Suitability

The suitability of a direct participation program can vary depending on its business, setup, and structure. For example, we discussed the three oil and gas programs previously, where the risk and benefit profile of each is unique. Regardless, there are a few common traits that apply to most direct participation programs.

Liquidity risk applies, especially to non-public limited partnerships. Investing in a limited partnership requires a lengthy process and a subscription agreement. Getting out of a limited partnership can require the approval of the general partners and/or finding a suitable investor as a replacement. You don’t need to know the specifics, but cashing out of a limited partnership is not nearly as easy as selling stocks or bonds.

The pass-through of losses is another staple of direct participation programs. While losing money isn’t fun, the ability to get a tax write-off due to business expenses or losses is not something afforded to other investments. For example, the only way to obtain a tax benefit from a stock investment is to sell it at a loss, which creates a potentially deductible capital loss. With a limited partnership, losses can be attained and used for deductions without selling the investment, which is a big advantage.

Beyond liquidity risk and pass-through of losses, DPPs can offer a variety of risks and benefits. Investors should always do enough research to understand the business and the risks it presents. Even if a DPP seems low-risk, liquidity risk and pass-through of losses make them especially suitable for wealthy investors seeking tax benefits. Regardless, investors should not seek out DPP investments purely for tax benefits. If the business is not successful at some point, the investor can lose large amounts of money. Tax benefits only go so far!

Limited partners can keep track of the success of their investment through its basis. Similar to cost basis for other securities, basis in a limited partnership keeps track of the amount invested, plus some other items. There are some items that add to the basis, while some items reduce the basis.

Adds to the basis

• Amount invested (including reinvestments)
• Recourse notes
• Non-recourse notes (for RELPs only)

Non-recourse notes are loans made to the partnership that the limited partners are not liable for. They typically do not add to the basis, unless the business is related to real estate.

Reduces the basis

• Income or revenue received
• Passive losses

Limited partners are only liable for losing their basis. The higher the basis, the more money is at risk. Whenever the partnership makes a payout or distributes tax-deductible losses to the investor, their basis and liability are reduced.