A - Direct Participation Programs

Question 1

An individual is interested in investing in a limited partnership. He signs the partnership agreement. By signing the agreement, he is:

A. Taking on the same liability as the general partner(s) B. Signing a power of attorney C. Stating that he is interested in investing in the partnership D. Only assuming limited liability

Answer 1

Correct Answer: B. Signing a power of attorney

Signing a power of attorney. The partnership agreement entitles the general partner to act on behalf of the limited partners. The agreement includes a power of attorney, which grants the general partner the authority necessary to operate the limited partnership on behalf of the limited partners. [Module 16, DPP, Section 1.3]

Question 2

Which two of the following receive a priority claim on the assets of a limited partnership that is being liquidated?

I. General creditors
II. Secured lenders
III. General partner(s)
IV. Limited partner(s)

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

Answer 2

Incorrect! The correct answer is: A. I and II

I and II. Secured lenders and creditors receive proceeds of a liquidated partnership ahead of the limited partners and the general partner. The general partner is last to receive any proceeds. [Module 16, DPP, Section 3.1]

Question 3

Which of the following will be passed-through in an oil and gas limited partnership program but not passed-through in a real estate limited partnership program?

A. Expenses B. Depletion C. Capital gains D. Depreciation

Answer 3

Incorrect! The correct answer is: B. Depletion

Depletion. Real estate can be depreciated, but it cannot be depleted. However, oil and gas can be depleted. These terms are used to indicate the use of the assets in the investment. The use of the assets becomes an expense that can be deducted against income or revenues. The limited partnership structure allows pass-through of income and expenses to limited partners associated with the operation of the partnership. [Module 16, DPP, Sections 7.2, 7.3, & 7.7]

Question 4

If a direct participation program is determined to be abusive by the IRS, the limited partner is responsible for:

I. Reporting additional tax credits
II. Lost tax credits
III. Interest
IV. Collecting penalties from the direct participation program

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

Answer 4

Correct Answer: C. II and III

II and III. If it is determined that a direct participation program is abusive, the taxpayer is responsible for lost tax credits as well as interest and penalties on any additional taxes that must be paid. Reporting additional tax credits and collecting penalties from the direct participation program are not obligations of the limited partner. [Module 16, DPP, Section 10.4]

Question 5

A customer has purchased an oil and gas income DPP. Which of the following statements best describes this program?

A. Pumping on proven land, then selling the oil and gas B. Exploring and drilling on unproven land C. Drilling and building on proven land D. Building oil and gas wells on proven land, and pumping, and selling the oil and gas to distributors

Answer 5

Incorrect! The correct answer is: A. Pumping on proven land, then selling the oil and gas

Pumping on proven land, then selling the oil and gas. This is an income program, so no building is involved. The four answers represent the four types of drilling programs, and they are easily identified. Exploring and drilling on unproven land is exploratory. Drilling and building on proven land is developmental. Building, pumping, and selling is a combination program. [Module 16, DPP, Sections 7.1 - 7.5]

Question 6

Which of the following is the most risky for an individual investor?

A. Limited partnership B. Corporation C. Mutual fund D. General partnership

Answer 6

Incorrect! The correct answer is: D. General partnership

General partnership. A general partnership is the most risky investment of the choices available. Mutual funds are the least risky of the investments listed since they offer diversification over different stocks. The investment in a corporation through the purchase of equity securities involves more investment risk than the mutual fund, but not as much risk as the limited partnership. The difference between the limited partnership and the general partnership is the personal liability that the general partnership assumes. Limited partners have limited legal and financial liability. [Module 16, DPP, Sections 1.0 & 1.5]

Question 7

Your customer asks you to help him invest in a REIT. What is the nature of this type of investment?

A. The building of Section 8 housing B. The building of a toll road C. The building of a new shopping center D. Growing permanent pasture on real estate property

Answer 7

Correct Answer: C. The building of a new shopping center

The building of a new shopping center. A REIT is similar to a limited partnership – or direct participation program – that invests in real estate. REITs do not get involved in roads, agricultural projects, or Section 8 housing since those programs have pass-through income and losses that cannot be taken advantage of in a REIT. Of the answers, a shopping center is the best, as would be a professional building, apartment building, and even a hotel. [Module 16, DPP, Section 11.0]

Question 8

A customer has purchased $50,000 worth of a REIT from you. All the following are passed- through to the investor, except:

A. Dividends B. Capital gains C. Capital losses D. Maintenance costs

Answer 8

Correct Answer: D. Maintenance costs

Maintenance costs. According to the IRS, at least 90% of dividends must be passed-through. If the property is sold at a gain or a loss, that gain or loss will also get passed-through since the value of the REIT will increase or decrease respectively – and the capital gains and losses will be realized by the investor. However, maintenance costs are deducted from the income and gains realized by the REIT. [Module 16, DPP, Section 11.1]

Question 9

An individual invests $20,000 in a direct participation program. For the year, the partnership gives a capital distribution of $8,000 and depletion of $10,000. The investor’s cost basis for tax purposes at the end of the year is:

A. $0 B. $2,000 C. $12,000 D. $24,000

Answer 9

Correct Answer: B. $2,000

$2,000. The basis of investment in the limited partnership is reduced by the capital distribution and the depletion amount. In this case, the original basis is $20,000. The return of capital through the $8,000 capital distribution reduces the basis by $8,000. The depletion allowance further reduces the basis by another $10,000. $20,000 - $8,000 - $10,000 = $2,000. [Module 16, DPP, Section 10.1]

Question 10

Which of the following is not a direct participation program?

A. Equipment leasing business B. Low-cost federal housing project (Section 8) C. Oil and gas development project D. Real estate investment trust

Answer 10

Incorrect! The correct answer is: D. Real estate investment trust

Real estate investment trust. A direct participation program is defined as an investment that offers flow-through tax consequences. An equipment leasing business, low-cost federal housing projects, and oil and gas development projects can all be structured as direct participation programs. A real estate investment trust, REIT, is not a flow-through of tax consequences program. Yes, income flows through, but not losses such as depreciation and expenses. If properties go up or down, it flows through to the value of the shares of the trust. [Module 16, DPP, Sections 8.0 & 11.0]

Question 11

Which of the following rights can limited partners exercise without losing their limited liability status and becoming a general partner?

I. Inspect the books and records on the general partner’s site
II. Vote to dissolve the limited partnership
III. Vote to remove a general partner
IV. Vote on the sale of some or all of the property

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

Answer 11

Correct Answer: A. I and IV

I and IV. Limited partners can inspect books and records and vote on the sale of property, but they may not vote on dissolving the partnership or the removal of a general partner. They may go to court to do so, but then the responsibility lies with the court, not the limited partner. [Module 16, DPP, Section 1.3]

Question 12

Where would you find the information on whom to serve with legal documents if you have a problem with a direct participation program?

A. The subscription agreement B. The partnership agreement C. The certificate of limited partnership D. The power of attorney granted to the general partners

Answer 12

Incorrect! The correct answer is: C. The certificate of limited partnership

The certificate of limited partnership. The certificate of limited partnership is the legal document that tells who outside the partnership is to be served with legal documents if a problem arises. The partnership agreement is the working document between the general partners and the limited partners. The subscription agreement is just the informational document to partake in the partnership. The power of attorney is misleading. [Module 16, DPP, Sections 1.2, 1.3, & 1.4]

Question 13

Who assumes the greatest risk in the following situations?

A. A general partner in a partnership B. A limited partner in a limited partnership C. A trustee for a trust account D. A CEO for a corporation in a manufacturing industry

Answer 13

Incorrect! The correct answer is: A. A general partner in a partnership

A general partner in a partnership. The general partner assumes the greatest risk because he is liable for all debts of the partnership as well as any legal liability associated with the activities of the partnership. [Module 16, DPP, Section 1.5]

Question 14

What is the greatest concern with limited partnership investments?

A. Liquidity B. Tax deductions C. Income D. Lack of control of the investment

Answer 14

Incorrect! The correct answer is: A. Liquidity

Liquidity is the greatest concern with limited partnerships. Most people in limited partnerships do not want control – they are simply looking for income. Generally, the tax deductions generated by the partnership can be used to offset the income from the partnership, so that is a benefit. [Module 16, DPP, Section 2.2]

Question 15

Which of the following requires a written statement of the customer’s net worth?

A. A unit investment trust B. A REIT C. A variable annuity D. A limited partnership

Answer 15

Correct Answer: D. A limited partnership

A limited partnership. A variable annuity and a unit investment trust are investments that pool investors’ money in stocks and bonds. The net worth is not needed. An investment in a REIT has certain risks, but it is the limited partnership that needs to have the net worth. It is one of the suitability requirements for selling to a customer. [Module 16, DPP, Sections 2.2 & 11.0]

Question 16

Which of the following would be most important in analyzing an existing real estate limited partnership for investment purposes?

A. Looking at yields of similar programs
B. Looking at the work experience of the general partner(s)
C. Looking at the projected deductions that will be generated
D. Looking at the cash flow analysis

Answer 16

Incorrect! The correct answer is: D. Looking at the cash flow analysis

Looking at the cash flow analysis. The cash flow analysis indicates whether the limited partnership produces cash, which can represent a potential profit from the investment. Investors should evaluate the yields of similar programs, the work experience of the general partner(s), and the projected deductions that will be generated. However, the main question to ask is, “Will the partnership make money?” [Module 16, DPP, Sections 2.0 & 2.1]

Question 17

Which is the primary tax advantage of an oil and gas limited partnership?

A. Depreciation B. Depletion allowance C. Limited capital risk D. Long-term capital gains

Answer 17

Incorrect! The correct answer is: B. Depletion allowance

Depletion allowance. The depletion allowance is the primary tax advantage of an oil and gas limited partnership. Depreciation, limited capital risk, and long-term capital gains are other expenses that are incurred by a limited partnership, but the depletion allowance provides the higher tax-deductible expense for a limited partner. [Module 16, DPP, Section 7.7]

Question 18

Which of the following statements is true in comparing an oil and gas exploratory limited partnership program to a development partnership program?

A. The risks associated with the exploratory program are higher. B. The risks associated with the exploratory program are less. C. The risks associated with both programs are the same. D. The risks are lower in both of these programs compared to an income program.

Answer 18

Incorrect! The correct answer is: A. The risks associated with the exploratory program are higher.

The risks associated with the exploratory program are higher. An exploratory program has not yet found the oil and gas to be developed, while the development program has. Therefore, the exploratory program carries more risk. Both the exploratory program and the development programs involve more risk than the income program. [Module 16, DPP, Sections 7.2 & 7.3]

Question 19

Some investors decide to take part in the management of their limited partnership. What effect could this have?

A. It would endanger their limited liability status. B. They would lose their tax-exempt status. C. They would endanger the limited liability status of the other limited partners. D. The general partners will be happy to have their help.

Answer 19

Incorrect! The correct answer is: A. It would endanger their limited liability status.

It would endanger their limited liability status. If certain investors participate in the management of their limited partnership, this can endanger the limited liability status for all investors. Making management decisions is the responsibility of the general partner, who assumes liability for the actions of the limited partnership. When the limited partners begin to manage as general partners, they assume liability similar to a general partner. [Module 16, DPP, Sections 1.3]

Question 20

An investor has been approached by a registered rep to invest in a real estate direct participation program. The investor looks over the important information and the offering memorandum and decides to purchase $30,000 of the program. When is the investor accepted into the real estate program?

A. When the certificate of limited partnership is recorded with the state B. When the investor signs the subscription agreement for the program C. When the general partners sign the subscription agreement to the program identifying the limited partner D. When the investor signs the limited partnership agreement

Answer 20

Incorrect! The correct answer is: C. When the general partners sign the subscription agreement to the program identifying the limited partner

When the general partners sign the subscription agreement to the program identifying the limited partner. A limited partner must be accepted as an investor into a limited partnership, which happens when the GP signs the subscription agreement. A certificate of limited partnership is a document filed with the state in which the partnership is domiciled. This document may record the names of the limited partners, but is submitted to register the limited partnership. The subscription agreement is used as an application by the investor to become a limited partner, but the investor does not become a limited partner until the general partner(s) accepts the investor. The partnership agreement clarifies the rights and duties of the partners, and when signed, the person officially becomes a limited partner. The question is asking when is the person “subscribed” to the LP, not when the person actually becomes a limited partner. [Module 16, DPP, Section 1.4]

Question 21

An oil drilling limited partnership has equipment that it uses for drilling. Much of the equipment, listed as five-year property, was purchased for $20 million. The limited partnership uses straight-line depreciation when making deductions to pass-through to the limited partners. The drilling program has been drilling and preparing wells for four years. What is the value on the books of the limited partnership at the end of four years?

A. $4 million B. $10 million C. $16 million D. $20 million

Answer 21

Incorrect! The correct answer is: A. $4 million

$4 million. First, find how much will be reduced each year for five years: 20 divided by 5 = $4 million per year; then, multiply by the time gone by – 4 years x $4 million = $16 million. This is how much has been depreciated, leaving the new value on the books of $4 million. [Module 16, DPP, Section 7.11]

Question 22

When can a registered representative present the offering materials to an investor’s accountants or attorneys in lieu of presenting the documents to the investor?

A. Never B. When also accompanied by the prospectus C. When also accompanied by the red herring D. When also accompanied by the offering circular

Answer 22

Incorrect! The correct answer is: A. Never

Never. A registered representative can only give the offering materials to the client or investor, not to the client’s attorney or accountant. The client is ultimately responsible for the decision of whether to invest; therefore, the materials must go to the client. The client can then send the materials to an attorney or accountant. [Module 16, DPP, Section 4.4]

Question 23

Potential investors in a limited partnership should consider all of the following characteristics of the limited partnership prior to investing, except:

A. The objectives and economic viability of the partnership B. The management’s qualifications C. The anticipated length of the investment program D. The ability of the limited partners to control the operation of the partnership

Answer 23

Incorrect! The correct answer is: D. The ability of the limited partners to control the operation of the partnership

Correct answer (false statement): The ability of the limited partners to control the operation of the partnership. Limited partners may not participate in the operation of a limited partnership; otherwise, the partnership risks losing its tax status. Limited partners sign a power of attorney to grant the general partner the authority to act on behalf of the limited partners. Potential investors must review the objectives and economic viability of the partnership, the management’s qualifications, and the anticipated length of the investment program. [Module 16, DPP, Sections 2.0 & 2.1]

Question 24

An investor wants to compare an oil and gas exploratory program with an oil and gas development program. Which of the following statements is true about the exploratory program?

A. There is higher risk and lower potential return. B. There is lower risk and higher potential return. C. There is higher risk and higher potential return. D. There is lower risk and lower potential return.

Answer 24

Correct Answer: C. There is higher risk and higher potential return.

There is higher risk and higher potential return. An investment in an exploratory program involves more risk, but also more potential return on the investment than a development program. The risks involved in exploring can include environmental costs, costs of exploring or discovering the resource, and the risk of being able to develop the resource. A development program is further along in the actual harvesting of the resource, so specific risks should be lessened. Generally, when risks are higher, potential returns should be higher to justify the risk of investing. There is a high degree of risk in drilling and in not knowing what is really under the ground. Many explorations end up without finding oil or gas. In a development program, the oil or gas has been located, but the objective is to develop the oil or gas deposits into a mining operation. The risks of exploring and not finding the resource are reduced and the potential return on the investment is also likely reduced. [Module 16, DPP, Sections 7.2, 7.3, & 7.4]

Question 25

What document signifies that a direct participation program is qualified as a limited partnership?

A. Limited partnership agreement B. Certificate of limited partnership C. The filing of the program with the SEC D. Subscription agreement

Answer 25

Correct Answer: B. Certificate of limited partnership

Certificate of limited partnership. This document, usually issued by the state in which the limited partnership is registered, is the primary legal document that represents the status of the partnership or program. The program is exempt from registration with the SEC. The subscription agreement is the document that is used by an investor to apply to invest in the program. The limited partnership agreement is the working document between the GPs and the LPs. [Module 16, DPP, Section 1.2]

Question 26

Limited partners may have the right to:

I. Inspect and copy partnership records
II. Assume management responsibilities
III. Fire the general partner
IV. Sue for dissolution of the partnership

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

Answer 26

Correct Answer: C. I and IV

I and IV. Limited partners have the right to inspect and copy partnership records and sue for dissolution of the partnership, among other rights. If limited partners exert too much management control over the operation of the limited partnership, the tax status of the partnership can be affected. By assuming management responsibilities or firing the general partner, the limited partners would take over management of the partnership. [Module 16, DPP, Section 1.3]

Question 27

Which two of the following are true about equity REITs?

I. They may qualify as regulated investment companies for tax purposes if they distribute 90% of their earnings to shareholders.
II. Their profits are derived from the difference between the interest they pay on loans and the rents they receive on real estate mortgages.
III. Equity REITs loan money for commercial construction.
IV. REIT securities pass-through income and gains as well as losses.

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

Answer 27

Incorrect! The correct answer is: A. I and II

I and II. Equity REITs invest in property and take out loans to buy the property. They borrow money to help pay for real estate, although many of the REITs invest in real estate without borrowing beyond what the investors contribute. REITs can be highly leveraged (borrowed money), but leverage increases risk. Profits are derived from the difference between the interest they pay, if any, and the rents they receive on the property. The profits are paid out to investors as dividends. In order to qualify for favorable tax treatment (in the same manner as “regulated” investment companies), they must pay out 90% of the net investment income to shareholders. Debt REITs loan money for commercial construction. Equity REITs purchase the property. REITs do not pass-through losses, such as depreciation and expenses. Capital losses, however, are realized through the decline of the price of the shares if the REIT loses money on property. Income, capital gains, and capital losses are passed-through to investors, but losses (note that these are not capital losses) are not passed through to the investor. [Module 16, DPP, Section 11.0]

Question 28

Which of the following is a potential conflict of interest on the part of the general partner in a limited partnership program?

A. Taking a short-term loan of $25,000 for the partnership from the general partner B. Payments by the limited partnership of $20,000 to the general partner for a covenant not to compete C. The general partner acting as an agent for the partnership in managing the partnership assets D. A general partner purchasing an office building for the partnership

Answer 28

Correct Answer: B. Payments by the limited partnership of $20,000 to the general partner for a covenant not to compete

Payments by the limited partnership of $20,000 to the general partner for a covenant not to compete. The GP is paid to act as an agent for the partnership, and therefore should not be paid to “not compete” with the partnership. This could definitely be a conflict of interest. The GP gives loans to partnerships as a matter of course when small amounts are needed. GPs must act as agents, since they are paid to do so. Purchasing property is a function of the GP in a real estate partnership. [Module 16, DPP, Section 1.5]

Question 29

Percentage depletion allowance is a method of deducting the harvesting of a resource in all of the following, except:

A. Timber B. Oil and gas C. Precious metals D. Coal mining

Answer 29

Incorrect! The correct answer is: A. Timber

Correct answer (false statement): Timber. Timber is the only natural resource that the IRS will not allow the use of percentage depletion allowance as a method for deducting expenses. Instead, tax laws require that timber harvesting use a method called cost depletion. Percentage depletion allowance is used to deduct portions of the investment in operations that are concerned with the exploration and mining of oil and gas, precious metals, and coal mining. [Module 16, DPP, Section 7.9]

Question 30

Where would you find the information and procedures for settling a problem within a direct participation program?

A. The subscription agreement B. The partnership agreement C. The certificate of limited partnership D. The power of attorney granted to the general partners

Answer 30

Correct Answer: B. The partnership agreement

The partnership agreement. This is the working document between the general partners and the limited partners. The partnership is a contract, which states the responsibilities of the general partner and the rights of the limited partners. The subscription agreement provides information for the investor to apply to become an investor in the limited partnership. The certificate of limited partnership is the legal document that indicates the status of the partnership. A power of attorney, usually contained within the partnership agreement, allows an investor to grant authority to the general partner to act on behalf of the limited partner. [Module 16, DPP, Section 1.3]

Question 31

You have an investor who is diversified in equity securities. However, the investor likes real estate and feels that after the 2008 meltdown, getting into real estate-backed securities might be a good idea. He is looking at REIT securities. You would tell him that the type of real estate in a REIT would be which of the following?

A. Raw land B. Section 8 housing C. Shopping centers D. Condominium complexes

Answer 31

Incorrect! The correct answer is: C. Shopping centers

Shopping centers. The answer here could also be hotels, office buildings, warehouses, or other income producing properties. Usually REITS are not in motels, and they are never in condominium units, raw land, or Section 8 housing. These projects take too much management and, in the case of Section 8 housing, are extremely risky. Motels, unless they are large, well known motels, do not produce enough income. Raw land is only for limited partnerships, as there is no income – just a lot of payments waiting for the value of the land to rise before selling it. Only individuals purchase private houses. [Module 16, DPP, Section 11.0]

Question 32

Your customer wants to invest in a DPP oil program. If the program is successful, which of the programs would have the highest rate of return?

A. Exploratory program
B. Developmental program
C. Income program
D. Balanced program

Answer 32

Incorrect! The correct answer is: A. Exploratory program

Exploratory program. The important word here is “successful.” Since the exploratory program pays the least amount for drilling on the property, it makes the most profit per barrel found. If the question did not say “successful,” then the developmental or the balanced program would probably have the highest rate of return since income programs make money, but only the difference between the cost of the oil per barrel and the price the oil will get on the market. [Module 16, DPP, Sections 7.2 - 7.5]

Question 33

Under FINRA rules, what is the maximum allowable sales charge that is permitted in the sale of a direct participation program?

A. 8.5% B. 9% C. 10% D. 10.5%

Answer 33

Incorrect! The correct answer is: C. 10%

10%. The maximum sales charge that can be charged by members of FINRA is 10%. The direct participation program may pay other costs, but the maximum sales charge allowed is 10%. [Module 16, DPP, Section 4.4]

Question 34

The three main types of oil and gas programs are:

A. Exploratory, development, and income B. Speculative, income, and limited C. Development, equipment leasing, and exploratory D. Lease acquisition, income, and wildcatting

Answer 34

Incorrect! The correct answer is: A. Exploratory, development, and income

Exploratory, development, and income. The three main types of oil and gas programs are exploratory, development, and income programs. The exploratory programs are speculative programs that have great risk. Development programs are formed to develop the resource that has been identified and income programs are formed to harvest the resource. [Module 16, DPP, Sections 7.2, 7.3, & 7.4]

Question 35

An investor in a real estate DPP has invested $50,000 in the limited partnership. The investor is also credited with an additional $200,000 on a nonrecourse loan. There have been no distributions by the limited partnership to the limited partner over the three-year period. The limited partnership is rolled up and very little cash is left to pay off the loans. The investor is now a general creditor for how much?

A. $0 B. $50,000 C. $200,000 D. $250,000

Answer 35

Incorrect! The correct answer is: A. $0
$0. The investor’s investment is not a creditor to the partnership, it is ownership in the partnership. If there are no assets left and the partnership is out of business, the owner loses all his money. The nonrecourse loan has nothing to do with the limited partner. The loan to the partnership is much like you would have on your home – the lender can only take your home. In this case, the lender can only take the property. However, the investor has $50,000 tied up in the limited partnership, and as an owner, he loses it. An investor cannot be a creditor under any circumstances. [Module 16, DPP, Tutorial Slides 10 & 11]

Question 36

Which two of the following actions would cause limited partners to lose their limited liability status and become general partners?

I. Inspect books and records at the general partner’s site
II. Vote to dissolve the limited partnership
III. Vote to remove a general partner
IV. Vote on the sale of some or all of the property held by the partnership

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

Answer 36

Incorrect! The correct answer is: B. II and III

II and III. Limited partners can inspect books and records and vote on the sale of property without losing their limited liability status. However, they may not vote on dissolving the partnership or remove a general partner. By doing so, they would be acting in a management capacity, thus becoming a general partner and losing their privileged limited liability status. They are able sue in a court of law to remove a general partner or dissolve a partnership, thereby letting the court make the decision. In this way, the limited partners maintain their limited liability status. [Module 16, DPP, Sections 1.2 - 1.4]

Question 37

A partnership becomes a limited partnership when:

A. The certificate of limited partnership is filed with the secretary of state. B. All the limited partnership interests are sold. C. All limited partners are notified that all units are sold. D. The limited partnership’s registration statement is filed.

Answer 37

Incorrect! The correct answer is: A. The certificate of limited partnership is filed with the secretary of state.

The certificate of limited partnership is filed with the secretary of state. The limited partnership must file with the state in which the partnership is domiciled. Before a limited partnership can sell interests in the partnership, the limited partnership registration must be filed with the state. [Module 16, DPP, Section 1.2]

Question 38

Which two of the following expenses are defined as intangible drilling costs?

I. Drilling equipment
II. Geological surveys
III. Supplies
IV. Trucks

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

Answer 38

Incorrect! The correct answer is: B. II and III

II and III. Geological surveys and supplies are intangible drilling costs. Intangible drilling costs are expenses that are paid during the course of drilling for oil that are not directly associated with the cost of pumping the oil. Intangible costs are borne by the limited partners, whereas tangible expenses are borne by the general partner. Drilling equipment and trucks are tangible costs that still have value after the well has been dug. [Module 16, DPP, Section 7.10]

Question 39

Which two of the following statements are not true regarding REITs?

I. REITs must pass-through 90% of their income to the investors.
II. REITs trade OTC or on the exchanges.
III. The interest is not taxable as ordinary income.
IV. REITs are investment companies under the Investment Company Act of 1940.

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

Answer 39

Incorrect! The correct answer is: D. III and IV

Correct answers (false statements): III and IV. The interest is not taxable as ordinary income and REITs are investment companies under the Investment Company Act of 1940. The interest paid to investors is taxable as ordinary income, and any capital gains are taxed as capital gains. A REIT is not an investment company under the Investment Company Act of 1940. A REIT is a regular corporation like IBM, or any other major company, with the exception that its business is investments in real estate. It is true that REITs must pass-through 90% of their net investment income to avoid being taxed as a corporation, the same as with investment companies. However, if you see a REIT question on the exam that offers a 95% pass-through option, accept that as being true. REITs do trade on the exchanges or OTC, similar to stock. [Module 16, DPP, Section 11.0]

Question 40

All of the following are benefits of oil and gas direct participation programs, except:

A. They allow diversification of a person’s investments. B. They generate tax benefits through oil and gas deductions. C. They generate income to offset passive losses. D. They generate expenses to offset passive income capital gains from other programs.

Answer 40

Incorrect! The correct answer is: A. They allow diversification of a person’s investments.

Correct answer (false statement): They allow diversification of a person’s investments. Direct participation programs are not considered diversified. All the investment in the program is dependent upon returns from a single business. Direct participation programs offer tax benefits for certain types of programs such as oil and gas. Direct participation programs can also provide income that can be used to offset passive losses. New oil and gas programs generate expenses that can be deducted from income on that LP or another LP that is successful. Prior to 1987, these expenses were deducted from ordinary income, but today, those deductions are not allowed against ordinary income – they can only be taken against passive income and passive capital gains. [Module 16, DPP, Section 2.2]