OK, this is quite a unique topic for a mortgage and real estate blog. Chances are that the reason you are reading this article is that you are a CPA, mortgage lender, or just found out that this line of your tax returns is causing a potential mortgage denial. But, this obscure line several pages back in a corporate tax return can cause serious damage to a mortgage loan approval. Even many loan officers overlook the “mortgages notes bonds payable in less than 1 year” line. So, let’s discuss the reason it is an issue and possible solutions.
Mortgages Notes Bonds Payable in Less Than 1 Year Explained
Business owners have several choices when it comes to the entity’s tax structure. Options include sole proprietorship, partnership, C Corp, and S Corp. This line shows up on the U.S. Corporation Income Tax Return Form 1120 and 1120S. It is way back on schedule L line 17 under the Liabilities and Shareholder’s Equity section.
Why is this Such a Big Deal?
If a borrower has 25% or more ownership in a business being used for income, tax returns must be provided. Even in the mortgage industry, many just review the first couple of pages of business owner tax returns. Usually, an approximate income calculation is performed, and pages further back are ignored. This is where the problem starts.
Example of Common Issue:
- Rough self-employed income calculation shows a profit of $96,000 or $8,000 per month. Buyer is under contract, an appraisal is ordered, the file is submitted to underwriting, and then the hammer is dropped!
- Mortgages notes bonds payable in less than a year is $108,000. Underwriting has calculated the income as a $12,000 loss or -$1,000 per month.
That’s right! This line is subtracted from the business owner’s income! This figure must be deducted from the after-tax income since it is not available for distribution because the funds must be used to meet the next year’s obligations shown.
Obviously, it is easy to see how much of an issue this may cause. Typically, this means mass confusion and frustration with the buyer.
Solutions to Mortgages Notes Bonds Payable in Less Than One Year
Now, the good thing is there are often solutions. Although, these are commonly overlooked or just not known.
- Prove sufficient assets
- Provide documentation that loan is paid off
- Document loan is a longer term
- Prove loan is renewable
Depending on the situation and the lender, these 4 options could take a loan from denial to approved.
First, proving the business has sufficient liquid assets to cover the amount due in less than a year. Accomplish this by providing business bank statements with a combined balance greater than the amount on schedule L. Also, proving the loan is paid off would work. The business’ CPA could verify the documented, paid off loan is the one reporting on the returns.
Another option is to prove that the mortgage, note, or bond is not due in less than a year. Believe it or not, this is often the case. Documentation may include terms of the loan complete with loan number, creditor name, balance, and payment. Furthermore, a signed letter from the CPA backing up the documented loan belongs to this line on the returns is required. The reason is schedule L does not say where the “due in less than 1 year” amount came from.
Finally, proof that a loan is actually renewable would work. A line of credit is a good example. This may be accomplished by a CPA letter stating the loan is renewable or documentation to prove it.
Additional Self Employed Mortgage Resources