Schedule K-1 Sections M and N: What Lenders Should Know
We’ve recently received a great question via the Bukers Taxanalysis hotline that deserves some explanation. The caller asked us to explain what is being presented in Sections M and N on the Schedule K-1 of Form 1065, and specifically if they affect the cash flow of the borrower.
Section M
Section M states whether or not the partner contributed property with a built-in gain. To put it briefly, a built-in gain occurs when the value of contributed property exceeds its basis and this must be tracked for tax purposes. If you see Section M marked “Yes”, then you know that the partner contributed property to the partnership during the tax year. A property contribution is typically a non-cash event and should, generally, be excluded from a cash flow analysis.
Section N
Section N, which was added for the 2019 Schedule K-1, reflects the amount of built-in gain that is allocable to the partner. The amounts in Section N do not represent cash inflows or outflows to the partner, but they could have cash flow implications for future years.
An amount of built-in gain listed in Section N could signal that there may be a future non-cash distribution to the partner. Since we know that property was contributed by the partner, we need to be aware that such property may be distributed back out in a future year.
We recommend that lenders stay alert for future distributions and pay attention to what exactly is being distributed to the borrower. As always, the letters shown to the left of amounts in Box 19 on the Schedule K-1 are the guide to determining what exactly is being distributed to the partner.
KEY TAKEAWAY FOR LENDERS
Sections M and N of Schedule K-1 can provide important insight on a partner’s contributions and distributions to and from a partnership. If Section M is marked “Yes” or if Section N reports values of gain or loss, that indicates that the partner previously contributed physical property to the partnership. This indication increases the likelihood of the partner receiving distributions of property instead of cash; which is a very important distinction for a lender’s cash flow analysis.
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