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How to judge the asset increase on the 1065

Jacqueline’s question:

The Buildings and other Depreciable Assets figure on the borrower’s 1065 Balance Sheet increased significantly from one year to the next. What part of the return will help me determine the reason for the increase or is this the type of question I must always ask the borrower?

Linda says:

Even though the tax return does not have to include a full equipment list, here are some options to either figure out for yourself what they are buying or have a more targeted conversation with your borrower.

Look for an Equipment List

Even though a detailed equipment list is not required, some software includes it. If you have it, you can see what they acquired this year. And, if you have it for several years, you can compare and see if they are buying equipment (or replacing it) at a typical pace for their business.

Details on the Form 4562

The location of the items on the Form 4562 often give you a hint as to what they have purchased.

Part I (Election to Expense Certain Property Under Section 179)
Anything here is new this year. They are required to describe the property and indicate the cost.

Part III: Line 19
Items listed here are new this year. The line they are on gives you a hint as to what they purchased:

 

  • Lines 19a, 19b, 19c are for furniture, equipment and vehicles
  • Line 19d is non-permanent ag buildings
  • Lines 19e and higher are permanent buildings

 

This is typical in lender tax return analysis. The tax return does not give the detail we would prefer because the IRS does not need that detail. So, the business lender won’t know if the company bought one piece of equipment that cost $10,000 or 5 pieces of equipment that totaled $10,000. But you will know what categories they are buying in.

Part V: Listed Property
This is where you will find new personal-type cars, and any property used for entertainment, recreation or amusement along with what they have from prior years.

Ask the borrower

If it is a significant increase and you are doing a commercial loan, you probably want to know what is up.

 

  • Are they replacing equipment and the new equipment is much more costly than what they are replacing?
  • Are they expanding and will keep expanding?
  • Were they expanding but they are done?

 

With that information you’ll have a better idea of their risk profile (fast-expanding companies are often more risky than stable ones) and whether you need to be careful not to max them out on their current loan request if they have more borrowing needs on the near horizon.

More you can learn from Form 4562

Tax Return Analysis – Essentials and 1040 Review Manual
Pages 2-42 through 2-45 cover everything you can learn from the Form 4562, but were missing because you figure you just add back depreciation so why bother to look at the form. Click here to get more info or to buy it.

30-minute-or-less Self-study Online Module
Depreciation in Financial Statements and Tax Returns covers:

  • Definition and methods
  • Treatment in financial statements and tax returns
  • Impact on Gain or Loss on Disposal of Assets
  • Run-through of Depreciation Form 4562 to learn more about the business

Click here to get more info or to buy it.

About the Author
Linda Keith CPA is an expert in credit risk readiness and credit analysis. She trains banks and credit unions throughout the United States, both in-house and in open-enrollment sessions, on Tax Return and Financial Statement Analysis. She is in the trenches with lenders, analysts and underwriters helping them say "yes" to good loans. Creator of the Tax Return Analysis Virtual Classroom at www.LendersOnlineTraining.com, she speaks at banking associations on risk management, lending and director finance topics.