April 15th is behind us… returns are filed (or at the very least, extensions are filed)… and now we turn our attention to qualifying for a home loan when self-employed.
Buyers who are W2 salaried have it easy as calculating and documenting their income is simple. Not so with self-employed buyers. This month, we’ll take a deeper look into the realm of those who are self-employed and wanting to buy a home.
This week – those using a Schedule C form.
Whether someone is running a small business, formed an LLC, promoting MLM products, or simply a 1099 employee (and yes, 1099 employees are considered self-employed), the easiest way to file taxes is using a Schedule C and doing business and personal returns on the same tax return.
The biggest misnomer out there when I speak with someone who is self-employed is the amount of money they earn. When looking at a Schedule C, many people give me the number on Line 1 of the form. This is their gross receipts or sales… gross income. I’m looking for net profit/income. This is Line 32 of the form. When speaking to a loan officer, the number at the bottom of the form will be used for qualifying purposes. This is the number with all deductions removed.
Some of the deductions can be added back to a buyer’s income. For instance, depletion and depreciation can be added back. On the 2023 Schedule C form, these are lines 12 and 13.
In short, take Line 32 of the Schedule C, add back the numbers in Lines 12 and 13 (if any), and divide this by 12 months. Now we have monthly qualifying income.
The next step is determining how many years of tax returns are needed. In previous years, Fannie Mae allowed for one year of tax returns, but this is no longer the case. Both Fannie Mae and Freddie Mac operate under the same guidelines:
- if a business is less than 5 years old at the time of application, two years of tax returns are used for qualifying. If the income declines from one year to the next, it could be problematic.
- if a business is more than 5 years old, only one year of tax returns is needed.
- meaning new businesses will need to be two years old before the owner qualifies to purchase a home using a conventional or government loan.
And there we have it… we now know how self-employed income is calculated for those filing using a Schedule C on their personal returns. We also know how many years of returns are required. In the coming weeks, we’ll look at self-employed buyers who file separate business returns followed by a Q&A type post with an assortment of things to be aware of when purchasing a home as a self-employed buyer.
Run your own business? Want to know how much income you have for qualifying purposes? If so, contact me today. We’ll go through your tax returns, calculate your qualifying income, and see your purchase price. I’ll have you ready to make offers in no time!