Limited Partnership Obsession

[JohnH]

Since we have some financial advisors on this forum, I'd like to ask why there seems to be this obsession with Limited Partnerships among some financial advisors. This puzzles me to no end.

I'll frequently see a situation where someone inherits money, goes to a finaancial advisor, and of course the reports start coming in each year showing alls sorts of trading activity. Much of it is with proprietary funds or other stuff which carries pretty high transaction costs. Not to defend or criticize the activity - I understand the advisor has to make money somehow.

But then stuck in the middle of the paperwork blizzard will be one or two K-1's with 6 pages explaining their limited partnership investments. A client with $100,000 or so in invested funds will often have two or three of these limited partnerships with $5,000 invested in each one. Frankly, they're more trouble then they're worth, they consistently lose money, and they're just a drain on everybody's time & resources. Plus you have to do that UBTI dance just to be sure there isn't a 990 filing requirement by somebody.

What's the strategy here? Do financial advisors recommend them in the misguided belief that this is a logical part of a "diversification" strategy? I thought limted parterships were discredited about 15-20 years ago to the point that nobody would promote them, yet they keep popping up with pretty much the same results as back then. Is there some grand plan that I'm missing, or is it just the simple fact that limited partnerships pay more commission? Or do my clients just have incredibly bad judgement in choosing financial advisors? Or do they have even worse luck in choosing a tax preparer who can't comprehend the big picture?

I plan to ask one or two f these guys this question directly when tax season is over, but I thought I'd throw it out here to see if I'm just way off base.

[jimmcg]

You would be surpised at the commission struture and other benefits
"advisors" receive for selling these partnership interests.

[AZ-Tax]

Partially correct...

You would be surpized at the commission struture and other benefits
"advisors" receive for selling these partnership interests.

The commission does not decrease gradually when the investment amt increases like commission breakpoints with mutual funds.

[JohnH]

When my wife and I talk about finances, we discuss whether she would want to enlist an outside part to advise her if I were no longer in the picture. I've already told her that if I die first and if she feels she needs to use a financial advisor, she should show them the door the minute they mention annuities. I've also added CMO's, anything paying OID interest, and a host of other acronymns. I think Limited Partnerships are moving to the top of the "show them the door" list, maybe even ahead of annuities.

[AZ-Tax]

Every investment has it place and fixed annuities has its place

When my wife and I talk about finances, we discuss whether she would want to enlist an outside part to advise her if I were no longer in the picture. I've already told her that if I die first and if she feels she needs to use a financial advisor, she should show them the door the minute they mention annuities. I've also added CMO's, anything paying OID interest, and a host of other acronymns. I think Limited Partnerships are moving to the top of the "show them the door" list, maybe even ahead of annuities.

I am not a fan of Variable Annuities but I sold quite a few fixed annuities (no stock market risk) many yrs ago when rates were much higher and the guaranteed rate was and still is for my polcyholders, 4%. Not to shabby of a tax deferred rate in today's interest enviorment.

[DixieEA]

agree

JohnH, I agree i have been in the tax business 35 yrs. I used to see a lot of these
in the late 70s and 80s. Now they seem to be making a come back. I hate these
things and I think the stock brokers that advise these investments should have to
do the tax return also.

DixieEA

[JohnH]

That is a good thing for your clients, and they were fortunate to have you giving that advice. Not to spend too much time unpacking the annuity argument, but would you call that good financial planning or serendipity? If it was a planning-based decision, then the process that led to the decision should be valid in all economic environments - in general terms what would be the best advice concerning fixed annuities today?

[Burke]

Since we have some financial advisors on this forum, I'd like to ask why there seems to be this obsession with Limited Partnerships among some financial advisors. This puzzles me to no end. What's the strategy here? Do financial advisors recommend them in the misguided belief that this is a logical part of a "diversification" strategy?
I plan to ask one or two f these guys this question directly when tax season is over, but I thought I'd throw it out here to see if I'm just way off base.

Are they energy-related? That's what I am seeing a blizzard of. These are apparently the darlings of brokers these days. Note that with oil & gas, they are not considered passive. And I am also seeing gold, silver, bullion and agriculture & commodity ptrship K-1's. Most seem to be PowerShares. I also see a broker buying and selling them in her own account all in one year, so that everything is written off, and (I suppose) generates commission income to herself?

[JoshinNC]

Lots of reasons for LP's

Caveat - I have a securities license but not the license necessary to sell these securities, so the ones my clients do own were not sold to them by me

Scenario 1 - TP is selling a capital asset and will receive large amount ($200k+) but only $25-50k will be taxable (basis = +/- $150k). TP can diversify the sale proceeds into many investments in many asset classes including a % to an oil and gas LP (energy sector), receiving a 1st year tax deduction equal to their initial investment, thus minimizing or potentially completing zeroing out the taxable gain on the initial asset sale

Scenario 2 - TP owns a beach rental house that was purchased for $50k in the SE coast of the US and now the lot is worth $1MM. TP wants to sell the house but doesn't want to pay the tax on the sale as adjusted basis is now $0. TP enters into a 1031 exchange taking the proceeds of the sale and investing them in a TIC (tenant in common) LP owning a commercial office building, residential apartment building, resort facility or some other real estate. TP will get to defer all the tax on the gain, gets a monthly or quarterly check from the investment on net rental income, still gets the tax deductions associated with depreciation on the structure, and obtain professional management. If they die still holding the LP interest the cost basis is stepped up for the heris.

There are other scenarios also, but these are the two most common I see.

[Lion]

I too have several clients with multiple PTPs, usually energy/gas/oil. When a client has 6 or more K-1s that each have 6 or more activities that cannot be netted against each other or against other passive activities, that's a lot of data entry time. And I can't import as is or scan/flow, because I can't enter the K-1 but must enter each separate activity. I never seem to get a K-1 where all the activities are nonpassive. Not to mention the multitude of states on each. I charge a lot but just can't charge enough for these.

Clients get upset with me for my prices. "But my broker said it's just like buying stock."

And I have to take extra time when they also show up on the consolidated 1099, dealing with a sale or making sure I don't double count a transaction that was already reported on the K-1.

I told one of my former DIYers that if he were still preparing his own tax returns, he wouldn't be investing in PTPs.

[Uncle Sam]

Partnership Obsession

The primary reason for this - that commission brokers won't tell you - is they receive
extremely high commissions for selling these risky investments. They don't care one bit
what the tax headaches are.
Quite often they deceive these clients into thinking that the mere fact they receive distribution checks - "they're making money" on the investment.
Also-if you'll notice that investments into these publicly traded partnerships are quite
often iniated at or near year end when the commission brokers get Christmas bonuses
based on performance in selling.
Or they churn the account simply to make additional commissions. Most of the accounts
I saw this tax season - had all investments sold on the same date.

So that's what the obsession is - grabbing commissions.

[Burke]

Quite often they deceive these clients into thinking that the mere fact they receive distribution checks - "they're making money" on the investment.
.

Roger that. I kept trying to tell an elderly of mine that in spite of the fact that he thought he was getting a 7% return on a recently bought REIT, it might not be all earnings, but a return of his own capital. That we would find out when the 1099 came in. Well, it came in and you know how much of that 7% was earnings? 19 cents. The rest was "non-taxable dividends." The brochure keeps calling these tax-sheltered "dividends," when in fact they flat-out state it could be a return of principal, or proceeds from loans, etc.

[JohnH]

Good discussion - thanks for all the responses thus far.

Josh, you make some interesting points, and I can see how a particular situation like the two you describe MIGHT call for something a little exotic. Although I frequently caution clients against making tax-motivated decisions without carefully investigating the new home for their hard-earned cash. Fact is, especially when there are LTCG's involved, the smartest thing to do is pay the tax and move on. But that isn't the type of situation I'm talking about.

My complaint revolves around a financial advisor who is selling one to five investments of $5K or so each in limited partnerships to a client with no more than $100K - $250K invested. I just don't see how that passes the smell test under any set of circumstances. Giving him the benefit of the doubt, maybe the advisor suffers from the delusion that this is a part of a good diversification strategy. If so, he needs to get out of the business and stop throwing his clients' money away. Unless of course he is willing to just step forward and admit he did it because he needed the commissions.

Uncle Sam raised a good point I hadn't really thought about, so I went back and looked. Sure enough, most everything takes place in Nov for most of these clients. I guess the advisor calls and says "It's near year-end. Time to rebalance."

I did run across one fund that caught my attention for marketing genius-ery. It's called "Porfolio Builder". Now that's a name to catch anyone's eye. After all, who doesn't want to build that portfolio? Sure beats "Portfolio Blaster", even though that's more often the reality.

[JohnH]

Got my Answer Today:

I suggested that client ask their investment advisor about the reason for the Limited Partnership, and here is an abbreviated portion of the response:

-->>> the investment models were updated last year to include investments in the "alternative" asset class which are investments such as commodities, hedge funds, managed futures and absolute return funds. ... designed to have a low correlation of return with traditional assets such as stocks, bonds and real estate.

We are currently using a combination of commodity mutual funds, a commodity ETF, managed futures funds (such as your Limited Partnership) and a diversified alternative fund to fill this portion of your asset allocation. <<<--

Now it's all crystal clear - silly me for even bringing it up.

[BP.]

If only

Client says yesterday, "If only I didn't have this K-1, I could get my taxes done free at the senior center."