Q: What is the best way to find out about contingent liabilities other than asking borrower to fill out debt schedule?
A: The very best way is to ask the borrower. And we should be able to do that. We can also look at company financial statements and the footnotes there can be helpful. The footnotes often state whether the owners guarantee the debt. We can also go to the Schedules K-1. For a partnership the Schedule K-1 (Form 1065) lists qualified non-recourse and recourse amounts in block K. The problem with those amounts is that they are computed to satisfy what is called at risk limitations. At risk limitations means how much the IRS will allow a partner in a partnership to report as a loss against taxable income. And that is going to usually be less than the amount that partner has guaranteed to lenders because that full amount of the debt will be broken out on the Schedule K-1 divided among all of the partners. For example, if you look at Schumacher’s Schedule K-1s for both Fresno Properties and Sequoia Properties, you will see that he is the 50% owner of each and half of the company’s interest bearing debt is reported on each Schedule K-1. We make the assumption in the case of Fresno Properties, that because he is the managing member of the LLC he guarantees the full amount of the debt. For Sequoia Properties, Schumacher is a general partner, and as such he is liable for all company debt regardless of whether or not he has executed a specific guarantee.
And so we can get information about guarantees from financial statements and from Schedules K-1, but the very best source is the borrower.
Q: How do you treat long-term capital gains? Based on current year's cash flow items or the net-gain loss reported in the tax year?
A. Many lenders follow the practice of throwing capital gains out as non-recurring. However, if we are to include capital gains and losses in the personal cash flow, we can treat them in one of three ways three ways.
First, let’s assume our borrower or guarantor paid $10,000 for stock and sold it three years later for $15,000. We could consider the cash capital gain of $5,000 as personal cash revenue to our borrower and keep it in our personal cash flow.
Second, we could consider the cash sales price as personal cash revenue if the purchase leading to the gain or loss took place in prior years. That is, the borrower or guarantor sold the equities and, in selling those equities, took in $15,000 of cash. Whether he had a gain or loss in some respects is immaterial. It’s the cash that comes into to him that really counts. He has the use of that $15,000 of cash.
However, if the borrower or guarantor purchased the $10,000 of equities in the same year he or she sold them, then the capital gain and cash capital gain are identical at $5,000.
Third, we could reclassify all the purchase and sale of equities as investment activities and remove from the personal cash revenue section. That would be consistent with the treatment of investment activities in the UCA cash flow that we construct for a business, where cash flow investment activities is categorized and computed with fixed asset spending.
My personal preference is the second alternative. The borrower or guarantor either benefited from a net $15,000 cash inflow from equities he purchased more than a year ago or from $5,000 from equities he purchased within the year. Either way, the $15,000 or $5,000 net cash inflow is cash available to the borrower or guarantor and contributes to his or her personal cash flow.
The general practice, and this will vary among lenders, is to include the cash capital gain as personal revenue rather than the full amount of the sales proceeds. Another key thing to keep in mind, however, is that this is normally treated by virtually everyone as a non-recurring event. Therefore, many institutions will eliminate any consideration of capital gains or losses, and so, the capital gains and losses are removed from the personal cash flow statement.
Please follow your institution’s policy about the treatment of capital gains in the personal cash flow statement, but do consider these alternatives. A comment or footnote about the total cash proceeds might be appropriate, especially if you have reason to believe that the capital gains will be recurring.
A: The very best way is to ask the borrower. And we should be able to do that. We can also look at company financial statements and the footnotes there can be helpful. The footnotes often state whether the owners guarantee the debt. We can also go to the Schedules K-1. For a partnership the Schedule K-1 (Form 1065) lists qualified non-recourse and recourse amounts in block K. The problem with those amounts is that they are computed to satisfy what is called at risk limitations. At risk limitations means how much the IRS will allow a partner in a partnership to report as a loss against taxable income. And that is going to usually be less than the amount that partner has guaranteed to lenders because that full amount of the debt will be broken out on the Schedule K-1 divided among all of the partners. For example, if you look at Schumacher’s Schedule K-1s for both Fresno Properties and Sequoia Properties, you will see that he is the 50% owner of each and half of the company’s interest bearing debt is reported on each Schedule K-1. We make the assumption in the case of Fresno Properties, that because he is the managing member of the LLC he guarantees the full amount of the debt. For Sequoia Properties, Schumacher is a general partner, and as such he is liable for all company debt regardless of whether or not he has executed a specific guarantee.
And so we can get information about guarantees from financial statements and from Schedules K-1, but the very best source is the borrower.
Q: How do you treat long-term capital gains? Based on current year's cash flow items or the net-gain loss reported in the tax year?
A. Many lenders follow the practice of throwing capital gains out as non-recurring. However, if we are to include capital gains and losses in the personal cash flow, we can treat them in one of three ways three ways.
First, let’s assume our borrower or guarantor paid $10,000 for stock and sold it three years later for $15,000. We could consider the cash capital gain of $5,000 as personal cash revenue to our borrower and keep it in our personal cash flow.
Second, we could consider the cash sales price as personal cash revenue if the purchase leading to the gain or loss took place in prior years. That is, the borrower or guarantor sold the equities and, in selling those equities, took in $15,000 of cash. Whether he had a gain or loss in some respects is immaterial. It’s the cash that comes into to him that really counts. He has the use of that $15,000 of cash.
However, if the borrower or guarantor purchased the $10,000 of equities in the same year he or she sold them, then the capital gain and cash capital gain are identical at $5,000.
Third, we could reclassify all the purchase and sale of equities as investment activities and remove from the personal cash revenue section. That would be consistent with the treatment of investment activities in the UCA cash flow that we construct for a business, where cash flow investment activities is categorized and computed with fixed asset spending.
My personal preference is the second alternative. The borrower or guarantor either benefited from a net $15,000 cash inflow from equities he purchased more than a year ago or from $5,000 from equities he purchased within the year. Either way, the $15,000 or $5,000 net cash inflow is cash available to the borrower or guarantor and contributes to his or her personal cash flow.
The general practice, and this will vary among lenders, is to include the cash capital gain as personal revenue rather than the full amount of the sales proceeds. Another key thing to keep in mind, however, is that this is normally treated by virtually everyone as a non-recurring event. Therefore, many institutions will eliminate any consideration of capital gains or losses, and so, the capital gains and losses are removed from the personal cash flow statement.
Please follow your institution’s policy about the treatment of capital gains in the personal cash flow statement, but do consider these alternatives. A comment or footnote about the total cash proceeds might be appropriate, especially if you have reason to believe that the capital gains will be recurring.