5. Other Investment Vehicles Flashcards
is a tax-advantaged savings plan designed to encourage saving for future education costs.
- allows money saved to be used for qualified expenses for K-12 and post-secondary education
- are state sponsored, which means they are defined as a municipal fund security
which means these plans must be accompanied or preceded by an official statement or offering circular (similar to a prospectus)
529 plan
Tax benefits: In some states, contributions to a 529 plan may be tax-deductible on your state tax return.
No income restrictions: There are no income restrictions for participating in a 529 plan, allowing anyone to start saving for college.
With no limits on the amount that can be contributed, a 529 plan can also serve as a way to transfer wealth to future generations.
Professionally managed and offer a range of investment options, making it easier to choose the right investment strategy for your needs.
Contributions to a 529 plan are considered gifts under federal tax law
Prepaid tuition plans for state residents and Savings plans - for residents and non-residents
Are considered two types of?
529 Plans
The more popular option is the savings plan, which allows donors to save money to be used later for education expenses
True or false
A 529 plan covers qualified education expenses such as tuition, room and board, and books.
True
Withdrawals for non-qualified expenses will be subject taxes on any gains and a 10% penalty on the gains
True or false?
Few states allow contributions to in-state plans to be tax deductible. So, don’t worry about advising a client who is opening an out of state 529 of any tax implications
False
Almost all states allow contributions to in-state plans to be tax deductible
If a client mentions opening a out-of-state 529 plan, you must advise the client that certain tax advantages may not be available to out-of-state donors
Which of the following does not have regulatory jurisdiction over the structure or sale of 529 plans?
A. SEC
B. IRA
C. MSRB
D. DEPARTMENT OF EDUCATION
D.
The department of education does define what is or is not a school, but that is it as far as a 529 plan goes.
The 529 plan is a type of securities account (SEC) that is sponsored by individual states (MSRB), and provides certain tax incentives (IRS)
is a type of education savings plan that allows parents, grandparents, and others to pre-pay a student’s future tuition costs at today’s prices. The plan allows the account owner to lock in the cost of tuition at participating schools and guarantee that the funds will cover tuition costs, regardless of future inflation or tuition increases.
Prepaid tuition plan
- Is considered a hedge against inflation regarding tuition costs
Are generally formed as a trust in which municipalities can purchase shares or units in the _______ investment portfolio.
- Not required to register with the SEC, as they fall under the exemption list.
- can be an attractive investment option for local governments looking for a safe, liquid, and cost-effective way to invest their funds.
(LGIPs) local government investment pools
Our tax-advantaged savings accounts for individuals with disabilities and their families.
- the beneficiary of the account is the account owner, and income earned by the accounts is not taxed.
- limited to individuals with significant disabilities where the age of onset occurred before turning age 26.
- contributions are made on after tax basis and our limited to a specific dollar amount per year
Achieving a better life experience accounts
(ABLE)
All the following are true for an Achieving a Better Life Experience account except:
A. The account must be open before the beneficiary turns 26
B. The account owner and the beneficiary must be disabled
C. The income is tax-free
D. The onset of the disability must have occurred before the owner turned 26
A.
The account does not need to be opened before the owner turns 26, but the qualifying disability does need to have begun before that age. Income from an ABLE account is received tax-free.
Is an unincorporated association of two or more individuals?
Partnerships
What has the following characteristics?
The business is not taxed as an entity. The following tax consequences flow to the Owners:
- Income
- Expenses
- Credits
- Deductions
- Losses
Direct Participation Programs (DPP)
The most common type being a Limited Partnership
True or false?
In a general partnership, all partners in the business have responsibility and manage the business
True
A general partnership is a type of business structure in which all partners have unlimited personal liability for the debts and obligations of the partnership. In the securities industry, a general partnership refers to a partnership in which all partners are active in the management and operations of the business and share equally in the profits and losses.
True or false?
All owners in a partnership may be held liable for actions of the partnership.
True
There is no liability protection
True or false?
The partnership is a tax reporting entity meaning they report their business results
And also a tax paying entity
False.
This is only half true. The partnership is not a tax paying entity
The owners would pay any taxes
is a type of investment vehicle that allows individuals to directly invest in specific assets or projects, typically in the form of limited partnerships, real estate investment trusts (REITs), or oil and gas drilling programs. These programs offer the opportunity for investors to participate in a specific project or asset, sharing in the profits or losses of the underlying investment.
- are not tax directly as a corporation would be, instead, the income or losses are passed directly through to the owners of the partnership- the investors
- investors are then individually responsible for satisfying any tax consequences
- considered highly a illiquid as there is virtually no secondary market for an investor to divest they’re interested!
Direct participation programs
is a type of business structure in which one or more general partners manage the day-to-day operations, while limited partners provide capital and share in the profits, but do not participate in management.
- are typically passive investors who are protected from personal liability for the debts and obligations of the partnership. The general partners, on the other hand, are responsible for the management of the partnership and are personally liable for the debts and obligations of the partnership.
- the businesses themselves are not tax paying entities.
- pass through to investors a share in the income, gains, losses , deductions, and tax credits of the business entity
- the investors (partners) but then have the responsibility to report individually to the IRS
- greatest disadvantage is the lack of liquidity in the partnership interest
Limited partnerships
Interest in the business is not freely transferable
Limited partnership
True or false?
Property in limited liability partnerships is usually held in the form of a tenants in common, which provides limited liability and no management responsibilities to the limited partners
True
General partners and limited partners are two owners in a ?
Limited partnership
Have unlimited liability, meaning that they can be held personally reliable for business losses and debts
- Their role is to manage all aspects of the partnership and have a fiduciary responsibility to use the invested capital in the best interest of the investors
- Decisions legally bind the partnership
- may not compete personally with the business, borrow money from the partnership, or commingle the partnership funds with their personal assets
General partners (GPs)
Have limited liability, meaning that they can’t lose more than they invested.
- No business management responsibilities, and in fact, should they participate in any day-to-day management of the business, they can lose their limited liability status and be considered a GP
- have the right to vote on overall business objectives and the right to receive a cash distributions, capital gains, and tax deductions generated by the business
- have the right to inspect all books and records
- have the right to sue the GP if the GP does not act in the best interest of the business
Limited partners
Enjoy several advantages such as
- An investment managed by others
- Limited liability (can only lose the amount invested)
- Passive Income (often can be offset with passive losses for tax purposes)
Limited partners
True or false?
LPs maybe sold through private placements or public offerings?
- these investors must be accredited investors, meeting income and net worth criteria and must have substantial investment experience
True
Generally, _____ are liquidated on a predetermined date specified in the partnership agreement.
- Early shut down may occur if the partnership sells or disposes of its assets or if a decision is made to dissolve the partnership by the limited partners holding a majority interest
When dissolution occurs, the _____ must settle accounts in the following order
- Secured lenders
- Other creditors
- Limited partners - first, for their claims to shares of profits and then for their claims to be return of a contributed capital
- GPs
LPs, GPs
invest in raw land, new construction, or existing properties
Depending on the properties held by the program, they can provide investors with:
- Capital growth potential - Property value increases
- Cash flow (income) - collected from rents
- Tax deductions- from mortgage interest expense and depreciation allowances for wearing out the building/capital improvements
- Tax credits - for government-assisted housing and historic rehabilitation (tax credits are very strong incentives because they reduce tax liability dollar for dollar)
Real estate programs
Include speculative or exploratory (wildcatting) programs to locate new oil deposits (consider the riskiest developmental programs that drill near existing producing wells in hopes of locating new deposits ) and
Oil and gas programs
Costs associated with drilling, such as wages, supplies, fuel, and insurance that have no salvage value when the program ends
- these can be written off (deducted) in full in the first year of operation
Intangible drilling costs
Are associated with items that have some salvage value at the end of the program, such as drilling equipment
- costs are deductible over seven years taken as depreciation
Depreciation = Each year it is worth less and less.
Tangible drilling costs
Tax deductions meant to compensate investors in oil or gas programs (or any other resource or mineral) for their diminished supply. (Depletion of resources) after it is taken out of the ground and sold.
- think less and less is gotten out of the work.
Depletion allowances
Which oil and gas program would be best for a given client?
A drilling program or an income program?
Depends
The drilling program offers the greatest chance for capital appreciation but would not provide current income
The income program will be better suited for an investor who desires current cash flow, but it likely offers the least capital appreciation potential
The primary objective of these programs is tax sheltered income.
- provide write offs for costs associated with lenting out an asset.
Leasing programs
Investors receive income from lease payments, as well as proportional share of write-offs from operating expenses, interest expense, and depreciation of the actual equipment owned by the company
The most common type of direct participation program in the securities industry is
A. A limited partnership
B. A real estate investment trust (REIT)
C. A collateralized mortgage obligation (CMO)
D. An investment company
A. Limited partnership
All of the following are benefits for the limited partners in a direct participation program except
A. Passive losses
B. Flow through of income
C. Unlimited liability
D. And investment managed by the general partner
C. Unlimited liability
Which of the following statements regarding a general partnership is correct?
A. Partners participate in the gains and losses of the business and are fully liable for the business actions.
B. Partners participate in the gains and losses of the business and are partially shielded from the business liabilities.
C. Partners participate in the gains and losses of the business and are fully shielded from the business liabilities
D. Partners participate in the gains but not the losses of the business and are fully shielded from the business liabilities
A.
In a general partnership, the results of the business flow through to the partners and there is no liability protection in this type of organization.
True or false?
Income from an LP is called passive income and is added to ordinary income for tax purposes. Losses from an LP are called passive losses. Passive losses offset passive income only. However, if an LP generates tax credits, those may be used to offset income taxes directly.
- tax credits are not a type of income.
True important to note
True or false?
Any transfer of interest in an LP requires permission of the general partner
An investor in a limited partnership should assume she will own the program until it ends
True
Remember, the __ is a tax reporting, but not a tax paying entity?
Limited partnership (LP)
All of the following would be considered tax advantages related to a DPP investment except
A. Depreciation recapture
B. Depletion
C. Intangible drilling costs
D. Accelerated depreciation
A. depreciation recapture
When investing in a DPP you are obligated to invest in the program until a set date when the partnership ends.
If you were to take deductions (Write Offs) and then somehow sell your position in th DPP early, the IRS would
penalise you. This process is known as depreciation recapture.
Each limited partner’s share of partnership losses
A. Maybe used to reduce ordinary income
B. May be used to offset passive income
C. Is deductible up to $3,000 per year
D. Cause a dollar for dollar decrease in the market value of the limited partnership units
B. may be used to offset passive income
Is a company that manages a portfolio of real estate, mortgages, or both & earns profits for shareholders
Real estate investment trust (REITs)
Pool capital in a manor similar to that of an investment company but are not investment companies, neither open nor closed to end.
- own commercial property (equity REITs)
- own mortgages on commercial property (mortgage REITs)
- do both (hybrid REITs)
Real estate investment trusts
Is a company that owns, operates or finances income-producing real estate.
- provide an opportunity (like a mutual funds does) to everyday Americans- not just Wall Street, banks, and hedge funds - to benefit from valuable real estate, present the opportunity to access dividend-based income and total returns.
- most trade on major stock exchanges or OTC markets.
Real estate investment trusts
REITs register with the SEC. Therefore are subject to all disclosure requirements are known as ?
Public REITs
Non-registered REITs are subject to greater risk because?
Not subject to the same disclosure requirements as public REITs
Unique risks exist for those securities or funds listed on the OTC market
True or false
True
These securities are not listed or not on a public exchange.
- therefore not subject to the base rules and regulations as a public security.
Remember:
- An owner of REIT’s holds an undivided interest in a pool of real estate investments
- REITs may or may not be registered with the SEC
- REITs may or may not be listed (trade) on exchanges
- REITs are not investment companies (Open ended or closed ended)
- REIT’s offer dividends and gains to investors but do not pass through losses like LPs and, therefore, are not considered DPPs
Test topic alert
All of the following are types of real estate investment trust except
A. Mortgage
B. Oil and gas
C. Equity
D. Hybrid
B. Oil and gas limited partnerships are common. The others are all types of REITs
A REIT’s is taxed as
A. A corporation
B. A partnership
C. A municipal bond
D. As a conduit
D. REITs fall under the conduit (or pipeline) tax theory
- this theory sustains the idea that an investment firm that passes all returns to clients should not be taxed like regular companies.
Your client is considering the Newport land in farming REIT and notes in the description that it is listed. What does” listed” mean in this context?
A. The REIT is registered and likely trades OTC
B. The REIT is unregistered and trades only in the primary market
C. The REIT is registered and likely trades on exchange
D. The REIT is unregistered as likely trading OTC bulletin board
C. A listed security is one that has been accepted for trading on exchange.
Only registered securities are listed
Are typically aggressively, managed and often construct portfolios of high risk investments with their primary investment objective being high returns.
Their common strategies include
- highly leveraged portfolios (borrowing to purchase securities)
- the use of short positions ( selling securities to portfolio does not own)
- utilization of derivative products such as options and futures
- currency speculation
- commodity speculation
- investment in politically unstable international markets
Hedge funds
Are often organized as limited partnerships and our sold as private placements
Require that investors maintain their investment for a minimum length of time into that extent can be considered illiquid
These minimum holding requirements are known as
Lock up provisions
Often associated with Hedge Funds
A private, unregulated investment company organized in such a way as to invest in achieve high returns utilizing debt leverage and derivative products such as options and margin is best describe as
A. Mutual fund
B. A direct participation program
C. A real estate investment trust
D. Hedge fund
D for hedge fund
Considered an equity security, invest in a specific group of stocks and generally does so to mimic a particular index, such as the S&P 500
- registered either as an open-ended fund or as a UIT, but are obviously different in many ways
- trades in the secondary market
- can be purchased on margin and sold short
- expenses tend to be lower than those of mutual funds and the management fee is also low
- every time a person purchases or sells shares, there is a commission, and those charges can add up over time
Exchange trade funds (ETF)
Are senior, unsecured debt securities issued by a bank or financial institution
Therefore, they’re backed only by the good faith and credit of the issuer
- track the performance of a particular market index, but do not represent ownership in a pool of securities. The way share ownership of a fund does
- Have a stated maturity date, but they do not pay interest and offer no principal protection
- investors receive a cash payment linked to the performance of the underlying index minus management fees when the note matures
Exchange traded note (ETN)
True or false?
Some of the advantages ETFs have over mutual funds include:
- They can be bought or sold anytime during the trading day at the price they are currently trading at as opposed to mutual funds
- Can be bought and sold short on margin. Mutual funds cannot be bought on margin, nor can they be sold short
- Traditionally have lower operating costs and expenses
Capital gain distributions are unlikely therefore there are no further tax consequences with ETF shares until investors sell their shares
- this may be the single greatest advantage associated with ETFs
True
True or false?
Some disadvantages of ETF’s compared to mutual funds include:
- Commissions - the purchase or sale of ETF shares is a commissionable transaction
- Overtrading - given the ability to trade in and out of ETFs easily, the temptation to do so is possible.
Market influence on price - share prices can be influenced by market forces such as supply and demand, like any other exchange-traded product (ETP). In this light, investors need to recognize it just as they might receive less than book value per share when selling corporate shares of stock, they might also receive less than NAV per share when selling ETF shares
True
True or false
ETNs have an additional risk compared with an ETF. This being that if the credit of the underwriting bank should falter, the note might lose value in the same way. Any other senior debt of the issuer would.
- additionally, there are limits to the size of ETN issues
- this means, with limited availability, there are times when an ETN might trade at a premium to its inherent valuation
Investors purchasing at a premium could be subject to losses later depending on the value of the note at maturity
True
Take note with ETNs
- The primary risk associated is default risk.
- Liquidity risk is also a common concern.
Even though they are called “exchange traded” , very few of them have ever actually been listed on an exchange
All the following are true for exchange traded funds except:
A. ETFs can be bought or sold throughout the trading day
B. ETFs are not marginal securities
C. ETF share prices are subject to market forces like supply and demand
D. ETF transactions are commissionable trades
B. ETF’s trade as all other exchange traded products do. Commissionable transactions can occur throughout the trading day where prices are subject to all normal market forces. They can be purchased on margin
An investor is placed money in a debt -like instrument issued by financial institution and linked to the performance of the s&p 500 index. From the investment, which has a state of maturity date but makes no interest payments, the investor anticipates receiving a cash payment minus any applicable management fees when the instrument matures. This describes which of the following investments
A. Municipal bond
B. Direct participation program
C. Exchange traded note
D. Variable annuity
C. ETNs or exchange traded notes
ETNs are debt-like instruments issued by banks and other financial institutions that trade on exchanges
Their performance is generally linked to a specific market index
That maturity of the note, investors receive a cash payment minus any management fees.
Are not traded, which means that they lack liquidity and a reliable pricing mechanism - especially compared to equities that trade on a stock market.
- tend to require clients meet asset and income thresholds to invest.
- requirements vary by state
- most are managed passively and have a lifespan of 5 to 10 years.
- during that time all tax deductions, as well as income, are passed to partners
Direct Participation Programs (DPPs)
Recommending a limited partnership DPP investment to a customer would be a defendable recommendation for client:
A. Seeking flow-through tax benefits
B. Who is not risk averse
C. Who does not have an immediate need for liquidity
D. Any of the above
D.
Investors seeking ‘tax shelter’ or ‘tax advantage’ are often suitable for the flow through benefits of DPPs (direct participation program — limited partnerships)
There is virtually no secondary market for an investor to divest interest in a _____.
- in this regard, they are highly illiquid.
- this makes them not suitable for many investors.
DPPs
In a _______ partnership, all partners share general responsibility for running the business.
- are not tax paying entities (though the owners pay taxes)
General partnership
Are investment opportunities that permit the economic consequences of a business to flow or pass through to investors.
- along with a share in the income, gains, losses, deductions, and tax credits of the business entity.
- businesses themselves are not tax paying entities
- the investors (partners) would then have the responsibility to report individually to the IRS.
Limited partnerships
True or false?
The secondary market for LP interests is extremely limited: investors who wish to sell their interests frequently cannot locate buyers (i.e., interest in the business is not freely transferable)
True
______ provides limited liability and no management responsibilities to the limited partners
- where two or more individuals own equal or unequal shares of the property, and each owner has a separate and distinct interest in the property (Limited Liability)
Tenants in common
In the case of a limited partnership
_______ partners have unlimited liability, meaning that they can be held personally liable for business losses and debts
General partners
Income from an LP is called _________.
Passive income
Losses from an LP are called ______.
Passive losses
All of the following would be considered tax advantages related to a DPP investment except:
A. Depreciation recapture
B. Depletion
C. Intangible drilling costs
D. Accelerated depreciation
A.
Depreciation recapture can occur when an investor sells his interest in a real estate program.
If, at the time of sale, the amount of accelerated depreciation taken exceeds the straight- line depreciation amount, the difference (called recapture) must be reported by the investor as ordinary income.
Each limited partner share partnership losses
A. Maybe used to reduce ordinary income
B. Maybe used to offset passive income?
C. Is deductible up to $3,000 per year
D. Cause a dollar- for-dollar decrease in the market value of the limited partnership units
B.
It is important to remember that passive losses can be used to offset only passive income.
An investor with $500,000 worth of passive income could write off up to $500,000 of passive losses (if he had that much of a loss).
Do not confuse this with the $3,000 maximum deduction against income for capital losses.
There is no maximum passive loss that can be written off against passive income.
is a type of security that allows individuals to invest in large-scale, income-producing real estate properties such as apartments, hotels, office buildings, and shopping centers.
- typically raise capital by issuing shares to the public, which are then traded on stock exchanges.
- typically operates by earning income from rents and property sales, and distributing a portion of this income to its shareholders in the form of dividends.
A Real Estate Investment Trust (REIT)
