Series 7 Direct Participation Programs and Taxation Practice Questions

Correct answer: C. Passive income generated by the investor's other limited partnership interests

The passive activity loss rules enacted by the Tax Reform Act of 1986 generally limit passive losses (such as those from a limited partnership interest in which the investor does not materially participate) to offsetting only passive income from other passive activities. They cannot be used to shelter earned income (wages, salary) or portfolio income (interest, dividends, capital gains on securities). Choice C correctly reflects this limitation. Choices A and B describe earned and portfolio income, respectively, both of which are off-limits to passive loss offset absent disposition of the activity. Choice D is an overbroad absolute statement that ignores the entire purpose of the passive loss rules.

• AA. Passive activity loss rules specifically bar using passive losses to offset active income like wages and salary.
• BB. Passive losses also cannot offset portfolio income such as interest and dividends, whether earned in brokerage or savings accounts - passive income is what absorbs passive losses.
• CC. Correct. Under the passive activity loss rules, passive losses may only be used to offset passive income, such as income from other limited partnership interests.
• DD. Passive losses are restricted to offsetting passive income only. They cannot be applied against just any income reported on the return.

• Source: IRC Section 469 (passive activity losses), accessed October 2026

Correct answer: D. Schedule K-1

Because a partnership is a pass-through entity, each partner's proportionate share of the partnership's taxable income, losses, deductions, and credits is reported annually on Schedule K-1 (Form 1065), which the partner then uses to complete his or her individual Form 1040. Form 1099-DIV reports corporate dividend distributions, not partnership allocations. Form W-2 reports employee wages and is irrelevant to a passive investor. The subscription agreement is the original purchase document, not an annual tax reporting form.

• AA. 1099-DIV reports corporate dividend distributions, not a limited partner's pass-through share of partnership income, losses, deductions, and credits.
• BB. The subscription agreement is the original investment contract signed at purchase, not an annual tax reporting document.
• CC. Form W-2 reports employee wages and has no relevance to a limited partner's investment income from a partnership.
• DD. A DPP, taxed as a partnership, issues each limited partner an annual Schedule K-1 reporting their allocated share of income, losses, deductions, and credits for tax filing purposes.

• Source: Exam outline: FINRA Series 7 Content Outline, accessed October 2026

Correct answer: C. The guaranteed minimum rate of return the program will provide to investors

A DPP suitability review centers on the customer: net worth, income, tax bracket, liquidity needs, investment objectives, and risk tolerance. DPP interests are illiquid, long-term, speculative investments, generally appropriate only for investors who can bear those risks and may benefit from flow-through tax treatment. A guaranteed minimum rate of return is not a factor in that review. DPP distributions and returns are not assured, and sponsor projections or targeted distributions are not guarantees. A rep who presented a return as guaranteed would be making a misleading representation. The review asks whether the investor can bear the program's risks, not what return the program promises.

• AA. Net worth, income, and tax bracket are all legitimate, standard suitability factors a rep must consider for a DPP recommendation. This is not the exception.
• BB. Liquidity needs are a core suitability consideration given DPPs' illiquid, thinly traded secondary markets. This is not the exception.
• CC. DPPs do not offer guaranteed returns; representing or relying on a "guaranteed minimum rate of return" would itself be a red flag, since no such guarantee legitimately exists to weigh. Making this the correct exception to the list of real suitability factors.
• DD. Investment objectives and risk tolerance are standard, required suitability factors for any recommendation, including DPPs. This is not the exception.

• Source: FINRA Rule 2310, accessed October 2026
• Source: FINRA Rule 2111, accessed October 2026

Correct answer: D. General partners only, since they bear personal liability for recourse debt

Basis attributable to partnership debt depends on who bears the economic risk of loss. General partners have unlimited personal liability for partnership obligations and therefore include their share of recourse debt in basis. Limited partners, whose liability is limited to their invested capital, generally do not include recourse debt in basis, though they may include their share of nonrecourse debt (subject to at-risk rules, with a notable exception for qualified real estate financing).

• AA. Reversed: limited partners generally do not receive recourse debt basis due to their limited liability.
• BB. Overstates the rule: recourse debt is included in basis, just for the partner (general partner) who bears the liability.
• CC. Incorrect: basis treatment differs materially based on each partner type's liability exposure.
• DD. Correct: general partners' unlimited personal liability supports including recourse debt in their basis.

• Source: 26 CFR § 1.752-2, accessed October 2026

Correct answer: C. $15,000; nonrecourse debt generally does not count toward a limited partner's at-risk amount unless it qualifies for the real-estate financing exception.

At-risk basis generally includes cash contributed plus debt for which the investor is personally liable (recourse debt). Nonrecourse debt is normally excluded from at-risk basis. The one major exception is 'qualified nonrecourse financing' secured by real property, which does not apply to an equipment-leasing program. So her at-risk amount here is limited to her $15,000 cash contribution.

• AA. Not all partnership debt increases at-risk basis; nonrecourse equipment financing for which the limited partner has no personal liability generally does not count, even if it finances equipment.
• BB. This ignores the cash contribution and improperly counts the nonrecourse equipment financing; she has no personal liability for it and it isn't qualified real estate financing, so it doesn't add to at-risk basis.
• CC. Her at-risk amount is limited to the $15,000 cash she actually has economically at stake; nonrecourse debt for which she bears no personal liability generally doesn't count toward at-risk basis unless it's real-estate financing meeting the qualified nonrecourse exception, which doesn't apply to equipment leasing.
• DD. Cash contributions do count toward a limited partner's at-risk basis, even when the partnership carries nonrecourse debt; this is typically the primary component of the at-risk amount.

• Source: IRC Section 465 (at-risk limitation), accessed October 2026

Correct answer: B. The limited partner's allocable share of partnership debt, including qualifying nonrecourse real estate debt

A limited partner's basis is increased by additional cash contributions and by the partner's allocable share of partnership liabilities, including qualifying nonrecourse debt used to finance partnership real estate. Basis is decreased by cash distributions received and by losses and deductions passed through.

• AA. Incorrect. Distributions decrease basis.
• BB. Correct.
• CC. Incorrect. Losses decrease basis.
• DD. Incorrect. Selling the interest is unrelated to the continuing basis calculation for the original partner.

• Source: IRC Section 752 (treatment of certain liabilities), accessed October 2026

Correct answer: C. Passive income generated by other DPP investments

Under the passive activity loss rules, losses from passive activities (such as a limited partnership interest in which the investor does not materially participate) can generally only be used to offset passive income from other passive activities - not earned income (wages) or portfolio income (interest, dividends, most capital gains), except under limited real estate professional or active participation exceptions.

• AA. Wages are active/earned income and generally cannot be offset by passive losses.
• BB. Interest and dividends are portfolio income, a separate category that passive losses cannot offset.
• CC. Correct. Passive losses can offset passive income from other passive activities.
• DD. Capital gains from unrelated stock are generally treated as portfolio-type income, not passive income.

• Source: IRC Section 469 (passive activity losses), accessed October 2026