Income or Loss Reported on IRS Form 1040, Schedule F
This guideline focuses on how income or loss from farming activities, as reported on IRS Form 1040, Schedule F, is considered in the mortgage process for someone who is self-employed.
Understanding Income from Farming
When someone earns money from farming, they report this income on a specific tax form known as IRS Form 1040, Schedule F. This form calculates the total income (or loss) from farming and then this total is included in their overall tax return on IRS Form 1040. It’s important to realize that not all the income listed on Schedule F might come directly from farming activities. Sometimes, the form might include other types of income that aren’t related to the actual farming operations.
Adjustments to Reported Farm Income
There are times when the lender, the financial institution giving the loan, may need to adjust the net income (the final income after expenses) reported on IRS Form 1040. This is because certain types of income, like federal agricultural program payments, co-op distributions, and proceeds from insurance or loans, might not be fully taxable. These sorts of income may not always be stable or might only happen once, which means they might not be reliable indicators of ongoing financial health.
If the lender checks and finds that the net income from farming that was reported is stable, consistent, and likely to continue, they will adjust the borrower’s cash flow. Cash flow is essentially the amount of money coming in and going out. In this case, they adjust it by adding back the nontaxable part of any income that will keep coming in. If the income from these sources isn’t likely to continue, it should be taken out of the calculation.
Additionally, the lender can also adjust the borrower’s cash flow upwards by adding back any amounts the borrower deducted on Schedule F for things like depreciation (the decrease in value of assets like equipment or buildings), amortization (spreading the cost of an asset over its useful life), casualty loss (losses from sudden events like natural disasters), depletion (reduction in the quantity of a resource), or the business use of their home.
Realistic Example
Imagine a borrower who is a farmer and reports a net income of $50,000 on their Schedule F, which includes $5,000 from a one-time crop insurance payout. If the lender determines that the rest of the income is consistent and likely to continue, they might add back the $5,000 to the borrower’s cash flow because it’s not taxable and not expected to recur. Additionally, if the borrower also claimed a $10,000 depreciation expense for a new tractor, the lender could add this amount back into their cash flow, increasing the amount of income considered for the mortgage application.
References
For more details, visit Income or Loss Reported on IRS Form 1040, Schedule F of the Fannie Mae Selling Guide.