The suitability of a direct participation program (DPP) depends on the specific business, how it’s set up, and how it’s structured. For example, the three oil and gas programs have different risk-and-reward profiles. Even so, a few traits show up in most DPPs.
Liquidity risk is common, especially with non-public limited partnerships. Buying into a limited partnership typically involves a longer process and a subscription agreement. Exiting the investment can be difficult because it may require approval from the general partners and/or finding another investor to take your place. The key point is that cashing out of a limited partnership is usually much harder than selling stocks or bonds.
Another common feature of DPPs is the pass-through of losses. Losses aren’t desirable, but they can create tax deductions through business expenses or operating losses - something most other investments don’t provide. For example, with stock, the typical way to get a tax benefit from a loss is to sell the stock at a loss, creating a potentially deductible capital loss. With a limited partnership, losses may be passed through and used for deductions without selling the investment.
Beyond liquidity risk and pass-through of losses, DPPs can involve a wide range of risks and benefits. Investors should research the underlying business and understand the risks it presents. Even when a DPP appears relatively low-risk, liquidity risk and pass-through of losses often make DPPs most suitable for wealthy investors who are seeking tax benefits. At the same time, investors shouldn’t choose a DPP purely for tax benefits. If the business performs poorly, the investor can still lose a significant amount of money. Tax benefits don’t eliminate investment risk.
Limited partners track the performance and risk of their investment through its basis. Similar to cost basis for other securities, basis in a limited partnership starts with the amount invested and is adjusted over time. Some items increase basis, and others decrease it.
Adds to the basis
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
Limited partners are only liable up to the amount of their basis. A higher basis means more money is at risk. When the partnership makes a payout or allocates tax-deductible losses to the investor, the investor’s basis (and therefore their liability) is reduced.
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