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Series 7 > unit 11 > Flashcards

unit 11 Flashcards

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Series 7 Top-off Exam flashcards
1
Q

packaged product

A
  • an investment that relieves the investor of daily decision making
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2
Q

Real Estate Investment Trust (REIT)

A
  • company that manages a portfolio of real estate investments to earn profits and/or income for its shareholders
  • undivided interest in a pool of RE investments
  • professionally managed
  • offer diversification
  • normally publicly traded
  • serve as a source of long term financing for real estate projects
  • organized as trusts where investors buy/sell shares on stock exchange or OTC
  • same liquidity as listed stocks
  • compute estimated NAV per unit
  • priced based on supply and demand and are not redeemed back to issuer
  • REITS are not DPPs (losses do not flow through to investors) or investment companies (mutual funds)
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3
Q

equity REIT

A
  • own a commercial property
  • receive rental income and possible cap gains on future sale of property
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4
Q

mortgage REIT

A
  • own mortgages on a commercial property
  • make real estate loans (mortgages).
  • earnings come from interest payments on the loans
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5
Q

hybrid REIT

A
  • commercial property and owns mortgages on commercial properties
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6
Q

benefits of REIT

A
  • invest in RE without the same liquidity risk as owning the property yourself
  • properties are selected by professionals
  • negative correlation to overall stock market
  • reasonable income and/or potential for cap gains
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7
Q

REIT risks

A
  • no direct control
  • greater price volatility than direct ownership bc they are influenced by market conditions
  • if the REIT isn’t publicly traded, liquify is limited
  • problem loans in the portfolio could cause income and or capital to decrease
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8
Q

REIT taxation

A
  • generally taxed only on dividends paid by the REIT and on gains at disposition of REIT shares
  • REIT is a corporation for tax purposes
  • generally not subject to corporate tax is if 1) 75% of income comes from RE, 2) distributes 90% of taxable income to shareholders
  • dividends are not qualified, taxed a ordinary income
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9
Q

direct participation programs (DPP)

A
  • investments that pass income, gains, losses and tax benefits (depreciation, depletion and tax credits) directly to LPs
  • LP are the most common type but can be S corp or LLC
  • As long as a direct participation program avoids at least two of the four characteristics of a corporation, it can remain a reporting-only entity to the IRS. That means it does not pay federal income taxes. Revenue, deductions, and tax credits (if any) are reported the IRS on Form 1065 and distributed proportionally to the investors on the Schedule K-1. The typical business organization of a DPP is a limited partnership having at least one general partner and at least one limited partner.
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10
Q

structuring LP

A
  • an org is classified as a partnership for federal tax purposes if it has 2+ members and is not:
    • an org that refers to itself as incorporated or a corporation
    • an insurance company
    • a REIT
    • an org classified as a trust or subject to special treatment under IRC
  • must avoid continuity of life - LP have a predetermined date of dissolution when they are established
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11
Q

continuity of life

A
  • LP have a predetermined date of dissolution when they are established
  • easiest to avoid
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12
Q

centralized management

A
  • no business can function without it so it is the most difficult to avoid
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13
Q

freely transferable assets

A
  • interests cannot be freely transferred, GP approval needed
  • DPP can avoid this corp characteristic
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14
Q

issuing LP interests

A
  • can be sold through private placements or public offerings
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15
Q

private placement LP

A
  • investor must get a private placement memo for disclosure
  • accredited investors (small group, large sums) - must meet net worth or income standards.
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16
Q

public offering of LP

A
  • sold with prospectus to a large number of investors making small investments
  • syndicator
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17
Q

syndicator

A
  • oversees the selling and promotion of the partnership
  • responsible for the prep of any paperwork necessary for the registration of the partnership
  • fees are limited to 10% of the gross dollar amt of securities sold
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18
Q

LP required documentation

A
  • certificate of LP
  • partnership agreement: describes the roles of GP and LPS and guidelines - contract between partners
  • subscription agreement
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19
Q

recourse loan

A
  • debt incurred for the purchase of an asset and that which holds the borrower personally liable for the debt
20
Q

nonrecourse loan

A
  • debt incurred for a partnership that does not hold the LPs personally liable
21
Q

dissolving a LP

A
  • generally liquidated on specified date
  • early shutdown may occur if the partnership sells or disposes of its assets or if the majority interest of LPs decide to
  • must settle accounts: 1) secured lenders, 2) other creditors, 3) LPs (first their claims to profits, then claims to a return of contributed cap), 4) GPs (first for fees and other claims not involving profits, then share of profits, then cap return)
22
Q

types of DPPs

A
  • RE partnerships
  • oil and gas partnerships
  • equipment leasing programs
23
Q

RE partnerships

A
  • most popular type
  • raw land - most speculative
  • new construction - less risky than new land, but more than existing property
  • existing property - relatively low risk
  • govt assisted housing - relatively low risk
  • historic rehab - same risk as new construction
24
Q

oil and gas partnerships

A
  • exploratory (wildcatting) - riskiest
  • developmental - medium to high risk
  • income - low risk
25
Q

equipment leasing programs

A
  • when DPPs buy equipment lease to other businesses
  • investors get income from lease payments and proportional share of write-offs from operation expenses, interest expenses and depreciation
  • objective is tax sheltered income
26
Q

DPP taxation

A
  • formerly tax shelters but tax revision now classify income and lost as passive income and loss
    • passive losses to shelter passive income
  • passive income is not considered earned income
  • flow through pass income, gains, losses, deductions, credits directly to investors
  • DPPs don’t pay dividends
27
Q

RE program taxation

A
  • expenses creating losses are: mortgage interest expense, depreciation allowances, expense for improvements
  • non recourse debt add to the investor’s cost basis
  • tax credits are offered for govt assisted housing and historic rehab
28
Q

oil and gas program taxation

A
  • write-offs doe the expense of drilling are usually 100% deductible in the first year include: wages, supplies, fuel costs, insurance.
  • intangible drilling costs - any costs after those listed above that have no salvage value
  • tangible drilling costs: costs incurred that have salvage value. these depreciate over several years
  • depletion allowances - decreasing supply of natural resources. can only be taken once oil and gas are sold. Two forms of depletion - Cost and percentage
29
Q

oil and gas sharing arrangements

A

ways to share costs and revenues:
- overriding royalty interest
- reversionary working interest
- net operating profits interest
- disproportionate sharing
- carried interest
- functional allocation (most common)

30
Q

DPP tax features

A
  • business deductions
  • tax basis
31
Q

business deductions

A
  • expenses of the partnership (salaries, interest payments, management fees) result in deduction int eh current year to the income of the business
  • principal payments on a property are NOT deductible expenses
  • cost recovery systems offer write offs over a period of years (depreciation or depletion)
32
Q

depreciation write offs

A
  • apply to cost recovery of expenditures for equipment and RE (land can’t be depreciated)
  • depreciation and depletion can only be claimed when income is being produced by the partnership
  • can be straight line (same amt each year) or accelerated (increased deductions in early years that decrease over time)
33
Q

depletion allowances:

A
  • applying to the using up of natural resources
  • depreciation and depletion can only be claimed when income is being produced by the partnership
34
Q

tax basis

A
  • rep the upper limit on deductibility of losses
  • tax basis = amt at risk
  • used to determined gain/loss upon sale of partnership interest
  • subject to adjustments
  • LP basis consists of:
    • cash contributions to the partnership
    • noncash property contributions to the partnership
    • recourse debt of the partnership
    • nonrecourse debt for RE partnerships only
  • basis must be adjusted a year end
  • any distribution of cash or property and repayment of recourse bet are reductions to a partner’s basis
  • partners are allowed deductions up to the amt of their adjust cost basis
35
Q

computing cost basis

A

Basis = investment in partnership + share of recourse debt (+ non recourse debt in RE programs) - cash distributions

36
Q

tax filing requirements

A
  • form 1065 and K-1
37
Q

economic viability

A
  • there is potential for returns from cash distributions and capital gains
38
Q

measuring economic soundness

A
  • cash flow analysis
  • IRR
39
Q

cash flow

A
  • cash flow analysis: compares income (revenues) to expenses
  • cash flow: net income or loss plus non cash changes
40
Q

IRR

A
  • the discount rate (r) that makes the future value of an investment equal to its present value
  • take the time value of money into account
  • favorite method of evaluating DPP
41
Q

DPP advantages

A
  • managed by others
  • flow through
  • limited liability
42
Q

DPP disadvantages

A
  • liquidity risk: great disadvantage. secondary market for DPPs is limited
  • legislative risk: when congress changes tax laws
  • leverage risk
  • risk of audit
  • depreciation recapture
43
Q

FINRA rule 2310

A
  • member firm must have reasonable grounds for believing that info provide in the prospectus, all material facts are adequately disclosed
44
Q

DPP suitability

A
  • must clearly stated standards of suitability in the prospectus
  • must be consistent with investor objectives and that customer is in a position to take advantage of tax benefits and has sufficient net worth
  • member must maintain docs describing the basis for this suitability rec
  • need written customer consent to execute DPP transaction
45
Q

DPP compensation resistrictions

A
  • limits overall expenses and compensation
  • above 15% is too high
  • compensation to member firm/wholesaler is 10%
46
Q
A

Series 7 (19 decks)

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