The IRS 8825 form, officially titled Rental Real Estate Income and Expenses of a Partnership or an S Corporation, is used to report rental income and expenses for company-owned real estate. This form functions similarly to Schedule E, which applies to personally owned rental properties. However, the 8825 form is tailored to properties owned by partnerships or S Corporations. 

Key Considerations

When underwriting loans, it’s essential to understand how different agencies handle rental income from business-owned properties. Among the five major agencies (Fannie Mae, Freddie Mac, FHA, VA, USDA), four treat this income similarly by including the rental income as part of the borrower’s K-1 income (or loss) and allowing depreciation to be added back to cash flow.

Fannie Mae, however, differs slightly. It provides the option to separate rental income when the property has a mortgage in the borrower’s name, adding complexity to the calculation.

Here is the wording from FNMA B3-3.1-08 Rental Income which we will explain in the steps below

If the borrower is personally obligated on the mortgage debt (as evidenced by inclusion of the related mortgage(s) on the credit report) and gross rents and related expenses are reported through a partnership or S corporation, the business tax returns may be used to offset the property’s PITIA.

How to Evaluate Rental Income from the Form 8825

Step 1: Confirm Agency Guidelines

• Determine which agency’s underwriting guidelines apply to the loan (Fannie Mae, Freddie Mac, FHA, VA, or USDA).

Step 2: For Freddie Mac, FHA, VA, or USDA

• Confirm that the business pays the property’s PITIA (Principal, Interest, Taxes, Insurance, and Association Dues).
• Remove the PITIA payment from the borrower’s debt-to-income (DTI) ratio.
• Add depreciation back to the cash flow for rental income onto your 1065/1120S calculations. 

Note: If using Fannie Mae, skip step 2 and proceed to Step 3.

Step 3: Special Rule for Fannie Mae Loans

If the loan is underwritten by Fannie Mae, there are two possible scenarios:

• First Possibility  – No Mortgage on Borrower’s Credit Report
  If the property listed on the Form 8825 does not have a mortgage on the borrowers credit report, follow the same rules for other agencies listed in step 2
• For Fannie Mae loans where the borrower’s credit report lists a mortgage for the property evaluate each property listed on Form 8825, as shown below:
  • From total gross rents, subtract total expenses.
  • Then add back insurance, mortgage interest, taxes, homeowners’ association dues (if applicable), depreciation, and non-recurring property expenses (if documented accordingly).
  • Divide by the number of months the property was in service.
  • Subtract the entire PITIA (proposed for subject property or actual for real estate owned) to determine the monthly property cash flow.

If the resulting net cash flow is positive, the lender may exclude the property PITIA from the borrower’s monthly obligations when calculating the debt-to-income ratio.

If the resulting net cash flow is negative (that is, the rental income derived from the investment property is not sufficient to fully offset the property PITIA), the calculated negative amount must be included in the borrower’s monthly debt obligations when calculating the debt-to-income ratio properly.

In order to include a positive net rental income received through a partnership or an S corporation in the borrower’s monthly qualifying income, the lender must evaluate it according to Fannie Mae’s guidelines for income received from a partnership or an S corporation. See B3-3.4-01, Analyzing Partnership Returns for a Partnership or LLC and B3-3.4-02, Analyzing Returns for an S Corporation.

Summary

Understanding the rules governing rental income calculations is crucial for accurate underwriting. As shown here, the agency and property financing method significantly impact how the 8825 form is evaluated. If possible, avoid Fannie Mae loans for borrowers with personally financed rentals when the mortgage appears on their credit report.

Guideline References

Fannie Mae
Analyzing S Corporation Returns:       B3-3.4-02
Analyzing Partnership Returns:           B3-3.4-01
Monthly Debt Obligations:                   B3-6-05

Freddie Mac
Rental Income Guidelines:                  5306.4(c)
Rental Income on Form 8825:              5304.1