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Series 7 - Direct Participation Programs
Understanding the specifics of DPPs, Distinguishing a limited partner from a general partner, Looking at the different types of DPPs
36
Finance
Professional
09/07/2011

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Term
Direct Participation Programs (DPPs)
Definition
  • A business venture designed to let investors participate directly in the cash flow and tax benefits of the underlying investment. DPPs are generally passive investments that investin real estate or energy-related ventures.
  • more commonly known as limited partnerships, these businesses are somewhat similar to corporations
  • have some specific tax advantages and disadvantages
  • invstors of DPPs will be required to tie up their investment dollars for a long period of time, although they will receive tax advantages for doing so


Term
Remember!
Definition
  • the IRS determines whether an enterpirse is a corporation or a limited partnership
  • For a limited partnership to actually be consiered (and taxed) like a limited partnership, its has to avoid at least 2 of the following corporate characteristics:
  1. Having a centeralized management
  2. Providing limited liability
  3. having perpectual (never ending) life
  4. Having fee transferablitly of partnership interest
Term
Having a Centeralized Management
Definition
  • corporations have management in one place
  • the challenges of having a limited partnership exist when its being managed from several locations make this corpoarte trait quite difficult  for a partnership to avoid
Term
Providing Limited Liability
Definition
  • Corporate shareholders have limited liability; well, so do limited partners
  • corporate shareholders are limited to the amount invested, and limited partners are limited by the amount invested plus a portion of any recourse loans taken out by the partnership (if any)
  • provoding limtied liability is pretty much unavoidable
Term
Having Perpetual (never-ending) Life
Definition
  • Unlike corporations, which hope to last forever, limited partnerships are set up for a definite period of time.
  • Limited partnerships are dissolved at a predetermined time - For example, when its goals are met or after a set number of years
Term
Having free transferability of parternship interest
Definition
  • DPPs are difficult to get in and out of
  • unlike with a stock purchase, where anyone can freely buy and sell shares, not only do limited partners have to pass your scrutiny, but they also require approval of the genreal partner
  • DPP investors must show that they have enough money to invest initially, plus have liquidity in other investments in the event that the partnership needs a loan
Term
Remember!
Definition
  • You should remember that the easiest corporate characteristics for a partnership to avoid are perpetual life and having free transferability of shares
  • the most difficult to avoid are providing limited liability and having a centralized management
Term
Note:
Definition
  • by law, limited partnerships require at least one limited partner and one general partner
  • limited partners are the investors
  • the general partners are the managers
  • general partners are responsible for the day-to-day decision making
  • limited partners provide the bulk of the money for the partnership but, unlike general partners, can't make any of the partnerships investment decisions
Term
Comparing General Partners and Limited Partners in:
Definition
  • Decision making
  • Tasks
  • liability and litigation
  • financial involvement
  • Financial rewards
  • conflicts of interset
Term
Decision making
Definition
  • General Partners: are legally bound to make decisions in the best interest of the partnership, make all partnerships day-to-day decisions
  • Limited Partners: have voting rights but cant make decisions for the partnership
Term
Tasks
Definition
  • Gneral Partners: buy and sell property for the partnership; manage the partnership assets
  • Limtied Partners: Provide capital, vote, can keep general partners in chcek by reviewing books
Term
Liability and Litigation
Definition
  • General Partners: have unlimtied liability (can be sued and held personally responsible for all partnership debts and losses)
  • Limited Partners: have limited liability (limited to the amount invested and a proportionate share of any recourse loans taken by the partnership). Can inspect all the partnership books; can sue the general partner or can sue to dissolve the partnership
Term
Financial Involvement
Definition
  • General Partner: maintain a financial interest in the partnership
  • Limited Partners: Provide money contributed to the partnership, recourse debt of the partnership, and non-recourse debt for real estate DPPs
Term
Financial Rewards
Definition
  • General Partners: receive compensation for managing the partnership
  • Limited Partners: receive their portion of profits and losses
Term
Conflicts of interest
Definition
  • General Partner: cant borrow money from the partnership; cant compete against the partnership
  • Limtied Partners: none, can invest in competing partnerships
Term
3 required documents necessary for a limited partnership to exist
Definition
  1. partnership agreement
  2. certificate of limited partnership
  3. subscription agreement
Term
Partnership Agreement
Definition
  • a document that includes the rights and responsibilites of the limtied and general parties
  • included in the agreement are the general partners right to:
  • charge a management fee for making decisions
  • enter the partnership into contracts
  • decide whether cash distributions will be made to the limited partners
  • accept or decline limited partners
Term
Certificate of limited partnership
Definition
  • the legal agreement between the general and limited partners filed in the home state of the partnership
  • includes basic information (name, address) as well as:
  • the objectives of the partnership and the length of time its expected to last
  • the amount contributed by each partner, plus future expected investments
  • how the profits are distributed
  • the roles of the participants
  • how the partnership can be dissolved
  • whether a limited partner can sell or assign his or her interest in the partnership
Term
Subscription Agreement
Definition
  • an application form that potential limited partners have to complete
  • the general partner uses this agreement to determine whether an investor is suitable to become a limited partner
  • One of your jobs as a registered representative is to review the agreement to ensure that the information the investor provides is complete and accurate
  • the subscription agreement has to include items such as the investors income and net worth, a statement explaining the risks of investing in the partnership, and a power of attorney that allows the general partner to make partnership investment decisions for the limited partner
Term
Taxes on partnerships
Definition
  • taxes on DPPs are classified as passive income and passive losses
  • investors can write off passive losses only against passive income from other DPP investments
Term
3 big types of DPPs
Definition
  • real estate
  • equipment leasing
  • oil and gas
Term
Real Esate Partnership info
Definition
  • include programs that invest in raw land, new construction, existing properties, or government assisted housing
  • 4 types of real estate DPPs (in order from riskiest to safest):
  • Raw Land
  • New Construction
  • Existing Properties
  • Public Housing (government-assisted housing programs)
Term
Raw Land DPP
Definition
  • invests in undeveloped land, looking for long-term capital appreciationl raw land DPPs dont build on or rent out the property
  • this is the riskiest because there is not any cash flow and the value of the land may decrease and not increase
Term
New Construction DPP
Definition
  • purchase property for the purpose of building
  • after completing the construction, the partnership goal is to sell the property and structure a profit after all expenses
Term
Existing Properties DPP
Definition
  • purchases existing properties, looking to generate a regular stream of rental income
  • because the properties already exist the DPP generates immediete cash flow
  • the risks associated are : maintenance or repair expenses will eat out the profit or that the tenants wont renew their leases
  • relatively low risk
Term
Public Housing (government-assisted housing programs)
Definition
  • develops in low-income and retirement housing
  • goal is to earn consistent income and receive tax credits
  • these are backed by the united states government are are therefore seen as the safest
Term
Equipment Leasing Parnership info
Definition
  • purchase equipment and lease it out to other businesses
  • the objective is to obtain steady cash flow and depreciation write-offs
  • two types:
  • operating Lease- purchases equipment and leases it out for a short period of time
  • Full payout lease-purchases equipment and leases it out for a long period of time
  • the operating lease is riskier because the equipment becomes less valuable or outdate over time and therefore less rentable
Term
Oil and Gas Partnership Info
Definition
  • include programs that produce income, are speculative in nature, or a combination of the two.
  • 3 tax advantages that are uniquie to oil and gas DPPs:
  • Intangible drilling costs (IDCs)
  • Tangible Drilling Costs (TDCs)
  • Depletion
Term
Intangible Drilling Costs (IDCs)
Definition
  • are write offs for drilling expenses
  • these costs include wages for employees, fuel, repairs, hauling of equipment, insurance, ect
  • IDCs are usually completely tax deductible in the tax year in which the intangible costs occurred
  • when a well is not producing the write offs are not allowed
Term
Tangbile Drilling Costs (TDCs)
Definition
  • write-offs on items purchased that have salvage value (items to be resold).
  • these costs are not immedietly written off but are depreciated over several years
  • depreciation may be claimed on a straight line or an accelerated basis
Term
Depletion
Definition
  • allows partnerships that deal with natural resources to deduct for the decreasing supply of the resource
  • partnerships can claim depletion only on the amount of natural resources sold
Term
4 types of oil and gas DPPs
Definition
  • exploratory (riskiest)
  • developmental
  • income
  • combination
Term
Exploratory DPP
Definition
  • locate and drill for oil in unproven, undiscovered areas
  • advantages: long term capital appreciation potential, high returns for discovery of new oil or gas reserves
  • risks: new oil reserves may never be found, high IDCs because the DPP isnt working with producing wells
Term
Developmental DPP
Definition
  • to drill near producing wells with the hope of finding new reserves
  • advantages: long term capital appreciation potential with less risk than exploratory programs
  • risks: the property is expensive and the drilling costs may be higher than expected; the risk of dry holes is still somewhat high; medium level of of ICDs
Term
Income DPP
Definition
  • to provide immediate income by purchasing producing wells
  • advantages: the partnership generates immediate cash flow, no IDCs
  • Risks: high initial costs. the least risky of oil and gas DPPs. there is the risk that the oil or gas well could dry up or gas/oil prices could be lower
Term
Comination
Definition
  • to provide income to help pay for the cost of finding new oil reserves
  • advantages: to be able to offset the new costs of drilling new wells by using income generated by existing wells
  • Risks: has the risk of potential rewards of all the other programs combined
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