Chapter 13 Part 11 Flashcards
Oil and Gas Limited Partnerships
Oil and gas programs are formed for the exploration, drilling, or development of oil and natural gas. The general partner typically provides the technology and organization, while the limited partners provide a major portion of the capital. Three of the major types of oil and gas partnerships are: 1. Exploratory programs 2. Developmental programs 3. Income programs
Explorato1y Programs
Exploratory drilling (wildcatting) involves searching for oil and gas in unproven areas. Although the potential profits may be high, the actual return (if any) cannot be determined until the wells are actually drilled. Exploratory programs do tend to provide significant tax advantages and may be appropriate for investors seeking to reduce their taxable income from passive sources. remember, anyone considering this investment must be willing to accept a high degree of risk.
Developmental Programs
In a developmental program, the partnership acquires leases for the right to drill in proven areas. This type of program has higher tax deductions and less risk than an exploratory program. however, since the program presents less risk, the potential returns are often less.
Income Programs
An income program acquires interests in wells that are already producing (generating cash now). These sites are often purchased from oil and gas operators who have completed the drilling and prefer to sell the reserves rather than hold on to the property. There are fewer tax deductions associated with these programs than exploratory or developmental
programs
NASAA recommends that investors meet one of the following financial criteria when investing in a real estate or oil and gas limited partnership: an annual income of at least
$70,000 or a minimum net worth of $250,000.
The main advantage of investing in a real estate limited partnership is that real estate is a
commodity with a fixed supply. Usually, the general partner has some expertise in real estate {i.e., as a real estate developer or general contractor). The general partner raises capital from the limited partners to acquire or construct propmties, such as shopping malls, office buildings, hotels, apartments, or warehouses. The general partner then manages the properties and distributes the profits to the limited partners
Most real estate limited partnerships can be divided into two categories
those formed to construct new properties whose primaiy objective is capital appreciation, and those formed to buy existing properties that are more income-oriented
New Construction
Partnerships that arc formed to construct new buildings are riskier than partnerships formed to invest in existing ones. A number of problems can arise with new developments, such as overruns in construction costs, issues with financing, changes in the local economy or government regulations, or overbuilding. The overbuilding issue arises when there is an excess of new buildings in the area at the project’s completion, making it difficult to attract tenants. New construction projects also tend to have a long duration. These partnerships typically provide few, if any, distributions to the limited partners in their early years; therefore, investors must be prepared to wait many years before receiving returns. However, many new construction projects will generate immediate up-front deductions
Existing Properties
The major advantage of partnerships that purchase existing properties is that it is easier to accurately predict the revenues that such properties will produce. The buildings are already standing and may be rented immediately. A key aspect to evaluating these programs is the nature of the existing tenants and the terms of the existing leases
A Real Estate Investment Trust manages a
portfolio of real-estate oriented investments in order to earn profits for investors. There are two types of REITs
An Equity Reit invests its portfolio in
real estate assets, and investors receive income from rents and capital gains from the sale of appreciated properly
A Mortgage REIT
borrows money from a commercial bank and then lends the borrowed funds, at a higher rate, to building developers. This type of trust passes interest income through to investors. At least 75% of gross income must be from real property
Although a REIT is similar to both investment companies and Direct Participation Programs {DPPs), it is important to note that a REIT is neither an investment company nor a dPP. As with a mutual fund, a REIT manages a
portfolio of investments in order to earn profits for investors. A REIT also has the same favorable tax treatment. lf 90% of the ordinary income generated from the portfolio is distributed to investors, it is taxable only to the investors. The REIT itself avoids paying taxes on distributed income
Unlike mutual funds and DPPs, however, the shares of most REITs are
publicly traded, both over the counter and on exchanges, and investors typically pay a commission when buying or selling a REIT. Publicly held REITs must be registered under the Securities Act of 1933, but are not covered by the Acts of 1940. Unlike a DPP, there is no pass-through of operating losses
For an investor, owning shares of a REit is similar to owning
shares of common stock. Both are long-term investments and trade in the secondary markets whereby investors buying and selling these securities will pay commissions. rEITs typically have high dividend yields, which is the major reason they are purchased by investors. however, unlike dividends paid by domestic stocks, the 70% corporate dividend exclusion does not apply to rEITs
