Quick Answer
A DPP is any program that flows income, gains, losses, deductions, and tax credits directly to investors with no entity-level tax, most commonly structured as a limited partnership. The general partner manages the business and carries unlimited liability; the limited partner is a passive investor whose liability is capped at the amount invested.
Now that you understand how REITs pool capital for real estate, this section covers a broader category of flow-through investments: Direct Participation Programs (DPPs). The core distinction to master is the split in rights, duties, and liability between general and limited partners.
What Is a DPP?
A Direct Participation Program (DPP) is any program that provides for flow-through of tax consequences regardless of the legal entity structure.
- DPPs pass income, gains, losses, deductions, and tax credits directly to investors without entity-level taxation
- Primary appeal: combination of potential income, capital appreciation, and tax benefits (depreciation, depletion, deductions)
- Unlike REITs, DPPs are typically illiquid with no secondary market
Think of it this way: In a regular corporation, the company pays tax on profits, and then shareholders pay tax again on dividends. A DPP skips the company-level tax entirely. Profits and losses "flow through" straight to each investor's personal tax return, as if they earned or lost that money themselves.
What Legal Structures Can a DPP Use?
| Structure | Characteristics |
|---|---|
| Limited partnership (LP) | Most common DPP structure; has general partner(s) and limited partner(s) |
| Limited liability company (LLC) | Members have limited liability; managed by members or designated managers |
| S corporation | Corporation with tax pass-through election from the IRS; limited to 100 shareholders |
The limited partnership is the structure you'll encounter most on the exam.
What Are the Roles and Duties of General vs. Limited Partners?
The limited partnership has two distinct roles with very different rights and responsibilities:
| Feature | General Partner (GP) | Limited Partner (LP) |
|---|---|---|
| Management | Manages day-to-day operations; makes all business decisions | No involvement in management; passive investor |
| Liability | Unlimited personal liability for all partnership debts and obligations | Liability limited to amount invested (plus any recourse notes signed) |
| Fiduciary duty | Owes fiduciary duty to limited partners | No fiduciary duty to partnership |
| Non-compete | Cannot compete with the partnership | May invest in competing businesses |
| Voting | Controls operations without LP approval (except fundamental changes) | May vote on fundamental matters only (admission of new GP, dissolution, sale of all assets) |
| Tax reporting | Files partnership return (Form 1065); issues Schedule K-1 to each partner | Reports share of income/loss on personal tax return via Schedule K-1 |
Key LP Rules
- A limited partner who participates in management risks losing limited liability protection
- The certificate of limited partnership must be filed with the state to legally form the LP
- The partnership agreement (also called the agreement of limited partnership) governs rights, duties, profit/loss sharing, and distributions
Exam Tip: Gotchas
A limited partner's maximum loss is the amount invested plus any recourse debt for which the LP is personally liable. If a limited partner contributes $50,000 cash and signs a $20,000 recourse note, their total at-risk amount is $70,000, not $50,000. A recourse note increases loss exposure beyond the cash contribution.
What Are the General Partner's Responsibilities?
The general partner (GP) carries the heaviest obligations in the partnership:
- Unlimited liability: Personal assets are at risk if partnership debts exceed partnership assets
- Fiduciary duty: Must act in the best interest of the limited partners
- Cannot compete: Prohibited from running a business that competes with the partnership
- Full management authority: Does not need limited partner (LP) approval for routine business decisions
- Tax compliance: Files Form 1065 (informational partnership return) and issues Schedule K-1 to each partner
Exam Tip: Gotchas
- The partnership itself pays no income tax. Form 1065 is purely informational. Each partner reports their share of income or loss on their own personal return via Schedule K-1.
- A GP's unlimited liability means creditors can pursue the GP's personal assets (home, savings) if the partnership cannot pay its debts.
What Can and Cannot a Limited Partner Do?
Limited partners (LPs) CAN:
- Vote on fundamental matters (new general partner (GP), dissolution, sale of substantially all assets)
- Inspect partnership books and records
- Invest in competing businesses
- Sue the general partner for breach of fiduciary duty
Limited partners CANNOT:
- Participate in day-to-day management (risk losing limited liability)
- Bind the partnership in transactions
- Act as an agent of the partnership
Exam Tip: Gotchas
- An LP who binds the partnership or acts as its agent may be treated as a general partner, taking on unlimited personal liability.
- The GP's non-compete obligation applies only to the partnership's line of business. LPs face no such restriction.
What Should You Check on Exam Day?
- A DPP is defined by flow-through of tax consequences, regardless of the legal entity used (limited partnership, LLC, or pass-through S corporation).
- The general partner manages the business, owes a fiduciary duty to limited partners, cannot compete with the partnership, and has unlimited personal liability.
- The limited partner is a passive investor whose liability is capped at the amount invested plus any recourse notes signed; participating in management, binding the partnership, or acting as its agent can strip that protection.
- Form 1065 is informational only; the partnership pays no federal income tax, and each partner reports their share of income or loss via Schedule K-1.