Q: May I know further about recourse debts and qualified recourse debts in a Partnership Schedule K1? Why aren't they counted in GCF analysis?

A: The Schedule K-1 presentation of a partner’s recourse and qualified recourse debt states that partner’s pro rata share of the partnership’s total debt. This information is used solely to determine the maximum amount the partner can claim as a partnership-related loss.

Said another way, the debt values stated on a Schedule K-1 issued by a partnership or LLC are used to determine the maximum tax loss a partner or member could claim in the event of the business entity’s default and bankruptcy. Since Schumacher is a 50% owner of both Fresno Properties and Sequoia Properties, his maximum tax write-off is half the recourse debt of the company plus his capital account investment in the company. The total of these two metrics is defined by the IRS as his "basis" in the business.

As we noted, Mr. Schumacher has guaranteed – or it is appropriate to assume he has guaranteed – the full amount of interest-bearing debt outstanding for both companies at the request of the lenders. Recall also that as a general partner, he is fully responsible for all of Sequoia Properties' debt and is also likely responsible for all of Fresno Properties interest-bearing debt as the LLC’s member-manger.

The amount of debt reported on the Schedule K-1 is not used in calculating global cash flow coverage because it does not represent any element of the company’s debt service. We identify debt service from the company’s accrual financial statements, which, for any one year, is the sum of interest expense plus scheduled long-term debt repayment. Recall that our objective is to determine if global cash flow is sufficient to meet debt service on all interest-bearing debt.

Schumacher's maximum tax deductible loss using information on Schedules K-1 is an issue totally separate from defining required debt service. The amount of interest-bearing debt reported on the Schedule K-1 is only a part of the company’s full amount of interest-bearing debt (one-half in the case of Mr. Schumacher) and does not represent interest-bearing debt service that we use in computing global cash flow coverage.