Loan Officer Training - 11/19/2024 - Analyzing Self-Employed Borrowers: Partnerships - Loan Officer Training with The Mortgage Calculator

Episode Transcript
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Restream recording Nov 19, 2 (00:00):
So what exactly is a partnership?

(00:03):
Well, a partnership is abusiness arrangement between two
companies.
Or more, uh, it is operatedaccording to a partnership
agreement.
Now that partnership agreementcould be an LLC, or it could be
a number of documents, could bea limited partnership.

(00:24):
There's different, uh, entitiesthat can be used to create a
partnership.
Uh, very important to note thatgeneral partners have unlimited
liability for the debts of thebusiness.
This is very important when youare figuring your debt to income

(00:45):
on your self employed borrowersbecause the business debt will
pass through to the borrowers.
As it states here in the nextbullet point, uh, a partnership
is a pass through entity.
where taxes are paid by thepartners personally through

(01:06):
their 1040 tax return.
And of course, the, anyliabilities are also passed
through to the partners.
Now, very important now here toconsider then, since we've
already stated that if there isa partnership and if they are
self employed, that they'regoing to be responsible for the

(01:28):
liabilities and taxes.
And, uh, the threshold is 25percent or greater ownership in
the business.
If they have a stake of 25percent or greater ownership in
the business, then they would beconsidered self employed and
then any of the income as wellas the expenses would pass

(01:50):
through to the borroweraccording to their proportionate
share in the business.
Now, uh, regarding selfemployment, obviously sometimes
we don't want it if it's toomany expenses, but then
sometimes we do want it if weneed the income.
So what do we do if the borroweris in business for less than two

(02:13):
years?
There are some exceptions.
Now again, this is a generalizedexception here.
Um, you would really have to digdeep into the guidelines of the
option that you're actuallyusing.
So if you're using a, um, youknow, if you're going full doc

(02:35):
or what it is exactly thatyou're doing here for your
borrow, but please note, youknow, cause if you're going non
QM, you've got to look at theguidelines.
If you're going agents for theguidelines for the specific
program, and if you're goingagency, in other words,
conventional VA FHA USDA, youhave to look at the selling
guide.
to see what it states in thereand then be aware of any

(02:58):
overlays that the investor mayhave.
But however, generally speaking,uh, the exception for the two
year rule for self employment isthat the borrower is receiving
the same or greater income in asimilar field or position or the
borrower is in a similaroccupation in which they had
similar responsibilities.

(03:20):
So, you know, it's all aboutwere they doing the same thing
before.
Um, A couple of examples herethat I always like to add is,
for example, a nurse.
The nurse could have been a W 2employee previously.
Nurses have licensure, right?
And now, all of a sudden, thenurse switched to 1099, right?

(03:43):
Self employed, 1099.
You know, they're a nurse.
They have their license.
So, typically, it's going to beas long as you have 12 months in
the new position.
In the new income stream, Iguess we should state that would
be good to still consider themself employed and be able to use
the income.

(04:03):
Another example would be anelectrician.
Electricians are also needing tobe licensed.
So they could have been workingas a W 2 employee and now Get a
1099 similar scenario.
It's real easy in those becauseyou got the license to prove
what they were doing is the sameIt's not always so cut and dry

(04:24):
when they don't have a license,but that's where you may need
additional letters ofexplanation including maybe from
an accountant so Uh, veryimportant here and I want to, I
want you to follow the incomestream here, right?
Uh, the, the paper trail, so tospeak.
Uh, the partnership reportsincome on IRS form 1065.

(04:52):
Now, uh, that's a partnership,uh, uh, report.
The 1065 report, that's wherethe partnership reports all
their income.
Be aware that if it's a realestate related partnership, be
on the lookout for, uh, form8825 form.

(05:14):
8825 is actually the form that'sused to report the, uh, profit
and loss.
from that particular realestate.
That's where you're going tohave also the depreciation that
you can add back and all theother components that you could
possibly add back to the income,which we're going to cover that
in the next slide.

(05:34):
But be aware IRS form 1065 andspecifically inside form 1065,
look for schedule 8825, whichwould list itemized.
the income and expense for thereal estate.
Now the partnership reports thepartnership income on form 1065

(05:55):
and then sends a schedule K1 toeach partner to report their
proportionate share of theincome.
So you got 1065, then we issue aK1 to our borrower for their 50
percent let's say of the incomethat borrower now gets that

(06:17):
schedule k1 and reports theamount that he received in that
schedule k1 in irs form 1040 thepersonal tax return schedule e
Page two.
Now, most of you know theSchedule E because that's where

(06:37):
we report the rental income forthe property, right?
But that's also in page twowhere you report income from a
partnership, from an S corp,from a C corp, you know, passive
incomes or active incomes formany of those entities are
reported on Schedule E, pagetwo.

(06:59):
So if you see a Schedule E, pagetwo, and it has a corporation.
Uh, tax ID number and the nameof a corporation or the name of
a partnership and it has a taxID number and it has an amount
in there, then you know thatyou're probably missing either
the 10 65 if, if it's from apartnership.

(07:21):
Or the 1120s if it's from an Scorp or the 1120 if it's from a
C corp.
So be on the lookout for a 1040Schedule E, page 2.
Now, the amount that's reportedon Schedule E, page 2 of the
1040 is then reported onSchedule 1 of the 1040.

(07:42):
So, Also, if you see you have aschedule one from a 1040 that
has an amount, but there's noschedule E and specifically no
schedule E page one and two,then you know you're missing
pages, right?
The same way, if you got aschedule E with a page two and
you don't have a schedule one,then you know you're missing
pages.
You're missing pages becausesometimes borrowers send us the

(08:06):
1040 tax returns page by page,and they may think they don't
need this page, they don't needthat page, or they may not, you
know, realize that they omitteda page because there's so many
pages, but you know, so that'swhere you would have to reach
back out.
So again, it goes from theSchedule E page 2 to the
Schedule 1, and then the amounton the Schedule 1 is then

(08:28):
reported finally on theborrower's 1040 page 1.
Line eight, right?
So again, taking this inreverse.
If you get a 1040 and it has anincome on page one, line eight,
but the borrower did not providethe schedule one and the

(08:50):
borrower did not provide theschedule E, Pages one and two,
then, you know, you're missingthose pages.
So please make sure you reachout to the borrower and ask them
to send you the missing pages.
So now, you know, it starts inIRS form 1065 and eventually
works its way, the income allthe way to page one line eight,

(09:11):
which is the borrower's finalproportionate share of the
income.
So I mentioned adding back andI'm going to get into it a
little bit more here.
Right?
Uh,'cause these are realimportant key concepts.
This is where when you'recompleting the, uh, income
worksheet for the self-employedborrowers, this is where

(09:33):
sometimes mistakes occur.
So let's talk about, uh,non-cash expenses.
For example, we're looking atdepreciation, depletion, and
amortization, right?
Now, those were, uh,depreciation is pretty obvious.
It's either depreciation of thereal estate or depreciation of

(09:56):
a, of a personal property assetfor the business.
Depletion is exhaustion of anatural resource that the
business uses for its businessoperations.
And amortization is one timebusiness startup expenses.
Now, this one is the tricky one.
It has to specifically stateamortization.

(10:19):
Now, if it does not state thespecific word amortization, but
the accountant puts businessstartup expense, you may be able
to get away with that onebecause they essentially mean
the same thing, right?
They're identifying it as abusiness startup expense because
then they're probably going towrite that off for the next
couple of years or write off acertain amount.

(10:41):
Now, um, one of the, uh, I, youknow, an item that I wanted to
add here, not on a bullet point,but very important when you're
completing some of theseexpenses that you may see on the
form is, for example, if you seeproperty taxes or if you see,
uh, interest and they're, andthey report that, uh, loan on

(11:07):
their personal credit.
And that loan is going to showup on their personal credit and
is going to be part and there'san REO and the schedule of real
estate home for that for theend.
And again, the library reportson their credit, then you would
be, uh, adding back theinterest.
You would be adding back thetaxes and you would be adding

(11:30):
back the insurance.
As long as the borrower isescrowing for taxes and
insurance.
So you would ask them for themortgage statement.
And if you confirm on themortgage statement that they are
asking for taxes and insurance,and this is a liability on his
personal credit, then you wouldadd those items back to the
income.
However, if the liability is notreporting on their credit and

(11:53):
you're just analyzing the taxreturn, uh, for income, then
you're not going to add back theinterest.
You're not going to add back thetaxes and you're not going to
add back the insurance.
You are going to add back thedepreciation.
Uh, in this scenario, but youwill not add back the other
three items.
So I just wanted to make a notethere, uh, that when adding back

(12:16):
taxes, insurance, and interest,it's only when that debt is
reporting on their personalcredit.
And when you've confirmed forthe taxes and the insurance that
they're actually escrowing forthat amount in the payment.
So next category we have isexpenses limited by the IRS.
And this, uh, Section, uh, theexpenses would be reduced from

(12:42):
the income.
The logic here is that since theexpense is limited by the IRS,
the amount that they did notwrite off is counted against
them.
So the most popular category forthis is, um, meals, right?
The IRS lets you deduct 50percent of the meals from the

(13:06):
income.
So that's the case.
If you get 50%.
Is reduced.
Uh, you know, if 50% isdeducted, excuse me, as a
business expense, the other 50%that is not deducted is reduced
from the income because you'reonly deducting half of it.
The logic is there's another,there's another half that's
floating around there, and thathalf needs to be deducted from

(13:31):
the income.
'cause the IRS only let youwrite off.
Half of it.
So that's the most popular andapplicable category for expenses
limited by the IRS.
And now the third category,which can be a little bit
confusing, but this is one thatI've used to my advantage to
save a deal is recurring versusnon recurring income and or

(13:54):
loss.
So first, what do we, what do wemean by recurring?
Recurring means that it isexpected to continue for at
least the next three years.
So if you do get a non, uh,something, uh, reported in the
non recurring income, uh,category, maybe it's recurring

(14:16):
reach out and find out what itwas.
Maybe it's something that youcan get added as an income, but
where we normally get, um,situations that arise here is
when we have loss, right?
We have a loss that's reporteddeducted from the income.
It's a non recurring loss.

(14:37):
If we can get explanation forwhat it is, we may be able to
get it omitted as a loss becausea non recurring loss is a one
time event that cannot beconsidered towards income nor
expenses, but you got to getdocumentation so that you can
get the underwriter to omit itfrom the expenses as a loss.

(14:59):
So, what would be some examplesof one time events that we could
get excluded?
Uh, from being counted as anexpense.
Well, the first one would be thesale of an asset where the
business is not in the sale ofassets.
Business like you sold a truckbecause you're buying a new

(15:22):
truck, but you're not in thetruck sale business.
You're not a truck dealership.
So you would not consider thattruck sale as income.
Second, second example would bea casualty loss.
Casualty loss is like a fire ortheft.

(15:43):
Uh, maybe it was not covered bythe insurance and you had to
bear the full brunt of the loss,or maybe insurance covered only
after a deductible of 5, 000 or10, 000, for which then you had
a 5, expense.
Uh, those one time events, canbe omitted from the expenses and
can be added, added back and apaper loss carried forward is

(16:08):
another popular example of a onetime event.
Uh, you could have had a lossthree, four years ago, a really
big loss, and then IRS rules letyou write those off over a
certain amount of time, acertain number of years.
So that could be one where youget an explanation from the
accountant as to what it was.

(16:30):
And then, uh, hopefully get thatexpense added back to the
income.
I've been pretty successful withthose.
And, um, like I was sayingthere, the expense would need to
be documented as a one timeexpense via letter from the
accountant, if a paper loss orsupporting documentation, if it

(16:52):
is a casualty loss.
Now these are, this recurringversus non recurring income or
loss is one where you're, where,So, this is probably the
scenario that would provide thegreatest opportunity for you to
recoup income and save a deal.
So, um, looking to see if wehave any questions.

(17:13):
I don't give everyone anopportunity here.
There has to be questions on howwe calculate these incomes.
Now, remember, these are allcalculated using the expense,
excuse me, the incomecalculator.
The Fannie Mae income calculatoris the 1084.
And the Freddie Mac incomecalculator is the form 91.

(17:37):
So make sure that you use thecorrect form for the loan type
that you are processing.
I'll give it another minute as Idon't see any questions here.
And this is a very importanttopic that we have.
So hopefully I made it veryclear on this scenario.

(17:57):
And hopefully, uh, by the timewe're done with the next week's
Uh, training on this, which willbe on LOCs and everybody here,
uh, a self employed borrowerexpert income.
Alright, well, no questions fortoday.
So, uh, everybody have a goodday and we will see you

(18:19):
tomorrow.
Thank you, everybody.

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Loan Officer Training - 11/19/2024 - Analyzing Self-Employed Borrowers: Partnerships

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