DPPs (limited partnerships) Flashcards
What is a Direct Participation programs (DPPs)?
Also known as Limited Partnerships are companies that for the most part invest in oil/gas, real estate, equipment leasing that pass the income and losses directly to the investors
What are features of DPPs?
- DPPs are illiquid meaning investing is for the long term with the goal to make money or write off some losses on their taxes
- Most invest in oil/gas, real estate, equipment leasing
- Setup with a finite lifetime (termination conditions)
- The IRS determines if an entity is a corporation or Limited partnership
- Partnerships are setup as tenants in common
- Require 3 documents to exist: Partnership agreement, certificate of limited partnership, Subscription agreement.
How does the IRS determine if an entity is a Limited partnership and not a corporation?
DPPs must AVOID two of the following reqs:
Having Centralized management - corps have management in one place, this is hard for DPPs
□ Hardest to avoid
Providing limited liability - like shareholders, limited partners have limited liability unless they start making decisions then they become general partners and have unlimited liability
□ Hardest to avoid
Having perpetual (never ending) life - Unlike corps, DPPs have a set goal or amount of years before being dissolved.
□ Easiest to avoid
Having free transferability of partnership interest - Unlike stock that is liquid, Limited partners have a hard time getting out, the general partner must review their request along with the registered rep but they also need to show they have enough liquid cash before investing in case the DPP needs more money.
□ Easiest to avoid
What does it mean when a partnership is setup with tenants in common?
Each limited partner owns an undivided interest in the property held by the partnership
What is the role of the Limited partner?
The limited partner provides the funding and does not make decisions
What is the role of the General partner?
The general partner makes the decisions day to day and applies the funding
Define the General Partners role within a Limited Partnership (DPP)
○ Decision making -
○ Tasks -
○ Liability and litigation -
○ Financial involvement -
○ Financial rewards -
○ Conflicts of Interest -
○ Decision making - Are legally bound to make day to day decisions in the best interest of the partnership
○ Tasks - Buy and sell property/manage assets
○ Liability and litigation - Unlimited liability, can be sued for all partnership debts and losses
○ Financial involvement - Maintains a financial interest in the partnership
○ Financial rewards - Compensated for managing the partnership
○ Conflicts of Interest - Can’t borrow money or manage two competing partnerships
Define the specifics within a Limited Partnership (DPP) for a Limited Partners
○ Decision making -
○ Tasks -
○ Liability and litigation -
○ Financial involvement -
○ Financial rewards -
○ Conflicts of Interest -
○ Decision making - Does not make decisions, they can vote tho
○ Tasks - Provides capital, can vote and review books to keep general partner in check
○ Liability and litigation - Have limited liability to amount they invested
○ Financial involvement - provide money, recourse debt, and non-recourse debt for real estate DPPs
○ Financial rewards - receives a portion of profits and losses
○ Conflicts of Interest - None; can invest in competing DPPs
DPP Paperwork - Partnership agreement
This document includes the rights and responsibilities of the limited and general partner along with basic information about the partnership like the type/name of the partnership, names of each person involved, address info, etc
It also includes the General Partners rights:
□ Charge of management fee for making decisions
□ Can the gen partner enter the partnership into contracts
□ Decide whether cash distributions will be made to limited partners
□ Accept or decline limited partners
DPP Paperwork - Certificate of limited partnership
This is the legal document filed with the SEC and the home state of the partnership that includes basic info like, the type/name of the partnership, names of each person involved, address info, etc
It also includes partnership specifics:
□ Objective and termination date
□ Contribution amounts by each limited partner (plus future investments)
□ Profit distribution info
□ Roles of the participants
□ How the partnership can be dissolved
□ Whether the limited partner can sell or assign their interest in the partnership
§ Any major changes like adding a new limited partner will require the certificate be amended.
DPP Paperwork - Subscription agreement
This is the application any potential limited partners must fill out. The general partner uses this form to determine if the candidate is suitable, if so, the gen partner signs to bring onboard to DPP, yay!
§ A registered rep is required to prescreen the candidate to ensure the partnership is a good fit by asking the
□ Does the investor have enough money to invest? (net worth and annual income)
□ Does the investor has more cash in other investments in case the partnership needs more money?
□ Is the candidate ok with tying up money for a long time?
□ Can they handle the risk?
§ The agreement typically requires a POA indicating the general partner can make decisions for the investor, it is also submitted with a payment.
Income and Loss: How are DPPs taxed?
○ DPP investors have their own IRS tax rule called Passive Income and Passive Losses because they are NOT directly involved in earning the income (or losses)
§ Passive income is taxed § Passive losses are written off (against passive income)
DPP Types - Public Vs Private
§ Public DPPs must be registered with the SEC
□ Pubs have lower unit costs (buy-in)
§ Private DPPs do not require registration and are reserved for wealthy investors.
DPP Types - Real Estate DPP
Also known as RELPs, these limited partnerships invest in raw land, new construction, existing properties, and government sponsored housing.
There are several subtypes each with the goal of providing capital growth through appreciation of the property; cash flow for DPPs that hold rentals; or tax deductions for mortgage interest, depreciation, and capital improvements; and tax credits for DPPs that hold government assisted housing.
DPP subtypes - Public Housing (government assisted housing programs)
A subtype of Real estate DPPs - Invests in low income and retirement housing that is backed by Government Agencies.
Lowest risk
DPP subtypes - Existing Properties
A subtype of Real estate DPPs - Invests in established property that has tenants and already produces income.
□ Risk here is that maintenance and repair costs eat into income, there is also the risk of tenants no renewing
Low risk
DPP subtypes - New Constructions
A subtype of Real estate DPPs - This limited partnership Invests in land to build property and flip for a profit, the land may appreciate and can be rented out to meet profit quotas.
□ Risk is the property does not sell or value goes down, this is considered speculatory
Moderate risk
DPP subtypes - Raw land
A subtype of Real estate DPPs - This limited partnership invests in undeveloped land in the hopes it goes up in price and they can sell at a premium, considered risky because the Investors do NOT have any income coming in from the land.
□ Risk is the land value can actually go down (if the area goes to shit)
Riskiest
DPP Types - Equipment Leasing
This limited partnership invests in movable equipment like trucks, trains, heavy machinery, computers, etc.; and lease it out to businesses. The goal is to get steady income and depreciation for write offs.
These come in two flavors
DPP subtypes - Operating Lease
A subtype of Equipment Leasing DPPs - Buys equipment and then leases it for short amounts of time, does not get enough income from the first lease so they lease it several times.
Operating Lease is riskier than Full Payout Lease because the equipment becomes more worn and harder to lease.
DPP subtypes - Full Payout Lease
A subtype of Equipment Leasing DPPs - Buys equipment and leases it long term to cover the cost and some. Usually for the usefulness life of the equipment.
Not as risky as the operating lease because the entire investment is covered by the first lease.
DPP Types - Oil and Gas DPP
Invests in Natural gas/oil and fund operating costs. Have the goal of producing income, are speculative in nature or a combo of both. There are three flavors, each with its own rewards, risks, and tax advantages.
DPP subtypes - Intangible drilling costs (IDCs)
A subtype of - Oil and Gas Limited partnerships. These are used for write off purposes only, they cover drilling and preparing a well for production of gas and oil. You don’t invest in anything physical instead this pays services/business expenses for wages, fuel, repairs, hauling, insurance, etc.
Tax deductible on current year
DPP subtypes - Tangible drilling costs (TDCs)
A subtype of - Oil and Gas Limited partnerships. These are used to purchase salvaged material, things that can be resold such as storage tanks and well equipment. These items are then tax written off over the life of the ownership.
Taxes can be written off under straight line basis (equal amount each year) or accelerated basis (more up front followed by the rest in the following years)
