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Direct Participation Programs (DPPs): Types, Risks & Advantages

Instructor: LEROY (Bill) RANDS

Bill has taught college undergraduate and MBA classes in finance, economics & management, 40 years of finance experience and has a MBA degree.

Direct participation programs are companies where small investors can make direct investments in different businesses. They are unregulated and can be high risk, but allow investors direct participation in the rewards of the business.

Direct Participation Programs

Hal likes to look for different investments. After he heard about direct participation programs, he decided to look into them.

Direct participation programs (DPP) are individual legal entities where an individual can invest directly in a pool that is invested in areas such as real estate and oil and gas projects. Investors become limited partners in the company making the investment by pooling their investment with other individuals.

Hal likes the excitement of direct participation programs, as well as the ability to invest directly in investments and receive his portion of the cash flow and tax benefits of the investment. He also doesn't see another way to invest in things like oil and gas exploration and development.

Formation of Direct Participation Programs

Direct participation programs are usually organized as Subchapter S corporations, limited liability companies (LLC), limited partnerships or general partnerships. In practice, regardless of the legal structure, they tend to behave as limited partnerships.

A general partner is responsible for the management of the direct participation program and makes all the decisions. The general partner has full liability for the operations of the DPP.

The investor's liability is limited to their investment in the DPP. They could lose their whole investment, but would not have any more personal liability for debts or liabilities of the direct participation program.

Investors, however, share in the cash flow and tax benefits of the DPP, as well as appreciation in assets. Income or losses from a DPP are passive income to the investors. What this means is that an investor must have passive income in order to offset any passive losses distributed to him. Otherwise, the losses are not deductible on his personal income taxes.

Hal has invested in several DPPs over the previous two years. He invested $20,000 in a DPP in real estate and $30,000 in a DPP that was developing oil and gas wells. In 2019, he had income of $1,500 from the real estate DPP but losses of $2,000 from the oil and gas DPP. When he did his taxes, he was able to offset the $1,500 in income from the losses but had $500 of passive losses that he could not use and had to carry over to a future year.

Types of DPPs

Hal likes that direct participation programs are used for many types of investments. DPPs are originated by developers as a way to raise capital for investments and generate income. It also allows small investors like Hal to be able to invest in projects that otherwise would not be available to them.

Some of the areas where direct participation programs are prominent are:

  • Over 2/3 of DPPs are involved in real estate investments. These investments include: raw land, construction projects, existing property or government-assisted housing projects. Returns to investors range from capital appreciation on raw land to income streams from rentals on existing properties or low-income housing.
  • Another major DPP area is oil and gas investments. DPPs in this area invest in exploration efforts, development through drilling new wells, or buying existing wells for income streams, or a combination of the three applications. Risk varies by what type of investment the DPP chooses to do.
  • A third area of investment for DPPs is equipment leasing. Direct participation programs buy equipment and lease it to businesses. It could be something like a bulldozer or front-end loader or a piece of manufacturing equipment. Investors get cash flow from the proceeds of the lease.
  • DPPs also do something called a business development company. Business development companies can be legally formed to make investments in smaller to medium-sized companies. These investments could be in the form of loans or financing, or an equity injection. Investors again participate in the cash flow and tax benefits from those investments.

Hal found that his investment in oil and gas development was rewarding. His DPP was doing drilling on sites adjacent to oil-producing areas of the Permian area of Texas. The first well the DPP drilled found oil and gas, so the DPP had to invest to take the well into production. Hal figured that he would get some significant income from this investment.

Advantages and Disadvantages

Direct participation programs provide unique investment opportunities to the right investors. There are many advantages and disadvantages to DPPs.

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