What Is A Direct Participation Program?
Direct Participation Program, or DPP, is an investment initiative where investors can pool their money and invest in real estate or energy projects. The prime purpose of the DPP is to provide funds to businesses to enhance their cash flow and tax benefits to investors.
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This program is also known as the ‘Direct Participation Plan.’ It allows investors to pool money and access a company’s financial statements. Members must buy into the program to receive the benefits of a DPP. It is a source of secondary income. However, this limited partnership can bring stress and expenses for the partners.
Table of contents
- What Is A Direct Participation Program?
- Direct Participation Program Explained
- Types
- Examples
- Benefits And Risks
- Frequently Asked Questions (FAQs)
- Recommended Articles
Key Takeaways
- A direct participation program, or DPP, is a limited liability house that allows investors to pool their money and invest in a business venture. It is also called a direct participation plan.
- Its prime purpose is to fund cash flow to a business and earn tax advantages on it.
- Businesses involved in this program are related to real estate, oil and gas, and equipment leasing projects. So, the types of DPP involve REITs, commodity pools, oil and gas programs, and others.
- The FINRA (Financial Industry Regulatory Authority) and Securities act of 1933 regulates the DPP.
Direct Participation Program Explained
Direct Participation Program is a limited liability company like a mutual fund house where investors can pool their money and invest in real estate, energy, power, and leasing projects. It acts as a substitute or alternative asset class for investors. Most DPPs are passively managed and last between five and ten years. All tax breaks and the DPP’s income are transferred to partners during that time. So, the direct participation program features enable various tax benefits. However, certain risks are associated with them.
The direct participation program funds have their origin in the United States. The Securities Act of 1933 and FINRA (Financial Industry Regulatory Authority) collectively govern DPPs. They also allow individuals to register for the DPP exam, which authorizes them to conduct the purchase and sale of direct participation program funds.
The direct participation program features a similar class structure to mutual fund houses. However, the only difference between DPP and mutual funds is that the former is a limited partnership or a subchapter S corporation. As a result, the investors who wish to pool money become partners in this company. So, individuals who have extra funds come together and invest in a business venture. Among them, a general partner will handle all the activities of the DPP. These investors get an opportunity to purchase units in this program. Later, these DPP partners can use their share to claim direct participation program tax benefits.
Due to the revenue they produce and the fact that they are pooled, DPPs have grown to be a well-liked method for common investors to gain access to investments that are typically only available to high net-worth individuals; however, with some limitations.
Types
Let us look at the types of direct participation programs to understand the concept better:
#1 – Real Estate Investment Trust (REIT)
REITs are direct investment programs where individuals can acquire a stake in the assets themselves. Here, the investors avail of different tax benefits. Also, they get various deductions on business expenses and transfers. In addition, they get the extra advantage of not paying any taxes on the prior income given out as a distribution. However, it needs high-leveraged financing.
#2 – Equipment And Leasing Projects
Investors can purchase DPP in the equipment leasing business of a company. The two types of leases include – a financial lease with no residual value and an operating lease with a value in the end. Here, the partners get various deductions on depreciation, borrowed funds’ interest income, and others. Nevertheless, at-risk rules limit an investor’s tax limit.
#3 – Oil And Gas Programs
Partners wanting to pool money in the oil and gas sectors can choose this DPP. However, it allows less liquidity compared to other programs. Although there are few front-end tax benefits, they get to capitalize on acquisition costs. Also, they can hedge and mitigate their risk during inflation.
#3 – Agricultural And Livestock
Partners, here, can acquire a stake in the agricultural land or create interest in the livestock animals. Also, they can avail of various deductions on start-up programs, row crops, depreciable property, and others. However, they have equal risk in the event of natural disasters, disease, or market conditions that may damage the asset.
#4 – Commodity Pools
These are limited partnerships or business trusts where individuals can invest in commodity futures. They offer similar benefits and risks to others.
#5 – Others
The other types that offer Direct Participation Program tax benefits include entertainment, debt-based, and others.
Examples
Let us look at the examples of DPP to comprehend the concept better:
Example #1
Suppose Michael is a full-time venture capitalist pooling money for various businesses. Then, some years later, he discovered a new investment program through a friend called the direct participation plan. According to DPP, Michael and other investors will come together, pool their money, and fund a business venture relating to real estate. Through this program, he will receive certain tax credits that will authorize him to deduct expenses. Also, each will get some units representing their stake in the business.
However, the existing benefits would have disappeared if he had invested the same money in another program.
Example #2
According to CNBC news, DPPs generate an income of 5-7% for retail investors. Besides that, non-listed real estate investment trusts have a market share of 65%. In contrast, business development companies capture 32% of the market.
Benefits And Risks
Direct participation plans allow individuals to invest their still money and make passive income. In addition, the interest earned through this investment is around five to seven percent. Moreover, since it is a highly curated program, the partners’ liability is also limited. Besides, they get certain tax benefits and deductions after incurring all expenses.
Although DPP is a great investment option, it has certain cons. While it offers investment options, the investors must wait to liquidate it. For example, if they buy a DPP with a minimum lock-in of 10 years, they can sell or access it only after ten years. Also, the investors need help accessing the company’s account records.
| Benefits | Risks |
|---|---|
| Good rate of interest earned. | Less liquidity of assets |
| Attracts limited liability | Limited disclosures of the company’s statements |
| Tax advantages | The fixed lock-in period of 10 years |
Frequently Asked Questions (FAQs)
DPPs are exempt from tax payments under Rule 2810 of FINRA. Therefore, they allow investors to get tax benefits on business expenses. Also, they do not have to pay any corporate tax on it.
DPP is a financial security that enables high returns and limited risk. Although the investor gets similar features to investment security, it offers maximum tax benefits to the users.
While DPP is a broader term, REIT is a type of DPP where investors can invest their pooled money in the real estate sector. Here, they receive high deductions on business transfers and distributions. However, DPP is a collective investment that allows investment in all sectors.
No, Hedge funds are not a part of DPP. Although the management of this limited liability company seems similar, there is a huge difference between both.
Recommended Articles
This has been a guide to what is a Direct Participation Program. We explain it with its types, examples, benefits, and risks. You can learn more about financing from the following articles –
- Accredited Investor
- Private Investors
- Activist Investor
This post first appeared on Free Investment Banking Tutorials |WallStreetMojo, please read the originial post: here
