S-Corps. And Partnerships
Many people think that lenders use their taxable income to qualify them for a home loan. If you own 25% or more of an S-Corp. or partnership, it is not that easy.
Most lenders use the lesser of your taxable income or Distributions reported on the K-1 to qualify you for a home loan. I find that many business tax returns do not report Distributions and some do not include a Balance Sheet. This issue could be a deal killer for you.
Distributions
Distributions represent your cash flow. It reports the money your S-Corp. or Partnership paid you personally. Most lenders care about the money you actually paid yourself, not the profit reported for the business.
If you are preparing to buy or refinance a residential property (1 to 4 units), then I suggest you give your accountant the information necessary to prepare an accurate Balance Sheet and report Distributions, even if the IRS doesn’t require it. The nuances of this lender guideline are complex, so if you have any questions or doubts about it, please call me. But the simple answer is to report Distributions accurately.
Short Term Debt
This is reported on Schedule L (line 16d on form 1065; line 17d on form 1120S). Standard lending calculations deduct the amount found on this line from income available to qualify. The reason for this guideline is that they assume you had to take that money out of cash flow to pay the debt in full.
I find that many accountants characterize business lines of credit as Short-term Debt. However, lines of credit typically roll over from year to year, and do not have to be paid and closed that year. It is more beneficial for lending purposes to report lines of credit as Long-term Debt.
Depreciation and Amortization
Most lenders add back Depreciation and Amortization because those are non-cash expenses. You write them off for tax purposes, but they do not represent funds out of your cash flow. Surprisingly, I have run into lenders who do not add those back. I suspect they don’t understand them.
If your Depreciation and Amortization are significant, I recommend that you ask the lender upfront whether they add them back. Amortization can be large in some businesses (e.g. film production and franchise food establishments).
If you have questions or want help assessing your situation, you can contact me at 877-728-2008; CustomerCare@HollyGustlin.com