Donald Asks
I recently reviewed a personal tax return where the individual reported a large capital gain from an asset sale. The individual historically reports capital gains, but not as large and not under Form 4797. Since it’s non-recurring it wasn’t included in cash flow.
If however, it were recurring how should it be treated? The event is reported on Form 4797, but it references the K1 of a non-related entity e.g. not a guarantor, where the cash flow is identified under Section 1231, which I’ve been informed that it should not be treated as cash flow, however, I’ve received conflicting opinions on how it should be treated. I wanted your thoughts on the matter. Please assist. Thank you for your time and help.
Linda Says
Your question is a good one and has several wrinkles in it.
Pass-thru income is not direct cashflow
You mention this is a personal cashflow analysis. Since it is a K-1 pass-thru it is noncash to the borrower, whether you find it on a 4797 (gain or loss on business property), Schedule B (pass-thru interest or dividend income) or Schedule E, page two (partnership or S corp). I would not include that in income even if it appears to be recurring because the borrower is not receiving it.
If it was not pass-thru
If it was not pass-thru, since it is a 4797, it is uncommon for gain/loss on disposal of business property to be recurring. That said, sometimes it is useful to make note in your write-up as to the proceeds. It can explain how they came up with the funds to spend on a non-recurring expense, expansion, paying down debt and the like.
Treatment of pass-thru entity not obligated varies
You mention the pass-thru entity is not obligated on the loan. First, be sure you are clear on your guidelines here. Some lenders disregard cash flow from a non-obligated entity in global cashflow. For others it depends on the borrowers % ownership.
If I own 80% of a company and it cannot afford the salary you are counting on in my personal cashflow because the company is running a deficit, you might want to notice.
K-1s complicate cashflow analysis
If you need a stronger understanding of k-1s, they are an integral part of the modules on both 1065 filing entities (partnerships and LLCs) and S Corporations. Check out our training at www.LendersOnlineTraining.com for more information.
