duties.

Losses from direct participation programs can be used to offset:

Passive losses can be used only to offset passive income, which is earned from direct participation programs and rental real estate.

Programs allowing for the direct pass-through of losses and income to investors include all of the following EXCEPT:

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.

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:

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.

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.

A registered representative must obtain written verification of an investor's net worth for which of the following investments?

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.

The certificate of limited partnership contains the market-out clause the amount of time the partnership expects to exist each investor's net worth all conditions of dissolution

II and IV The certificate contains, among other information, the limited partnership's name and business, the amount of time the partnership intends to exist, 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.

Your client is interested in a direct participation program (DPP) limited partnership. Which of the following two are most likely to factor into a discussion on suitability of such an investment? Beta. Liquidity. Alpha. Age.

II and IV The key here is to recognize that with DPPs, the customer's age is a relevant consideration in determining suitability. DPPs are long-term and illiquid. For example, it is unlikely that DPPs would be suitable for a customer near retirement age, regardless of the customer's financial situation. Beta, having to do with measuring an investment's volatility as related to the overall market, and alpha being a measure of performance adjusted for risk are not factors generally associated with DPPs.

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.

III and IV 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.

A blind pool offering:

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.

A high net worth investor with substantial annual income likes real estate as a potential investment. The investor notes that any potentially offering tax credits would be most interesting to consider first. Which of the following would be suitable investments to discuss?

Real estate investments trusts (REITs), either equity or mortgage, should be eliminated as they offer no tax credits. Given the customer's high net worth and income, a discussion of DPPs is suitable. Of those DPPs shown here, only historic rehabilitation and government assisted housing offer tax credits and either should be suitable for discussion.