Tax Advantages of DPPs
DPPs fund risky, capital-intensive businesses. As such, they may generate losses, especially in the beginning, that the partners can use to offset passive income.
The IRS defines passive income as primarily income from rental property and limited partnerships, including DPPs. The IRS considers the investor not to be actively involved in earning this type of income and, thus, labels it “passive” income (the same idea holds for “passive” losses). Passive income does not include portfolio income, such as income from annuities, mutual funds, and stocks and bonds. This “tax shelter” benefit is a reason some high-end investors choose to invest in DPPs.
Even though using losses from a DPP as a tax shelter is a possibility for investors, the primary goal of a DPP needs to be to earn money, not to lose it. Investors in DPPs who set up DPPs for the sole purpose of a tax shelter (the business is designed to be unprofitable) are subject to fraud charges and back taxes, among other unpleasant consequences.
For the IRS to consider a business a partnership rather than a corporation, the business may not have more than two of the following defining feat