Exclude mortgage, notes, and bonds from reducing your income

mortgage less than one year

Mortgage, notes, and bonds due in under 1 year is a line item well known, but little discussed in the guidelines.  This single item on a self employed borrower can take a deal from approved to declined in an instant!  Even though this requirement for review has been around for years, yet I still find it handled wrong in many cases.  Don’t loose a good borrower over this issue, here is an outline of options you have when underwriting your borrower.  Let’s dig into mortgage, notes and bonds more deeply.

What is Schedule L for?

First let’s talk about what this line on SCH L represents, understanding what this line means on a tax return makes the following rules easier to understand.  When a business establishes diverse types of credit to run the business such as private loans, mortgages, lines of credit, some of these types of credit will have an “end date” to the term.  This end date maybe 90 days away or 10 years away depending on type of line of credit.

The CPA for the company will track these debts on the SCH L (which is a balance sheet) using mainly lines 17 and 20 for an 1120S or 1120, and lines 16 and 19A & B on the 1065.  Any debt that is due in the tax year reported it is listed on the “less than 1-year line” versus the other debt lines.  For example, if a borrower took a 5-year line of credit back in 2012 the CPA would report any remaining balance that must be paid in full on the “less than 1 year” line of the SCH L on the 2017 SCH L.  Another example is something we are very familiar with in the mortgage space that is a balloon note.  If a business took a $50,000 balloon note in 2014 that had 2 years of payments and the balloon due in 2016, the CPA would list the balance of the balloon note on the “due in less than 1 year” line on the 2016 SCH L.

Since these notes are not an expense written off the bottom line of the company (you don’t record loans as income and you can’t deduct them as expenses) we must reduce the company’s profit to allow for payback… unless you can use one of the two options below!

How to exclude mortgage, notes, and bonds from reducing your income

Option 1
The reason we reduce the company’s profit by the amount owed is assuming that the company will take the profit from the current tax year to pay off that debt.  But if the business has enough cash on hand showing on line 1D of the SCH L form, we can now ignore these deductions from income.  The key here is to omit this deduction on your income worksheet and put a note to your investor you took this route. For example, the note on the income worksheet can say “UW confirmed $50,000 short term debt can be mitigated by $65,000 on line 1D of the SCH L”.

Option 2
If the company does not show enough cash on hand to use option one, your next move is to have the company CPA confirm if the debt is going to “roll over”.  In other words are the notes due this year renewable giving the business more time to pay them off.  This roll over is very common in business, since business loans are generally very short term (one to five years).

Footnote about always be in learning mode
A few weeks back a customer on IncomeXpert asked me why we “grayed out” the oldest year (right hand column) on our IncomeXpert income analyzer software.  Over the last few years I was under the impression that we only counted “most recent year” total because of how the SCH L worked.  Without adding on another thousand words to this blog, I will just cut this explanation to say “I was wrong!” .  The skinny version was that because line 16A or 17A ‘rolled over” debt from the previous year I assumed that total was included in the total at the end of the year (Line 16D or 17D). The truth is the end total may or may not include that same starting debt so it is best not to assume it does!  We have now since opened up this line on IncomeXpert for the 1065, 1120S, and 1120 income types.  As I am always stating in my trainings, the goal of a good underwriter is to get the right answer not the answer that makes ME feel right!

That’s all for this week, I hope this helped your knowledge of how to handle mortgage, notes, and bonds.  I will talk to you again next week and we go over other another underwriting topic!

7 responses to “Exclude mortgage, notes, and bonds from reducing your income”

  1. Jean says:

    I think this was us:) Anyway, thanks for this and so many other trainings you have done for us, you are AMAZING!

  2. Love your posts! Always educational! You explain it better than anyone! Keep up the great work!

  3. Heather says:

    I do have a question — If you are not showing Payable in less than a year Line 17 –would you question if the “other current Liabilities” Line 21? Would you ask the borrower to get a letter from the CPA what type of note is this and provide a copy of the terms of the note to ensure it is not payable in <12 mos.
    Under the statement 9 the description shows "Notes Payable" so I guess since it doesn't state Credit cards or so on it is being questioned? Do you think this is a bit much?

    • Michael Whitbeck says:

      Hi Heather

      Line 21 is not required to be investigated this is longer-term debt and won’t affect the profitability of the company short term. The IRS required notes under 12 months to be listed in the short-term debt so we can be pretty sure it should not have any negative impact on profitablity.

      Thanks for reading the blogs!

  4. Kevin says:


    Great content!

    For the first option to offset the debt; if the company has $50k cash on 1D, but the debt is $65k would you only use the $15k left over? If yes, is there any ratio of cash to debt that is unacceptable?

    • Michael Whitbeck says:

      Hi Kevin

      The method outlined in the guidelines does not specify if a partial “payoff” would work or not. BUT in theory, I could see if you had a $65,000 “debt” and $50,000 in cash, that would mean you could reduce the deduction to $15,000 of off the income. But that would be a risk that your risk or QC manager decision since it “outside” the normal box.

  5. Lena says:

    If a business tax returns shows mortgages, notes, due payable in less than 1 year – do you typically have to count this liability against the self- employed borrower’s income calculation?

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