Chapter 5 Questions

Income from which of the following investments is passive income? I. Real estate DPP. II. Vacation cottage rentals. III. REITs. IV. CMOs. A)I and III. B)II and IV. C)I and II. D)II and III.

I and II. Explanation Passive income results from DPPs and personal real estate rentals. REITs and CMOs are securities; income from securities is considered portfolio income.

When analyzing a DPP investment, a method that takes into account the revenues and expenses is: A) liquidity analysis. B) cash flow analysis. C) fundamental analysis. D) technical analysis.

cash flow analysis. Explanation Revenues and expenses are cash items and would be analyzed by cash flow analysis.

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

drilling for oil or gas where none has occurred previously. Explanation 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).

The document attesting to the formation of a limited partnership, filed with designated authorities, is called: A) the offering memorandum. B) the certificate of limited partnership. C) the subscription agreement. D) the registration statement.

the certificate of limited partnership. Explanation 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.

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? A) 1850 B) 4000 C) 18000 D) 2000

2000 Explanation The FINRA rules for limited partnership offerings limit underwriting compensation to 10% of the total money raised (10% of $20,000 is $2,000).

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. A) 420 B) 0 C) 220 D) 200

420 Explanation $160 + $160 + $100 = $420. This would all be taxable as ordinary 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: A) 70000 B) 30000 C) 50000 D) 20000

70000 Explanation 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 NOT generally associated with an existing real estate DPP? A) Immediate income stream B) Lower risk than other types of real estate programs C) Known history of income and expenses D) Appreciation potential

Appreciation potential Explanation Appreciation potential is generally not associated with existing real estate programs because most appreciation occurs in the earliest years for real estate assets.

If a book author receives royalty payments from a publisher, the payments will be taxable as which of the following types of income? A) Earned income. B) The payments are not taxable. C) Passive income. D) Portfolio income.

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

If near term liquidity were the only objective for a client, which of the following pairs of investments would represent the most/least liquid? A) Variable annuity (VA)/direct participation programs B) Exchange listed equities/direct participation program (DPP) C) Variable annuity (VA)/money market mutual funds D) 10-year corporate bonds/U.S. T-bills

Exchange listed equities/direct participation program (DPP) Explanation Of the pairings offered to choose from, exchange listed equities are considered liquid as they could be easily divested of, and DPPs all having predetermined (scheduled) end dates, would be the least liquid.

Some limited partnership programs provide potential tax credits to partners. Which of the following typically provide potential tax credits? I. Rehabilitation of historic properties II. Equipment leasing III. Developmental oil and gas programs IV. Government-assisted housing programs A)I and II B)I and IV C)II and III D)III and IV

I and IV Explanation Historic rehabilitation and government-assisted housing are two programs that offer potential tax credits. Tax credits are no longer available for equipment leasing and while developmental oil and gas programs offer high IDCs, these are not ITCs (investment tax credits).

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? I. The investor's tax basis will be $10,000. II. The investor's tax basis will be $50,000. III. The investor's maximum loss will be $10,000. IV. The investor's maximum loss will be $50,000. A)I and IV. B)II and IV. C)I and III. D)II and III.

II and IV. Explanation 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) Raw land. B) Developmental. C) Income. D) Exploratory.

Income. Explanation 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 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) Lowest risk of capital. C) Highest tax write-off. D) Greatest risk of capital.

Lowest risk of capital. Explanation 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.

Which of the following statements describes an oil and gas blind pool offering? A) The income from producing wells is purchased at a discount from the present value of the projected future flows. B) The oil exploration occurs in an area that is not adjacent to any known oil reserves. C) Money is raised without a specific property being stated, and the GP selects the investments. D) An unknown number of representatives participates in the sale of known partnership units.

Money is raised without a specific property being stated, and the GP selects the investments. Explanation A blind pool offering, also known as a nonspecified program, involves an investment in a program without specific prospects or properties being identified.

For tax-reporting purposes, qualified dividends are considered to be what type of income? A) Passive. B) Portfolio. C) Earned. D) Phantom.

Portfolio. Explanation Portfolio income includes dividends, interest, and net capital gains derived from the sale of securities.

All of the following are required by limited partnerships EXCEPT: A) partnership agreement. B) certificate of limited partnership. C) subscription agreement. D) SEC approval.

SEC approval. Explanation 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.

Which of the following registers the securities and packages the program for a limited partnership? A) Property manager. B) Limited partners. C) Syndicator. D) General partner.

Syndicator. Explanation A syndicator handles the registration of the limited partnership units.//

A limited partner assisting the general partner to solicit new investors. A) is permitted if stated in the partnership agreement. B) is permitted if no compensation is paid. C) is permitted if done within 90 days of his acceptance as limited partner. D) could jeopardize his limited partner status.

could jeopardize his limited partner status. Explanation 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.

Losses from direct participation programs can be used to offset: A) income from limited partnerships. B) none of these. C) portfolio income. D) earned income from salary or commissions.

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

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)$1.4 million. B)$3 million. C)a loss. D)$1.6 million.

$1.6 million. Explanation 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.

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? A) 5500 B) 0 C) 7000 D) $6.000.

0 Explanation 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.

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? A) Overriding royalty interest B) Carried interest C) Functional allocation D) Net operating profits interest

Functional allocation Explanation 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.

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

I and II. Explanation 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.

When conducting a discussion with a client about the merits of investing in a DPP, all of the following could be tax advantages EXCEPT: I. accelerated depreciation. II. depletion allowances. III. recapture of depreciation. IV. tangible drilling expenses. A)II and III. B)I and II. C)I and IV. D)III and IV.

III and IV. Explanation 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.

Programs allowing for the direct pass-through of losses and income to investors include all of the following EXCEPT: A) S corporations. B) new construction real estate direct participation programs. C) REITs. D) oil and gas drilling direct participation programs.

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

providing unlimited capital for the partnership business. Explanation 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.

All of the following statements are true with respect to a limited partnership subscription agreement EXCEPT: A) the investor's signature indicates that he has read the offering document. B) the general partner's signature grants the limited partners power of attorney to conduct the partnership's affairs. C) the investor's registered representative must verify that the investor has provided accurate information. D) the general partner endorses the subscription agreement, signifying that a limited partner is acceptable.

the general partner's signature grants the limited partners power of attorney to conduct the partnership's affairs. Explanation 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.

An investor in an equipment leasing DPP using straight-line depreciation would probably not be concerned about A) the likelihood of recapture B) legislative risk C) liquidity risk D) the quality of the management

the likelihood of recapture Explanation Recapture of deductions is a concern when accelerated, but not straight-line depreciation is used. In any business, there is always concern about the quality of the management. By and large, DPPs are not liquid investments so an investor needing a quick sale may have problems. The nature of DPPs tends to make them more sensitive to legislative risk than most other securities.

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) 55000 B) 0 C) 75000 D) 35000

55000 Explanation 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.

As a requirement of investing in a particular business 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. The signed statement, once submitted with the intended investment amount, will either be approved or disapproved. Approval allows the investor to subscribe to the investment. Which of the following investments would have such a requirement? A) A variable annuity B) A special situation fund C) A direct participation program D) A collateralized mortgage obligation

A direct participation program Explanation 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.

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

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

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) 100000 C) 300000 D) 200000

0 Explanation 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.

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? A) 0 B) 10000 C) 100000 D) 33000

0 Explanation 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.

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) 32000 B) 0 C) 10000 D) 100000

0 Explanation There is a lot more information in this question than is needed. Simply, the deal went bankrupt - the asset was sold for less than the mortgage. That means the investor's $100,000 is totally lost.

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 investment trust. B) An oil and gas limited partnership. C) An equipment leasing limited partnership. D) A real estate limited partnership.

A real estate investment trust. Explanation 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.

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) Existing housing. B) An oil and gas drilling program. C) Raw land. D) An oil and gas income program.

An oil and gas drilling program. Explanation Oil and gas drilling programs pass through IDCs (intangible drillings costs), which the partners may use to reduce passive income.

Which of the following would NOT be a valid use of the partnership democracy? A) Deciding which partnership assets should be liquidated to pay creditors. 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) Removing the general partner.

Deciding which partnership assets should be liquidated to pay creditors. Explanation 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.

A registered representative must obtain written verification of an investor's net worth for which of the following investments? A) Mutual fund. B) Direct participation program. C) Variable contract. D) Real estate investment trust.

Direct participation program. Explanation 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.

Which of the following types of oil and gas limited partnership programs is the riskiest? A) Existing property. B) Developmental. C) Income. D) Exploratory.

Exploratory. Explanation 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.

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? A) Real estate investment equity trusts (REITs) and new construction direct participation programs (DPPs) B) Raw land and existing property direct participation programs (DPPs) C) Real estate investment mortgage trusts (REITs) D) Historic rehabilitation and government assisted housing direct participation programs (DPPs)

Historic rehabilitation and government assisted housing direct participation programs (DPPs) Explanation 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.

Which of the following real estate limited partnerships allows tax credits to the investor? A) New construction. B) Raw land. C) Existing property. D) Historic rehabilitation.

Historic rehabilitation. Explanation 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.

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

I and II. Explanation 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.

Which of the following could an analyst use to establish the rate of return on a direct participation program? I. Present value. II. Internal rate of return. III. Yield to maturity. IV. First in, first out. A)II and III. B)III and IV. C)I and II. D)I and IV.

I and II. Explanation 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? I. The general partner picks up all tangible drilling costs. II. The general partner picks up all intangible drilling costs. III. The limited partners pick up all tangible drilling costs. IV. The limited partners pick up all intangible drilling costs. A)II and III. B)I and II. C)III and IV. D)I and IV.

I and IV. Explanation 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? I. Fellow limited partners. II. Bank that holds the mortgage on the property. III. Bank that holds the unsecured loans on the property. IV. General partner. A)I and III. B)I and II. C)II and III. D)III and IV.

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

II and IV. Explanation 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.

"Which of the following are part of the depreciable basis of a limited partner in a real estate DPP? I. Land. II. Buildings. III. Supplies used for cleaning and maintenance. IV. Air conditioning equipment. A)I and III. B)II and IV. C)II and III. D)I and IV.

II and IV. Explanation 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.

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? I. Beta. II. Liquidity. III. Alpha. IV. Age. A)II and IV. B)II and III. C)I and III. D)I and IV.

II and IV. Explanation 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.

Which of the following best describes an intangible drilling cost? A) Tax liability. B) Labor, fuel, or drilling rig rental. C) Proven reserve of oil or gas. D) Exploratory well drilling.

Labor, fuel, or drilling rig rental. Explanation 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) New construction real estate limited partnership. C) Oil and gas income program. D) Exploratory oil and gas drilling program.

Oil and gas income program. Explanation 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.

Which of the following is least likely to be part of an equipment leasing partnership? A) Aircraft. B) Oil well casing and piping. C) Computers. D) Railroad cars.

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

Advantages of oil and gas direct participation programs do not generally include? A) IDC. B) Depletion. C) Potential alternative minimum tax D) Potential cash flow and/or income.

Potential alternative minimum tax Explanation Alternative minimum tax is not considered an investment benefit of an oil and gas DPP. This tax arises from excess intangible drilling costs being considered a tax-preference item. An oil and gas limited partnership has the advantages of intangible drilling costs (IDCs), 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, as long as not treated as excess by the IRS, and depletion are advantages to an oil and gas program that are available to no other limited 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) That limited partner's limited liability is jeopardized. B) This is allowed, but only with a majority vote of the other limited partners and written approval of the sponsor. C) The limited partner's participation is disallowed and the program continues as before, but the remaining partners are required to prorate the remaining unit. D) There are no adverse consequences if, in performing management functions, the limited partner's expertise benefits the program.

That limited partner's limited liability is jeopardized. Explanation 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.

A taxpayer's most advantageous tax benefit is: A) a tax credit. B) straight-line depreciation. C) a tax deduction. D) a depletion allowance.

a tax credit. Explanation 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: A) original basis. B) adjusted basis. C) total of tax preference items allocated to the investor. D) total of the deductible losses taken by the investor.

adjusted basis. Explanation The 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) all or none underwriting arrangement. B) reversionary working interest. C) disproportionate sharing. D) functional allocation.

all or none underwriting arrangement. Explanation 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.

An individual who invests in an undeveloped land limited partnership would be most interested in: A) operating expense deductions. B) appreciation. C) depreciation. D) depletion.

appreciation. Explanation Investors seek appreciation when investing in undeveloped land limited partnerships.

A general partner may do all of the following EXCEPT: A) borrow money from the partnership. B) make general management decisions regarding the partnership. C) sell property to the limited partnership. D) act as an agent for the partnership in managing partnership assets.

borrow money from the partnership. Explanation 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.

A general partner is considered to have a conflict of interest with the business of a limited partnership if he: A) loans money to the business. B) acts as agent for the business. C) manages the business. D) borrows money from the business.

borrows money from the business. Explanation 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.

All of the following documentation is necessary for a publicly subscribed limited partnership EXCEPT: A) cash flow analysis. B) subscription agreement. C) Certificate of Limited Partnership. D) partnership agreement.

cash flow analysis. Explanation 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.

A customer wanting to invest in an oil and gas limited partnership wants to know what her cost basis would be for tax purposes. While there can be a number of variables, cost basis for a limited partner is best defined as A) noncash contribution + nonrecourse debt - recourse debt B) cash investment made - distributions C) cash investment made + recourse debt - distributions D) recourse debt - cash contributions

cash investment made + recourse debt - distributions Explanation Cost basis for a limited partner is defined as investment made (cash contributions) + recourse debt (debt the LP is responsible for) - distributions. Nonrecourse debt would only be included for real estate programs. Real estate programs are the only types where LPs can be responsible for both recourse and nonrecourse debt.

Intangible drilling costs would include all of the following EXCEPT: A) fuel. B) land surveys. C) casing. D) wages.

casing. Explanation 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.

Limited partners have the right to do all of the following EXCEPT A) vote to remove the GP B) inspect and copy partnership records C) choose the assets for the partnership D) sue the GP for damages if he acts outside of his authority

choose the assets for the partnership Explanation All of these are rights of the LP except choosing the assets to be purchased for the partnership which is a function of the general partner.

An investor wanting to know about the tax consequences of a direct participation program (DPP) should know which asset types can be depleted or depreciated. All of the following asset types can be depleted or depreciated EXCEPT: A) buildings. B) crops. C) oil. D) gas.

crops. Explanation Oil and gas are examples of asset types that can be depleted, whereas buildings are a depreciable asset. Farm crops are considered to be renewable assets.

All of the following are characteristics of both oil and gas, and real estate limited partnerships, EXCEPT: A) deferral of benefits. B) limited liability. C) depreciation. D) depletion.

depletion. Explanation 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.

The primary tax benefit of an income oil and gas program is: A) tangible drilling costs. B) depletion. C) intangible drilling costs. D) depreciation.

depletion. Explanation In an income program, the partnership is buying producing oil and gas wells. There are no drilling costs involved in these programs. While there may be a small amount of depreciation as a tax benefit, the primary benefit is depletion which is taken once the oil and gas have been sold.

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) development programs have higher risk than exploratory programs. C) income programs have fewer tax benefits than exploratory programs. D) development programs may involve acquisition of expensive leases.

development programs have higher risk than exploratory programs. Explanation 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.

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) overriding royalty arrangement. B) functional allocation. C) carried interest. D) reversionary sharing arrangement.

functional allocation. Explanation 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).

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.

increase a limited partners original cost basis. Explanation 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.

The principal tax benefit of investing in an exploratory oil and gas drilling program is derived from: A) capital appreciation. B) intangible drilling costs. C) recapture. D) depreciation expenses.

intangible drilling costs. Explanation 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.

A blind pool offering: A) is one in which the properties are purchased on a lottery basis. B) is connected with oil and gas leases. C) is one in which 25% or more of the properties are not specified. D) generates nonallocated income.

is one in which 25% or more of the properties are not specified. Explanation 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 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)income $1.6 million. B)income $2.7 million. C)loss $3 million. D)loss $1.4 million.

loss $1.4 million. Explanation 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.

All of the following are types of oil and gas direct participation programs EXCEPT: A) income. B) developmental. C) combination. D) minimum guarantee wildcat.

minimum guarantee wildcat. Explanation 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.

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

one who has limited liability Explanation 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.

All of the following would flow through as a loss to limited partners EXCEPT: A) interest payments on recourse debt. B) accelerated depreciation. C) depletion. D) principal repayment on recourse debt.

principal repayment on recourse debt. Explanation Principal repayments are not deductible for tax purposes. The interest is deductible.

Written verification of the financial status of the customer is needed for all of the following EXCEPT: A) real estate limited partnerships. B) real estate investment trusts. C) oil and gas limited partnerships. D) equipment leasing limited partnerships.

real estate investment trusts. Explanation Real estate investment trusts (REITs) do not require proof of financial status for investment. Limited partnerships and other DPPs do.

Once the IRS determines that a tax shelter is abusive, it may do all of the following EXCEPT: A) charge interest on back taxes. B) charge the taxpayer with intent to defraud. C) sentence the abuser to a prison sentence. D) disallow all deductions.

sentence the abuser to a prison sentence. Explanation The IRS does not have the authority to hand out prison sentences.

All of the following are objectives in a DPP EXCEPT: A) long-term capital gains. B) deferment of taxes. C) short-term capital gains. D) deductions against passive income.

short-term capital gains. Explanation DPPs are used to defer present income into the future and take advantage of time. In doing so, any gains will be taxed at favorable long-term rates. The expected losses in the early years may be taken as deductions against passive income from other sources.

Depletion allowances in oil and gas programs are based on the amount of oil: A) in reserve. B) lost to shrinkage. C) sold. D) extracted.

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

In the partnership agreement of a limited partnership, all of the following would be disclosed EXCEPT: A) what matters the limited partners can vote on under the democracy provisions. B) the procedures for the annual election of general partners. C) how the general partners will be compensated. D) how the operating profits will be distributed.

the procedures for the annual election of general partners. Explanation 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.