7.2 Types of DPPs

Real Estate DPPs

Real estate partnerships generate cash flow from rents and shelter income through depreciation and mortgage interest deductions. The Series 7 expects you to rank the sub-types by write-offs and risk.

Key trap: raw land has the fewest write-offs precisely because land is never depreciated — only buildings and improvements are. A raw-land program therefore offers no annual deductions and depends entirely on selling the land later at a profit, which makes it the most speculative real-estate DPP despite sounding "safe." Government-assisted housing is the income-oriented program that delivers tax credits, which reduce tax owed dollar-for-dollar rather than merely reducing taxable income — far more valuable per dollar than a deduction.

Rank the four programs two ways the exam asks about: by current income, existing income property is highest and raw land is lowest; by write-offs, government-assisted (credits) and existing income property (depreciation) lead while raw land trails. A common question gives a retiree who needs steady income and asks which real-estate DPP fits — the answer is an existing income property program, not raw land or new construction.

Oil and Gas DPPs

These offer the largest deductions and the largest risks. Memorize the risk ladder:

Drilling Cost Deductions

• Intangible Drilling Costs (IDCs) — labor, fuel, repairs, supplies, and hauling that have no salvage value. They are 100% deductible in the year incurred and typically represent 60%–80% of drilling cost. IDCs are the headline early-year deduction.
• Tangible Drilling Costs (TDCs) — physical equipment with salvage value (casing, pumps, storage tanks). These are capitalized and depreciated, generally over a 7-year recovery period; they are roughly 20%–40% of cost.

Depletion

Depletion accounts for the reservoir being used up. Two methods:

• Cost depletion — recovers actual basis based on units extracted.
• Percentage depletion — a fixed 15% of gross income for qualifying small producers (not available to integrated major oil companies). Percentage depletion can exceed basis over time, which is why the exam flags it as more generous than cost depletion for a producing program.

Tie the deductions to the program type. Exploratory and developmental programs are heavy in IDCs, so they front-load large early-year deductions — attractive to a high-bracket investor wanting current write-offs. Income (producing) programs already have wells in the ground, so their main tax feature is depletion against ongoing revenue, plus current income. That is why exploratory programs pair maximum risk with maximum early deductions, and income programs pair minimum risk with steady cash flow.

AMT Preference Items

Excess IDCs and excess (percentage) depletion are tax-preference items that can trigger the Alternative Minimum Tax (AMT). A high-bracket investor expecting a large write-off may instead owe AMT, so suitability discussions must raise this.

Equipment Leasing DPPs

The least-tested type. The partnership buys equipment and leases it out, aiming for steady cash flow plus depreciation.

• Operating lease — short-term; equipment is returned, so the GP must re-lease repeatedly to recover cost.
• Full-payout (finance) lease — long-term; a single lease term recovers the full equipment cost.

Risks: obsolescence, lessee default, and uncertain residual value. Because the goal is dependable lease cash flow rather than big tax shelters, equipment leasing is generally pitched to investors who want income with moderate write-offs (depreciation) rather than aggressive deductions. The exam rarely drills into it, but know that an operating lease forces the GP to keep re-leasing the asset, raising re-marketing and vacancy risk, while a full-payout lease recovers the equipment's full cost over a single long term and is the more conservative choice.

Evaluating Economic Soundness

Before recommending any DPP, weigh the deal on its merits, not its tax breaks:

1. Would it be profitable ignoring tax benefits?
2. Are income and expense projections realistic?
3. What is the GP's track record and experience?
4. Use of proceeds — how much funds the actual venture versus fees and commissions?
5. Is there a credible exit strategy?

Economic-substance rule: The IRS may disallow deductions from programs whose only purpose is tax avoidance. A DPP recommended chiefly as a "tax shelter" with no real economic prospect is both a suitability problem and an audit risk — the historic abuse that prompted the passive-loss rules in the first place. The exam's preferred answer always favors the program with genuine cash-flow potential over the one offering only deductions.