Direct Participation Program Basics
Direct Participation Programs (DPPs) are unique investment structures that allow investors to participate directly in the cash flow and tax benefits of an underlying business, most commonly organized as limited partnerships.
Why DPPs Matter for Series 7
DPPs represent a significant portion of the Series 7 exam. You must understand:
- Limited partnership structure and roles
- Pass-through taxation of income and losses
- Types of DPP investments (oil & gas, real estate, equipment leasing)
- Suitability considerations and risks
What is a Direct Participation Program?
A Direct Participation Program (DPP) is an investment entity that allows all taxable events—income, losses, deductions, and credits—to flow directly through to investors without being taxed at the entity level.
Key Characteristics
- Pass-through taxation - Income and losses flow directly to investors
- Not publicly traded - No secondary market (illiquid)
- Tax-advantaged - Can generate deductions and credits
- High risk - Suitable only for sophisticated, high-net-worth investors
Limited Partnership Structure
Most DPPs are organized as limited partnerships (LPs), which consist of two types of partners:
General Partner (GP)
The General Partner manages the partnership and has unlimited liability:
| Responsibility | Description |
|---|---|
| Management | Makes all day-to-day business decisions |
| Fiduciary duty | Must act in best interest of limited partners |
| Unlimited liability | Personally liable for all partnership debts |
| Capital contribution | Must contribute at least 1% of capital |
| Compensation | Receives management fees and share of profits |
| Restrictions | Cannot borrow from or compete with the partnership |
Limited Partner (LP)
Limited Partners are passive investors with limited liability:
| Rights/Limitations | Description |
|---|---|
| Limited liability | Can only lose amount invested (plus recourse debt share) |
| No management role | Cannot participate in day-to-day decisions |
| Voting rights | Can vote on major matters (admission of new partners, sale of assets) |
| Inspection rights | Can review partnership books and records |
| Legal rights | Can sue general partner or sue to dissolve partnership |
| No conflicts | Can invest in competing partnerships |
Pass-Through Taxation
DPPs use conduit (pass-through) taxation:
How It Works
- Partnership earns income or generates losses
- Income/losses "pass through" to partners' individual tax returns
- Partners pay taxes at their personal tax rates
- Partnership itself pays no entity-level tax
Passive Income and Losses
Because limited partners don't actively participate in the business:
- All income and losses are classified as passive
- Passive losses can only offset passive income
- Cannot offset wages, portfolio income, or active business income
- Excess passive losses can be carried forward to future years
Example:
An investor with $50,000 in passive losses from a DPP and $30,000 in passive income from another DPP can only deduct $30,000. The remaining $20,000 is carried forward.
Partnership Formation
Certificate of Limited Partnership
The partnership files this document with the state to:
- Formally create the limited partnership
- Identify the general partner
- Define the partnership's purpose
Partnership Agreement
The internal document governing operations:
- Rights and responsibilities of partners
- Profit and loss allocation
- Distribution policies
- Transfer restrictions
Exam Tip: Liability Rule A limited partner who participates in management may lose their limited liability protection and become personally liable like a general partner. This is why LPs must remain passive investors.
7.2 Types of DPPs
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