Sec 751 accounts receivable

[BHoffman]

I'm going to be dealing with the sale of a partnership soon.  The only "hot asset" is accounts receivable.  How do I determine the amount that is likely to be collectible?  Historically, they have about 20% that has been uncollectible, but has not been recorded as an allowance for doubtful accounts on the books.  They have been reporting taxes on the cash basis. 

What if, after the fact, the actual amount of collected AR is more or is less?

 

[Edsel]

My suggestion is to report the gain/loss on Sch D, or whatever 8949 category fits.  Accts Receivable is an asset just like any other.  The carrying value before gain/loss should be reported as the cost basis, and the amount actually collected should be the proceeds.

Both numbers should be known factors when consummated, so there should be no problem.

[jklcpa]

Under sec 751 the A/R is an unrealized receivable (hot asset) and will be taxed as ordinary income.  This is one return that is a good candidate for an extension. Based on historical data, is it likely that the a/r will mostly all be collected within that "extended" time frame? 

Don't know if you looked at older articles, but this one touches on the a/r as part of sec 751.

https://www.thetaxadviser.com/issues/2010/aug/clinic-story-08.html

[BHoffman]

The sale is supposed to take place this year 2017, but I don't think that's going to happen.  The company provides medical care and exclusively bills Medicare.  The correct estimate of collectible AR is hard to determine, and they still have open AR from a year ago.  I can give an educated guess that around 20% of open AR will not be collectible.   I think that is going to equate to around $600k in bad debt.  A material amount either way   

Should the company start booking an allowance for bad debt?  The broker isn't going to like that.  I'm going to press on the client how important it is to have the collectible amount on the books, and not just what has been billed.  

Judy, I did read that article and it is printed and kept in a special folder that I will refer to for this transaction. 

[Edsel]

19 hours ago, jklcpa said:

Under sec 751 the A/R is an unrealized receivable (hot asset) and will be taxed as ordinary income. 

Looks like I was wrong about these receivables.  I still think my calculation of gain/loss is appropriate.

Judy, my question at this point is how to report.  Should it simply be allocated (along with other ordinary income) to the partner in box 1 "Ordinary Income?"

[Edsel]

A few days have passed since I last visited this thread - I'm still as igginernt now as then.  I'll ask the questions to the group, and maybe better illustrate with a hypothetical example.

Receivables furnished by partner were $10,000 and are still outstanding at the close of business.  Eventual recovery turned out to be $10,400.  Partner's share of otherwise ordinary income is $25,000.  How is the recovery of the hot receivables reported?  Here are some possibilites, and no, I don't know the answer:

1. Ordinary Income K-1 Box 1 becomes $25,400. (If this happens there will be SE tax)
2. Net short-term capital gain K-1 Box 8 is $400.
3. Partnership issues 1099-B to partner for $10,400, Partner files on 8949 (short-term)
4. None of the above.

I've never been good at "special" allocations.  Not my strong suit.

[jklcpa]

On 9/18/2017 at 11:45 PM, Edsel said:

Looks like I was wrong about these receivables.  I still think my calculation of gain/loss is appropriate.

Judy, my question at this point is how to report.  Should it simply be allocated (along with other ordinary income) to the partner in box 1 "Ordinary Income?"

 

1 hour ago, Edsel said:

A few days have passed since I last visited this thread - I'm still as igginernt now as then.  I'll ask the questions to the group, and maybe better illustrate with a hypothetical example.

Receivables furnished by partner were $10,000 and are still outstanding at the close of business.  Eventual recovery turned out to be $10,400.  Partner's share of otherwise ordinary income is $25,000.  How is the recovery of the hot receivables reported?  Here are some possibilites, and no, I don't know the answer:

1. Ordinary Income K-1 Box 1 becomes $25,400. (If this happens there will be SE tax)
2. Net short-term capital gain K-1 Box 8 is $400.
3. Partnership issues 1099-B to partner for $10,400, Partner files on 8949 (short-term)
4. None of the above.

I've never been good at "special" allocations.  Not my strong suit.

Well, I didn't answer for a couple of reasons, the lease of which is so not to derail the topic into hypotheticals, and also because the calculations can be rather complicated with alocations depending on what else is in the mix for BHoffman's client, so I didn't want to post a misleading answer to you that may not accurate for the actual case.

That being said, in a general sense, yes, the partnership would report the receivables as ordinary income.  It is NOT capital gain income.  Sec 751 specifically defines hot assets, and that code section specifically functions to make sure that the partnership or partners do NOT convert the income from what would be ordinary income property into capital gain property.  Therefore, the inventory or collection of a/r will generate ordinary income.

It really is very complicated, but if you'd like to read about this more and the mechanics of calculations, here's the text of a CPE course that I found that might give you an idea of the complexity. Look at section 3 and some of the examples.

http://media.straffordpub.com/products/irc-751-hot-assets-calculating-and-reporting-ordinary-income-in-disposition-of-partnership-or-llc-interests-2015-07-09/reference-materials.pdf

[Edsel]

Thank you.  The link is very informative.  If you can remember all this stuff, you are indeed gifted.

[jklcpa]

6 minutes ago, Edsel said:

Thank you.  The link is very informative.  If you can remember all this stuff, you are indeed gifted.

Heck no!  The older I get, the more I look up.  There are areas I have absolutely no experience in and learn new things here all the time by reading how others approach issues.

[Catherine]

Don't let her fool you!  Our Judy is *amazing* and her knowledge is extensive.