Mike asks:
I have a borrower who derives a large percentage of her cash flow from capital gains. She shows a $404M capital gain from sale of ownership in an entity. On the k-1 the entity shows a negative capital account of (309M). It seems to me that the cash gain is probably only $95M since $309 of the gain was netting out her capital account to 0. Is this correct or should I give her all of the $404M gain as cash flow?
Linda says:
It can be difficult to tell the cash impact of amounts reported on the K-1. It depends, in part, on whether the k-1 is on the tax-basis or FMV basis. And when all is said and done, if it is significant, you may need to ask for the sale agreement. Here is the scoop…
Show Me the Money
I agree, Mike, that it is likely the cash impact is the difference, $95M. The negative basis in the capital account of ($309M) can occur when the partnership has run up debt. A partner’s basis in his or her interest is the sum of the capital account and the share of partnership debt.
If she sells her interest for $95M and is ‘forgiven’ debt of $309M that leads to the $404M taxable gain. For historical cash flow I would use the $95M and for recurring cash flow I would consider if this is her normal activity.
Or I would ask for the contract or agreement of sale to be sure of the cash flow.
Dig Deeper
My friend, Tony Mailhot, is a CPA who knows more about taxes than anyone else I know and I was curious how he would answer Mike's question.
I was not disappointed! What I like about Tony's answer is that he goes a bit deeper than just how it looks on paper and explains how a negative basis can come about, and what it means for cash proceeds vs gain when the partnership interest is sold. If you're also curious, click here to read Tony's response.
More on partnerships
Three of our online modules on Tax Return Analysis cover partnerships and other 1065-filing entities.
Here is the link to our demo so you can see for yourself what learning with Lender’s Online Training is like.
We have also “written the books” on Tax Return Analysis. Check out our Lender Training Manuals.
