Understanding DPPs

A look at direct participation programs, and their appeal to sophisticated investors.

Have you ever heard of a “direct participation program”? You’re probably more familiar with the term “limited partnership.” While DPPs and LPs are not synonymous, DPPs are usually structured as limited partnerships, and often equated with them. Here’s a look at why certain investors are attracted to limited partnerships conceived as DPPs.

An attractive structure with potential tax advantages. By definition, a limited partnership is formed for a specific business venture that lasts for a set time period. You have a general partner (who runs the business) and limited partners (who invest money rather than time or effort by simply buying units in the partnership). The limited partners directly participate in any cash flow and tax benefits.

Any income that the limited partners receive is considered passive by the IRS (Form 1065 and Schedule K-1 are used to state annual profits, losses and distributions). This passive income is taxed once. Corporations are essentially taxed twice – their profit is whittled down by state and federal taxes, and their stockholders have to pay taxes on dividends. So that is one potential tax advantage of a DPP.

If a corporation suffers losses, its stock and its shareholders take a hit. If a DPP suffers a loss, the limited partners can use the losses to counterbalance other passive income, or even carry the losses forward to offset passive income in future years. So here is another potential tax advantage.

DPPs also offer an investor many possible tax deductions linked to tax credits, interest expenses, maintenance and day-to-day operation, and depreciation and depletion.

When the DPP terminates, any profits that go to the limited partners are considered long-term capital gains by the IRS. If the DPP has lasted at least 5 years, the limited partners only face a maximum capital gains tax of 8% on the profits.

An intriguing alternative investment. Most DPPs are not correlated to the stock market. They encompass many types of businesses and business sectors, including non-traded real estate investment trusts (REITs), R&D firms, energy firms, even film and TV production companies. So a DPP allows an investor to add more diversification to a portfolio, and to enter a possibly promising sector.

An opportunity you may want to explore. Obviously, DPPs are not for every investor. But they offer sophisticated investors some notable potential advantages. For the record, the Securities and Exchange Commission views limited partnership agreements as investment contracts, and limited partnership units as securities. This means that before you explore the world of DPPs, you should consult with a qualified financial advisor.

Comments

[Living Off Dividends & Passive Income]

are these the same as MLPs?

[Spencer Hill]

No. MLPs are Master Limited Partnerships that mostly trade on major exchanges. Direct Participation Programs don't trade as readily. The current favored exit strategies are an exchange listing or a private of the portfolios assets with capital gains distribution to its memebers.

MLPs and DPPs do resemble one another with the exception that most MLPs can be bought and sold more easily on a major exchange.