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Purchased Receivables

Technical topics regarding tax preparation.
#1
EADave  
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Hello all!

I have a client that purchased an existing events venue. How does my client, the purchaser, who is an individual using the Accrual Method of Accounting for their new business, treat the purchase of existing contracts (receivables)?

If my client must realize income upon the purchase (Accrual Basis), should we re-think the accounting method; change it to Cash?

Thanks all, and yes, my brain is officially melted at this point. :)
 

#2
sjrcpa  
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They have a basis in those receivables = to the amount paid for them.
No income upon purchase of the AR or upon collecting the AR.
 

#3
EADave  
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I see, so, for tax purposes and on the return (Schedule C taxpayer), this is treated as a non-event, no asset to amortize, and no income to report? Makes sense, they paid for the future income, so to speak.
 

#4
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Thanks all, and yes, my brain is officially melted at this point.


Perhaps. Here’s what I’d do: Debit A/R and credit Cash. And then, when your client collects, debit Cash and credit A/R. No income to client…because client paid for those receivables.

Now, I don’t know if client paid something other than face.
 

#5
sjrcpa  
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They might be 197 amortizable intangibles.
 

#6
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They might be 197 amortizable intangibles.


Dave will have to clarify himself…if he’s talking about actual/existing Receivables or mere contracts, which would be worked and would later give rise to Receivables.
 

#7
EADave  
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My apologies, these are contracts that will be fulfilled by my client. The customers already placed their security deposits to secure their date/event with the prior business owner. My client purchased, at face value, the remaining contract that will be fulfilled by my client in 2021. Most events will take place in 2021; I am referring to weddings and company parties, etc.
 

#8
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Ok. It’s “those” type of contracts…the fixed type where we agree to conduct an event and get paid $X.

To SJR’s point, I think this will boil down to whether or not such contracts would constitute “customer based intangibles” under 197(d)(1) and Reg. Sec. 1.197-2(b)(6).
 

#9
Nilodop  
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While I can see a literal application of the rules of 197(d)(1) [and (d)(2)] and reg. 1.197-2(b)(6), somehow this set of facts does not seem to me to be what those authorities are meant to encompass. They speak of
... any composition of market, market share, or other value resulting from the future provision of goods or services pursuant to contractual or other relationships in the ordinary course of business with customers. Thus, the amount paid or incurred for customer-based intangibles includes, for example, any portion of the purchase price of an acquired trade or business attributable to the existence of a customer base, a circulation base, an undeveloped market or market growth, insurance in force, the existence of a qualification to supply goods or services to a particular customer, a mortgage servicing contract (as defined in paragraph (c)(11) of this section), an investment management contract, or other relationship with customers involving the future provision of goods or services.
. Those are all long-term and general in nature. If part of the purchase price involves a customer base, sure, it fits. And that may indeed be the facts here. But if, in addition to that general customer base, existing contracts that will almost all be completed in 2021 are specified as separate assets being acquired, it seems they are tantamount to receivables. In fact, I wonder if, as an accrual-method taxpayer, they are receivables. That's a separate question to be considered under 451 and the all-events test, etc.

And if somehow these contracts are viewed as 197 intangibles (which I doubt), then look into whether they are considered disposed of under 1.197-2(g)(1)(ii) or some other authority.
 

#10
JR1  
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Exactly. I know the tax law isn't intended to be 'fair', but to take these, which will all be ordinary income shortly and trade out the cost of them over 15 years is just absurd.
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#11
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While I can see a literal application of the rules of 197(d)(1) [and (d)(2)] and reg. 1.197-2(b)(6), somehow this set of facts does not seem to me to be what those authorities are meant to encompass.

Totally agree. It is this part of the Reg that is troublesome:

the existence of a qualification to supply goods or services to a particular customer, a mortgage servicing contract (as defined in paragraph (c)(11) of this section), an investment management contract, or other relationship with customers involving the future provision of goods or services.

Not sure what “existence of a qualification” means. But I better understand the “other relationship” part…

It does seem that the Reg starts with the “long-term,” “all customers” type of stuff, but then it seems to narrow to a “particular customer” and then gets into one-on-one type of things, like individual contracts with individual customers. And then it ends with that big splash about “other” relationships…
 

#12
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An example to me of a “qualification” would be an approved vendor status (perhaps, federal contractor), or an approved merchant supplier in a utility system (like a power plant that is allowed to sell into the market). Those contracts can be very valuable and provide a long-term benefit and pre-established revenue stream even with a single customer.

Buying a paving company with a backlog and in-progress jobs (including unbilled receivables) wouldn’t seem to fall under the 197 provisions with respect to these items (imo)
 

#13
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Did they pay the full contract amount, or just the deposit amount previously received. EX: $1,000 contract, $100 deposit. Did they pay $100 or $1,000?

If they paid $1,000, how is the mismatch between revenue and the expense to put on the event dealt with? Seller made out pretty good if they got the full price and left the expense to the buyer.
 

#14
EADave  
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I am enjoying the back and forth, but seriously, thank you for the references. I am completely confused now!

Regarding the contracts, for example, the Smiths are getting married on June 15, 2021 (ahhhhhh, how sweet!). They put a $2,500 deposit on a total value of contract of $5,000 with the prior venue owners on 01/20/2020. My clients purchased the venue in late 2020. This contract has a value of $2,500, if the clients proceed with the wedding, of course, which means my clients are obligated to fulfill the contract. My clients paid $2,500 for this particular contract, face value.

I was thinking, just thinking, if we used the Cash Basis of accounting, my clients wouldn't realize income until 2021, BUT, I don't like using the Cash Basis of accounting if there will be deposits made at year end, which means my clients pick up income for deposits on contracts not yet fulfilled, BUT, if it gets us out of having to report $100K in income (the value of the contracts they purchased) for this first year (tax year 2020), then maybe it is worth it.

Thoughts?
 

#15
Nilodop  
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My clients paid $2,500 for this particular contract, face value. . Face value of what? The seller is keeping the deposit, right? So they paid $2,500 for the right to collect the $2,500 balance AND the obligation to fulfill the contract at some cost. Why would they do that? taxcpa wonders as well.

Now as to cash vs accrual method. You say on cash your client would not "realize" income until 2021. I think you mean recognize, but anyway ... What other year than 2021 were you considering? I don't think we care about the deposit they made in 2020 to the prior owners. They report that however they report it. They are keeping it. sjrcpa in #2 and Jeff-Ohio in #4 have pretty much told you how to account for that particular contract. No income involved. Almost certainly a loss (fulfillment expenses). But it has nothing to do with the overall method they adopt.

I now understand (but please confirm) that the purchase of the "venue" is a purchase of a business with contracts, deposits, fulfillment obligations, maybe intangibles, whatever. Is that correct? And is the contract you specify just one of the many, and being used as an example? Did they buy a business or just $100k in contracts? 197 may turn ou to be relevant after all.

As to an ongoing method, please describe what you see as how cash method and accrual method would work. I think you'd want to know such things as typical time between signing a contract and fulfilling it, whether the deposits are refundable, and whether any significant fulfillment expenses are incurred before the actual fulfillment date.
 

#16
EADave  
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As usual, Len is the voice of reason, and I am clearly over-thinking this. I got a bit nervous when I spotted the mention of claiming the income if the taxpayer uses an Accrual Method. My apologies.

To clarify, they purchased the business contracts, the building, furniture and fixtures and a bit of Goodwill too.
 

#17
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So they paid $2,500 for the right to collect the $2,500 balance AND the obligation to fulfill the contract at some cost. Why would they do that? taxcpa wonders as well.

They would do that if they considered the fulfillment costs in some other aspect of the purchase agreement. Let’s say the cost to fulfill is expected to be $1k. And let’s say the purchase price for the business was $102,500…$100k goodwill and other assets plus $2,500 for this one-and-only contract (let’s pretend this was the only contract at play). What they could have done is paid (allocated) $2,500 for/to the one contract and then valued the other assets at $99k.
 

#18
Nilodop  
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Had not thought of that. How would that get reported under 1060 if this is an applicable asset acquisition?
 


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