DPP Key Characteristics

Now that you've seen both limited partnerships and tenants in common, let's consolidate the characteristics that make DPPs unique, and the ones the exam tests most frequently.

Pass-Through Tax Treatment

The defining feature of all DPPs:

  • Income, gains, losses, and deductions flow through to investors' personal tax returns
  • No double taxation (unlike C corporations, where profits are taxed at the corporate level AND as dividends to shareholders)
  • Investors receive a K-1 form annually

Tax limitations on losses:

  • Passive activity rules: DPP losses are "passive" and can generally only offset passive income (not wages, salaries, or portfolio income)
  • At-risk rules: investors can only deduct losses up to the amount they have "at risk" (their investment plus any recourse debt)
  • These rules prevent investors from using DPP losses as unlimited tax shelters

Exam Tip: Gotchas

  • DPP losses can only offset passive income, not wages or investment income
  • "At-risk rules" limit loss deductions to the amount actually invested

Illiquidity

DPP interests are among the least liquid investments available:

  • No active secondary market for DPP interests
  • Interests are difficult to sell or transfer
  • Investors should be prepared to hold for the life of the program, often 7 to 12+ years
  • Not listed on exchanges (unlisted securities)
  • This illiquidity is a major suitability concern

Exam Tip: Gotchas

DPPs are NOT listed on exchanges. They have no active secondary market. If a question asks about selling DPP interests on an exchange, the answer is that you cannot.

Suitability Requirements (FINRA Rule 2310)

FINRA imposes specific rules on who should invest in DPPs:

  • DPPs are suitable only for investors who can bear the economic risk
  • Investors must meet net worth and income requirements
  • The registered representative must have reasonable grounds to believe the program is suitable for the specific customer
  • The rep must conduct due diligence on the program before recommending it
  • FINRA Rule 2310 requires that compensation to underwriters and affiliates be fair and reasonable

Exam Tip: Gotchas

The three things to remember about all DPPs: (1) pass-through taxation (no double tax), (2) illiquid (no secondary market), and (3) suitability requirements. If the exam describes an investment with these three features, it's describing a DPP.

With DPPs covered, let's move on to REITs, a way to invest in real estate without directly owning property.