Capital Gains and Losses: Recurring or Non-recurring?
The other day, an analyst called in to the Bukers Hotline asking about some items that were reported on their individual borrower’s Schedule D. They wanted to know whether their borrower’s capital gain was recurring or non-recurring, and what the associated cash flow adjustments should be. On this week’s cash flow article, let’s review the facts and circumstances, and help the analyst with their cash flow analysis.
Facts and Circumstances
The best way to determine whether capital gains and losses are recurring or non-recurring in nature is to get a detailed understanding of the facts and circumstances surrounding the transaction. The more information that you, as the analyst, can garner, the more successful you will be in this situation.
Our analyst told us that their individual borrower was operating a sole proprietorship whose primary activity was purchasing and developing real estate. The capital gain in question was related to the sale of a truck during the year. The borrower held the truck for several years and sold it for a gain of about $5,000.
Immediately, we already are given a wealth of valuable information that can help us make our decision. Often, capital gains or losses are more likely to recur in future years if they are directly related to a main source of cash flow to the borrower. In this case, our borrower’s main source of cash flow is their sole proprietorship related to flipping houses, but this is unrelated to the sale of a long-held personal asset, like their truck. With this information, we are already headed down the track of a non-recurring capital gain.
Historical Analysis
At this point in the call on the Bukers Hotline, our CPA asked the analyst if the borrower had any capital gains or losses recognized on the past couple of years’ worth of tax returns. The analyst responded that there were no other capital gains or losses recognized in the two preceding tax return years. This additional context lets us know that our borrower does not have a history of reporting cash inflows related to capital gains. Since they don’t have any historical capital gains, we feel even better about our assertion that this year’s capital gain is likely non-recurring in nature.
Conclusion and more!
Our ultimate recommendation to the analyst is that their borrower’s capital gain for the current tax year, related to the sale of their truck for a $5,000 gain, is likely to be non-recurring in nature. To arrive at this recommendation, we combined the current year’s facts and circumstances with the borrower’s historical performance, both of which contributed to the same conclusion. As a result of this, the appropriate cash flow treatment would be to not include this gain or return of capital in cash flow available to service debt.
This situation called in to our Bukers Hotline was a great example of how the recurring nature of capital gains and losses can affect cash flow analysis. Would you like more information about this topic, and beyond? Check out our Bukers Academy Online training course. We walk enrollees step-by-step through the entire analysis related to Schedule D, and everything else under the umbrella of individual tax return analysis. We use hundreds of examples to cement ideas and cover even the most complex topics.