Two investors can each own a piece of the same apartment complex and get opposite results. One reports depreciation losses on a personal tax return but cannot sell for years. The other receives taxable dividends, never a loss, and can sell in seconds. The way the investment is structured decides how it is taxed and how you get out.
A direct participation program (DPP) is an investment built so that its income, gains, losses and deductions flow through to the investors' own tax returns. Financial Industry Regulatory Authority (FINRA) Rule 2310(a)(4) defines a DPP by that flow-through result, whatever its legal form. Examples include oil and gas, real estate, agricultural and cattle programs, condominium securities and Subchapter S corporate offerings. The rule excludes real estate investment trusts (REITs), qualified retirement plans, individual retirement accounts and companies registered under the Investment Company Act of 1940.
Most direct participation programs are limited partnerships. Under Rule 2310(a)(9), a limited partnership has one or more general partners and one or more limited partners. Each side plays a different role:
Common mistakes
- Treating a REIT as a DPP. Rule 2310 excludes REITs. A stem about passing losses through to investors points to a DPP.
- Using LP losses to shelter a salary. A limited partner's losses are passive. In the lesson's example, $7,000 of excess loss carries forward instead of offsetting $90,000 of wages.
- Reading Section 3(c)(1) as "100 accredited investors." The exclusion counts up to 100 beneficial owners (250 for a qualifying venture capital fund). Accredited status comes from Regulation D.
Bottom line
- A DPP passes income, gains, losses and deductions through to investors (IRC 701 and 702); the GP has unlimited liability, and an LP's is limited to the investment.
- An LP's DPP losses are passive: they offset only passive income, carry forward, and are freed by a fully taxable sale of the whole interest.
- DPPs and non-listed REITs are illiquid; Rule 2310 requires liquidity disclosure, suitability that includes fair market net worth, and prior written approval for discretionary DPP trades.
- A TIC interest is an undivided fractional share of real property (up to 35 co-owners) and can be Section 1031 replacement property.
Exam shortcut
Sort every product question with three tests, in this order: Is it a pool or a promise? A fund owns assets. An ETN is only the issuer's unsecured promise to pay, so the risk answer for an ETN is credit risk. Is it listed? You can sell listed REITs, ETFs, ETNs and exchange-listed partnership units today. Anything unlisted points to the illiquidity answer. What flows through?
The full lesson (about 4,803 words, 32 min read) adds 2 worked examples, all 5 common mistakes, a self-check, free in the app.
Learning objectives
- B10
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