Introduction
This section explains how income or loss from a business is reported for someone who owns a part of a partnership, S corporation, or LLC. When you own part of such a business, your share of the income or loss it makes is shown on a tax form called Schedule K-1. There are different Schedule K-1 forms depending on the type of business.
Income or Loss Reported on IRS Form 1065 or IRS Form 1120S, Schedule K-1
When it comes to reporting your share of income or loss from a business, the type of form you’ll use depends on how the business is set up for tax purposes. If you’re part of a partnership or an LLC that reports like a partnership, you’ll use IRS Form 1065, Schedule K-1. If you’re part of an S corporation, or an LLC that reports like an S corporation, you’ll use IRS Form 1120S, Schedule K-1.
When you’re applying for a mortgage, the lender will look at the income you get from your business to decide if you can afford the loan. They are careful to make sure that the business can afford to give you this income without putting its operations at risk. Here’s what they consider:
– If you’ve been getting regular payments from the business that are guaranteed, and you’ve been getting them for at least two years, these can be counted as part of your income.
– If the business has been consistently giving you cash that matches the income level you want to use to qualify for the mortgage, and this is shown on your Schedule K-1, then the lender doesn’t need more proof that you can access this income. If your Schedule K-1 doesn’t show this consistent income, the lender will need to check the business’s finances to ensure it has enough liquid assets.
– If you need to provide business tax returns, how the business is structured will affect how these are reviewed. This is detailed in a specific part of the guidelines, referred to as B3-3.2-01.
To check if the business has enough liquid assets, lenders can use different calculations depending on how the business operates. If the business has a lot of inventory, they might use the Quick Ratio, which compares the business’s liquid assets (excluding inventory) to its short-term obligations. The formula is: (current assets – inventory) ÷ current liabilities. For businesses that don’t rely on inventory, the Current Ratio might be used instead, which includes inventory in the calculation: current assets ÷ current liabilities. A result of one or more generally means the business is in a good position, but lenders can use other methods to determine this as well.
Documentation Requirements
When you’re applying for a mortgage, you need to provide certain documents, including:
– Your personal tax returns for the most recent one or two years, which must include IRS Schedule K-1. The exact requirements are found in the guidelines section B3-3.2-01.
– The business’s tax returns for the most recent two years (using IRS Form 1065 or IRS Form 1120S), unless you meet certain criteria that allow you to not provide these.
– Or, the business’s tax returns for the most recent year, following the guidelines in B3-3.2-01.
Recent Related Announcements
Updates or changes related to this topic are listed in a table format, including the issue date and the title of the announcement. For example, an announcement titled “Announcement SEL-2024-01” was issued on February 07, 2024.
References
For more details, visit Income or Loss Reported on IRS Form 1065 or IRS Form 1120S, Schedule K-1 of the Fannie Mae Selling Guide.