Unit 13 - Direct Participation Programs

Which of the following would NOT be a valid use of the partnership democracy? A) Removing the general partner. B) Consenting to an action of a general partner that is contrary to the agreement of limited partnership. C) Consenting to a legal judgment against the partnership. D) Deciding which partnership assets should be liquidated to pay creditors.

Your answer, Consenting to an action of a general partner that is contrary to the agreement of limited partnership., was incorrect. The correct answer was: 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. Reference: 13.1.4 in the License Exam Manual.

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. A) III and IV. B) II and III. C) I and II. D) I and IV.

Your answer, I and II., was correct!. 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. Reference: 13.2.4 in the License Exam Manual.

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. A) II and III. B) II and IV. C) I and IV. D) I and III.

Your answer, II and III., was incorrect. The correct answer was: II and IV. 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. Reference: 13.2.1 in the License Exam Manual.

Rank the following oil and gas programs from highest risk to lowest risk. Income. Exploratory Developmental. A) I, III, II. B) II, III, I. C) I, II, III. D) II, I, III.

Your answer, II, III, I., was correct!. Exploratory drilling programs represent the highest risk as they involve drilling in previously unexplored areas. Developmental drilling involves drilling in areas where oil and gas have already been discovered, so the risk is less. Income programs involve purchasing existing oil and gas wells and selling the production, so the risk is low. Reference: 13.2.2 in the License Exam Manual.

The term "wildcatting" refers to: A) small-cap mutual fund diversification. B) limiting your investment portfolio to IPOs. C) buying new-construction real estate for speculative appreciation value. D) drilling for oil or gas where none has occurred previously.

Your answer, buying new-construction real estate for speculative appreciation value., was incorrect. The correct answer was: 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). Reference: 13.2.2.4 in the License Exam Manual.

An investor acquires limited partner status in a direct participation program when: A) his money is received by the general partner. B) the certificate of limited partnership is filed in its home state. C) he submits a signed copy of the subscription agreement. D) he and the general partner have both signed the subscription agreement.

Your answer, he and the general partner have both signed the subscription agreement., was correct!. 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. Reference: 13.1.2.1.3 in the License Exam Manual.

A nonleveraged direct participation program has all of the following risks EXCEPT: A) liquidity risk. B) management risk. C) rate risk. D) legislative risk.

Your answer, legislative risk., was incorrect. The correct answer was: rate risk. If debt is not used by the partnership, rate risk does not exist. Reference: 13.2.4 in the License Exam Manual.

In a DPP, a general partner is all of the following EXCEPT: A) one who appoints the property manager. B) one who has limited liability. C) one who buys and sells the program's property. D) a key executive.

Your answer, one who has limited liability., was correct!. 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. Reference: 13.1.4 in the License Exam Manual.

All of the following are common to both DPPs and REITs EXCEPT: A) centralized management. B) pass-through of income. C) capital gains distributions. D) pass-through of losses.

Your answer, pass-through of losses., was correct!. 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. Reference: 13.1 in the License Exam Manual.

Depletion allowances apply to all of the following EXCEPT: A) timber. B) copper mining. C) real estate. D) oil and gas.

Your answer, real estate., was correct!. Depletion is applicable to natural resources such as mining or timber. It is not applicable to real estate. However, buildings can be depreciated. Reference: 13.2.2.3 in the License Exam Manual.

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) the procedures for the annual election of general partners. C) what matters the limited partners can vote on under the democracy provisions. D) how the general partners will be compensated.

Your answer, the procedures for the annual election of general partners., was correct!. 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. Reference: 13.1.2.1.2 in the License Exam Manual.

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

Your answer, A direct participation program, was correct!. 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. Reference: 13.1.2.1.3 in the License Exam Manual.

An investor's cost basis in a real estate program could be increased by: cash contributions. contributions of property. nonrecourse financing. distributions of cash to the partner. A) I, II, III and IV. B) I and II. C) I, II and III. D) I and III.

Your answer, I, II, III and IV., was incorrect. The correct answer was: I, II and III. An investor's original cost basis will be increased by cash contributions made by the limited partner, property, fully paid securities and in the case of real estate programs, nonrecourse financing. A distribution of cash to a limited partner will decrease the investor's cost basis. Reference: 13.2.6 in the License Exam Manual.

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) 35,000. B) 75,000. C) 55,000. D) 0.

Your answer, 35,000., was incorrect. The correct answer was: 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. Reference: 13.2.4.2.1 in the License Exam Manual.

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) 30,000. B) 20,000. C) 50,000. D) 70,000.

Your answer, 50,000., was incorrect. The correct answer was: 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. Reference: 13.2.6 in the License Exam Manual.

What are the advantages of oil and gas direct participation programs? A) Depletion. B) IDC. C) Potential cash flow and/or income. D) All of these.

Your answer, All of these., was correct!. An oil and gas limited partnership has the advantages of intangible drilling cost (IDC), depletion, depreciation, and the potential for cash flow and/or income. Such a program would also usually have the advantage of the deductions of operating expenses. For the exam, intangible drilling costs and depletion are advantages to an oil and gas program that are available to no other limited partnership. Reference: 13.2.2 in the License Exam Manual.

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) II and III. B) III and IV. C) I and II. D) I and IV.

Your answer, I and IV., was correct!. 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. Reference: 13.2.2.7 in the License Exam Manual.

The managing partner of a limited partnership has responsibility for all of the following EXCEPT: A) providing unlimited capital for the partnership business. B) organizing the business. C) paying partnership's debts. D) managing the operations.

Your answer, providing unlimited capital for the partnership business., was correct!. 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. Reference: 13.1.2.1.3 in the License Exam Manual.

In real estate limited partnerships, the general partner has: A) limited liability and an active role. B) unlimited liability and an active role. C) limited liability and a passive role. D) unlimited liability and a passive role.

Your answer, unlimited liability and an active role., was correct!. In partnerships, whether real estate or not, the general partner is the active partner managing the business and taking on unlimited liability. Reference: 13.1.4 in the License Exam Manual.