Unit 5 Flashcards
Direct Participation Programs
Limited Partnerships
unitque investment opportunities that permit economic consequences to flow through investors
Investors share in income, gains , losses, deductions and tax credits
Limited Partners IN DPP advantage
An investment managed by others
Limited Liability
Flow through of income and certain expenses
Greatest disadvantage for LP IN DPP
Lack of liquidity
Secondary market is very limited
Master Limited Partnerships
Where LP interests are actually negotiable and trade on OTC and exchanges
DPP features
Structured as limited partnership / S-corp
Entity does not pay taxes
Investors share all income and losses on Form K-1
No double taxation on distributions
Passive income
Income and losses which come from rental property, limited partnerships and enterprises where individual is not actively involved
Earned Income
salary, bonuses, income derived from active participation
General Partners report earned income on LP
Profit motive
DPP without a profit motive or intention of generating income could be determined abusinve
No profit motive penalties include
Back taxes
Recapture of tax credit
Interest penalties
Prosecution for fraud
Partnerships
Two or more individuals and cannot be two OR MORE of the following:
Org formed under federal or state law that refers to itself as incorporation, corporation, or corporate body
Organizations formed under state law that refers to itself as joint-stock company
Insurance company
Certain banks
Organization wholly owned by state or local government
Certain foreign organizations
Tax exempt orgs
REITS
Trusts
Partnerships tenor
Must have a predetermined stop date
What characteristics of partnerships is most difficult to avoid
Centralized management - no business can function without it
What characteristics of partnership is easiest to avoid
Continuity of life - predetermined time which partnership must dissolve
Two characteristics most likely to be avoided by DPP
Continuity of life and freely transferable interests
DPP tax shelter
Only allows passive losses to shelter only passive income. NOT ORDINARY INCOME.
Forming LP
LP may be sold through private placement OR public offerings
If sold privately - need private placement memorandum. Must be accredited investors
If sold publicly - large amount of relatively small contributions (usually 1 - 5k)
Syndicator in LP
oversees the selling and promotion of partnership.
Syndicator is responsible for preparation of any paperwork necessary for registration.
Fees limited to 10%
Required Documentation for LP
Certificate of LP
Partnership agreement
Subscription Agreement
Certificate of Limited Partnership
Must be filed in home state and includes:
Partnerships name Partnerships business Principal place of business Amount of time the LP expects to be in business Size of current and future investments contribution return date share of profits or other comp
Partnership Agreement
describes roles of GP and LP and guidelines for partnerships operation
Rights of GP (in partnership agreement)
Charge management fee for making business decisions
Authority to bind partnerships into contracts
Right to determine which partners should be included in partnership
Right to determine if cash distributions are made
Subscription Agreement
All investors interested in become LP’s must complete SA. Appoints one or more GP to act on behalf of LP and is only effective when signed.
Must include (along with subscribers money): Investors net worth Annual income Acknowledge risks involved Power of attorney to GP
Dissolving a LP
When dissolution occurs, GP must cancel certificat of LP and settle accounts.
Secured Creditors
Other creditors
LP (first claims to profits, 2nd capital contributions)
GP (first fees, 2nd profits, 3rd capital return)
General Partner vs Limited Partner
GP LP
Unlimited Liability Limited Liability
Mngmt Responsibibility No management responsib
Fiduciary responsibility May sue GP over damages
Allowed Activities GP vs LP
GP Make decisions that are legally binding Buy and sell company property receive compensation per partnership agreement maintain financial interest of company
LP vote on changes Vote on sale of property receive cash distributions inspect books exercise partnership democracy
Prohibited activities GP vs LP
GP
Compete against partnership for personal gain
borrow from partnership
co mingle partnership funds
Admit new GPs or LPs or continue the partnership after the loss of GP
LP
Act on behalf of partnership / management
knowingly sign document with false info
have names appear as part of partnerships name
Real estate partnerships benefits
Capital growth
cash flow income
Tax deductions
Tax credits
Raw Land Partnership
Objective: Purchase undeveloped land Advantage: Appreciation of property Disadvantage: No income distributions Tax: No tax deductions Degree of risk: MOST SPECULATIVE
New Construction Partnership
Objective: build new property Advantage: appreciation of property Disadvantage: Potential cost overruns Tax: Deprecation and expense deductions Degree of risk: Less risky than new land, still risky
Existing Property Partnership
Objective: Generate income from property
Advantage: Immediate cash flow, history of expenses
Disadvantage: greater maintenance or repairs
Tax: deduction for mortgage interests/depreciation
Degree of risk: Relatively low-risk
Government Assisted Housing Partnership
Objective: Develop low income housing Advantage: Tax credits and rent subsidiaries Disadvantage: Low appreciation potential Tax: Tax credits/losses Degree of risk: Relatively low-risk
Historic Rehab Partnership
Objective: Develop historic sites for commercial use
Advantage: Tax credits
Disadvantage: Cost overruns; no track record
Tax: Tax credits for expenses and depreciation
Degree of risk: Similar risk to new construction
Oil and Gas Partnershps
include speculative drilling programs and income programs that invest in producing wells
Intangible Drilling Costs (IDC)
Write-offs for expenses of drilling usually 100% deductible in FIRST YEAR
Expenses include: wages, supplies, fuel, insurance.
NO SALVAGE VALUE
Tangible Drilling Costs (TDC)
Costs incurred that have salvage value (storage tanks wellhead equipment)
Deducted over time
Depletion allowances
Tax deduction that compensate the partnership for decreasing supply of oil and gas
Types of O&G Partnerships
Income
Developmental
Income
Sharing Arrangments with OG Programs
Overriding Royalty Interest Revisionary Working Interest Net Operating Profits Interest Disproportionate Sharing Carried Interest Functional Allocation
Overriding Royalty Interest
Holder of interest receives royalties but has no partnership risk. Landowner selling mineral rights
Revisionary Working Interest
Bears no cost of the program and receives no revenue until LP have recovered their capital
Net Operating Profit Interest
GP bears none of programs cost but is entitled to percent of profits
Carried Interest
GP shares intangible drilling costs with LP but receives no IDC. LP receives immediate deduction, GP receives write offs from depreciation over the life of property.
Functional Allocation
MOST COMMON SHARING ARRANGEMENT.
LP receives IDCs, GP receives tangible drilling costs. Revenues are shared.
Deductions for partnerships
Expenses of partnerships are deductions to LP
Depreciation write offs
Depletion allowances - only claimed when income is being produced
Crossover point
when program begins to generate taxable income instead of losses.
Tax basis of LP
amount at risk used to determine their gain or loss upon the sale of partnership interest.
Subject to adjustment periodically for events such as:
Cash distributions and additional investments
Blind pool
non-specific porgram
Less than 75% of assets are specified as to use
Specified - more than 75% are specified
Basis formula
Basis =
Investment in partnership + Share of recourse debt - cash distribution
Up front consts incurred by LP will not effect beginning basis.
50k investment - $3K BD commish = $75 beginning basis
LIKE MUTUTAL FUND LOAD
Cost Basis example: Initial investment and recourse note
LP invests $10K and signs $40K recourse note.
During 1st year investor receives $5K dividend. At year end, statement of share of LP losses is $60K, how much is deductible?
$50K initial investment - $5K dividend = $45K deductible
Depreciation recapture
If a partnership is sold and was using accelerated depreciation, the difference between straight line and what was actually deducted could be subject to income tax
