Man reviewing K-1 income for California jumbo loan.

K-1 Income and Your California Jumbo Loan Approval

Q: How do underwriters evaluate K-1 income for a jumbo loan?

A lender's seasoning period is a mandatory waiting time after you purchase or refinance a property before you can access the full after-repair value (ARV) for a cash-out refinance. Most DSCR lenders require a seasoning period of 6 to 12 months. Refinancing before the seasoning period concludes typically means the lender will base the loan amount on your original purchase price plus rehab costs, which severely limits the amount of equity you can cash out. Waiting until after the period allows you to borrow against the full market value you created through your renovations.

Q: Do lenders use my ordinary business income or my distributions for qualification?

To justify a higher appraised value, you should provide the appraiser with a detailed and organized renovation packet. This packet removes guesswork and provides concrete evidence of the work performed. It should include: a cover letter summarizing the major upgrades, a detailed scope of work document itemizing all improvements, compelling before-and-after photos showing the property's transformation, copies of paid invoices and receipts for materials and labor, and copies of any official building permits that were issued for the work.

Q: Besides my K-1, what parts of the partnership's tax return do lenders scrutinize?

No, LTV limits for cash-out refinances vary significantly among different DSCR lenders, as each has its own guidelines and risk tolerance. While purchase loans may reach 80% LTV, cash-out refinances are often capped at 70% or 75% LTV. The specific LTV offered to an investor is influenced by several factors, including: Credit Score (higher scores typically qualify for higher LTVs), DSCR Ratio (a stronger income-to-debt ratio may result in a better LTV offer), Property Type (a single-family home might receive a higher LTV than a multi-unit property), and Loan Amount (some lenders may offer different terms based on the size of the loan).

Q: Can non-cash expenses like depreciation be used to help me qualify for a loan?

Your property's monthly rental income is the foundation of a DSCR loan approval. The formula is: DSCR = Gross Rental Income / Total Monthly Housing Payment. A higher rent results in a higher DSCR. This proves to the lender that the property can comfortably support a larger loan payment, which in turn allows you to qualify for a larger loan amount and maximize your cash-out.

Q: How do guaranteed payments affect my qualifying income?

Yes, it is often possible to pay for closing costs with the proceeds from your new loan, meaning you don't need to bring cash to closing. However, these costs are not added on top of your loan limit. Instead, the closing costs are subtracted from the total cash-out funds available to you after your existing mortgage is paid off. The total loan amount, including these costs, cannot exceed the lender's maximum LTV limit based on the property's appraised value.

Q: What happens if my partnership shows a loss but I still received distributions?

Investors can make several avoidable errors that reduce their available cash-out funds. The most common mistakes include: Poor Documentation (failing to provide an appraiser with a thorough renovation packet can lead to a conservative and lower valuation), Refinancing Too Soon (not waiting for the lender's seasoning period to expire is a costly mistake that forces the loan to be based on cost rather than value), Lacking a Tenant (attempting to refinance a vacant property is less favorable, as lenders prefer the security of a signed lease over estimated market rents), and Ignoring Lender Differences (accepting the first loan offer without comparing options can mean missing out on better LTV limits or shorter seasoning requirements from other lenders).

Q: What information must my CPA provide in a letter to the lender?

The ideal time to begin the refinance process is 30 to 45 days before your lender's seasoning period expires. This allows you to gather all necessary documentation, secure an appraisal, and complete underwriting so that you can close immediately once the seasoning requirement is met. Crucially, by this time, the property should also be 'stabilized,' which means you have a qualified tenant in place with a signed lease and have collected at least the first month's rent.

Specialized In Jumbo Loans, Investor Loans, DSCR Loans, Non-QM Financing, Commercial Mortgages, and Tax-Informed Lending Strategies

Published By

David Ghazaryan

Owner / Broker / Banker

Contact Me At

(702) 766-3744

NMLS 1486726

Let's Connect

TL;DR

Qualifying for a jumbo loan with partnership income involves more than just showing your personal distributions. Lenders conduct a deep analysis of your business's overall financial stability to ensure your income is sustainable. Here are the key takeaways:

Comprehensive Financial Review: Lenders assess your Schedule K-1 alongside the partnership's Form 1065, focusing on income consistency and the company's long-term health, not just the money you've received.
Understanding Underwriting Calculations: Your qualifying income can be increased by adding back non-cash expenses like depreciation found on the partnership's tax return.
CPA Verification is Crucial: A formal letter from a third-party CPA is often mandatory. This letter must confirm your ownership, the business's operational status, and that your income withdrawals do not negatively impact the company.

How Underwriters Analyze a Schedule K-1 for Qualifying Income

When you apply for a jumbo loan in California using income from a partnership, lenders scrutinize your Schedule K-1 far more intensely than a standard W-2. They aren't just looking at the final number; they are evaluating the stability, consistency, and source of that income. Your K-1 is a direct window into the financial health of your business partnership, and for a high-value loan in a market like Los Angeles, lenders need absolute confidence in your ability to repay.

An underwriter’s analysis typically involves a two-year review of both your personal and business tax returns. They look for trends. Is revenue growing? Are profits consistent? A one-year spike in income followed by a weak year is a major red flag. They want to see a predictable pattern that assures them the income used for qualification is likely to continue for at least the next three years. (The data, information, or policy mentioned here may vary over time.)

Key areas of focus include:

Ownership Percentage: Your share of the profits, losses, and liabilities must be clearly defined.
Income Consistency: They will average the qualifying income over the most recent 24 months. (The data, information, or policy mentioned here may vary over time.)
Business Viability: The overall health of the partnership, as shown on the Form 1065, is just as important as the income reported on your K-1.

Distributions vs. Ordinary Business Income: What Lenders Use

A common point of confusion for partners is whether a lender will use their ordinary business income (Box 1 of the K-1) or their distributions (Box 19). The answer is nuanced, but lenders often start with the lesser of the two figures after adjustments. (The data, information, or policy mentioned here may vary over time.) Their goal is to ensure you are not taking more money out of the business than it is actually earning and can sustainably afford.

Underwriter analyzing business financial documents for a loan

Ordinary Business Income (Box 1): This represents your share of the partnership's profits on paper for tax purposes. It includes deductions for non-cash expenses like depreciation.
Distributions (Box 19): This is the actual cash you took out of the business during the year.

Here’s a practical example. Let's say you are a partner in a successful marketing firm in San Diego looking for a jumbo loan.

Scenario A: Your K-1 shows $400,000 in ordinary business income, but you only took $300,000 in distributions to leave working capital in the company. The lender will likely use the $300,000 distribution figure as the starting point for your qualifying income, as it reflects the cash you actually received.
Scenario B: Your K-1 shows $400,000 in ordinary income, and you took $500,000 in distributions. This is a major red flag. It suggests you are depleting the company's capital reserves or funding your lifestyle with debt. A jumbo underwriter will likely view this negatively and may count zero income or deny the loan outright.

The lender’s core principle is sustainability. They will only give you credit for income that the business can demonstrably support year after year without harming its financial position.

What Sections of the Partnership Tax Return Matter Most to a Lender?

Your Schedule K-1 is only one piece of the puzzle. To approve a jumbo loan, lenders require the full partnership tax return, Form 1065, for the last two years. They are digging deep into the business's fundamentals. Three sections are particularly critical.

Key sections of a partnership tax return highlighted

H3: The Balance Sheet (Schedule L)

This schedule provides a snapshot of the company's assets, liabilities, and equity. Underwriters are looking for:

Liquidity: Does the business have enough cash on hand (or current assets) to cover its short-term debts? Low cash reserves can signal financial distress.
Leverage: How much debt is the company carrying compared to its assets? A highly leveraged business is riskier, and lenders may question its ability to continue paying partners consistently.

H3: Reconciliation of Income (Schedule M-1)

Schedule M-1 reconciles the company's net income per its accounting books with the income reported on its tax return. This is important because it highlights expenses that are not tax-deductible, such as certain meals and entertainment. It gives the lender a clearer picture of the company's true profitability and cash flow, separate from its tax strategy.

H3: Analysis of Net Income (Schedule M-2)

This schedule tracks the partners' capital accounts from the beginning to the end of the year. It shows capital contributions, net income, distributions, and other items. For an underwriter, Schedule M-2 confirms whether the distributions you took were paid from profits or if they were a return of your initial capital investment. For a jumbo loan, income must come from profits.

Can I Add Back Paper Losses Like Depreciation?

Yes, and this is where a knowledgeable mortgage professional can make a significant difference. Certain non-cash expenses, often called 'paper losses', can be added back to the partnership's net income to increase your total qualifying income. This is because these expenses reduce taxable income but don't actually involve a cash outlay.

The most common add-back is depreciation. Let's imagine your Los Angeles real estate partnership owns several properties.

The partnership's Form 1065 shows a net income of $500,000.
It also shows a $150,000 depreciation expense for its buildings.
The lender can add this $150,000 back, resulting in an adjusted business income of $650,000.

If you are a 50% partner, your share of this add-back would be $75,000. This amount is added to your base qualifying income, potentially helping you qualify for a larger loan amount. Other potential add-backs include amortization, depletion, and sometimes one-time, non-recurring business expenses, though the latter requires extensive documentation. (The data, information, or policy mentioned here may vary over time.)

What if the Partnership Shows a Loss but I Still Took Distributions?

This scenario is almost always a deal-breaker for a jumbo loan. If the partnership's Form 1065 shows a net loss for the year, but your K-1 shows that you received distributions, it means you were paid from other sources—not profits.

This could be:

A return of your or other partners' capital contributions.
Funds from a business line of credit or other loan.
Cash reserves from prior, profitable years.

Regardless of the source, underwriters view this as fundamentally unsustainable. Taking money from a losing business jeopardizes its long-term health. In this situation, the lender will calculate your qualifying income from the partnership as zero, or even as a negative figure (a loss), which would then be counted against any other income you have.

How Do Guaranteed Payments Affect My Total Qualifying Income?

Guaranteed Payments, reported in Box 4 of your K-1, are a significant advantage in jumbo loan qualification. These are payments made to a partner for services or the use of capital, and they are paid out regardless of the business's profitability for the year. Essentially, they function like a salary.

Because of their reliability, lenders view Guaranteed Payments very favorably. They are considered stable and predictable income. The amount listed in Box 4 is typically added directly to your calculated qualifying income from the partnership's profits.

For example, a partner in a San Diego law firm might receive $200,000 in Guaranteed Payments plus a share of the remaining profits. The lender will add that $200,000 directly to the income calculated from their share of the business's net earnings (after adjustments and add-backs), resulting in a much stronger financial profile.

What Specific Letters Will a Jumbo Lender Require from My CPA?

For nearly any self-employed borrower using K-1 income, and especially for jumbo loans, lenders will require a formal letter from a third-party Certified Public Accountant (CPA). The letter cannot come from an internal bookkeeper or someone who is not a licensed CPA.

This letter serves as an independent verification of the business's health and your income stream. While the specific requirements can vary slightly between lenders, the letter must generally confirm the following:

The CPA has prepared both the partnership's (Form 1065) and your personal (Form 1040) tax returns for at least the last two years.
The CPA confirms your ownership percentage in the business.
A statement affirming that the business is currently operating and is considered a 'going concern'.
Crucially, a statement that your withdrawal of funds (distributions) has not had a negative impact on the business's financial operations or liquidity.
An explanation for any large, unusual swings in revenue or profitability between the two years being reviewed.

This letter provides the underwriter with a vital layer of confidence that the financial data presented in the tax returns is accurate and sustainable. (The data, information, or policy mentioned here may vary over time.) If you're a business partner navigating the complexities of K-1 income for a jumbo loan, the right strategy is essential. A mortgage expert specializing in self-employed borrowers can help you present your financial picture for the strongest possible approval.

Navigating the complexities of K-1 income for a jumbo loan requires an expert touch. If you're a business partner ready to present your financial picture for the strongest possible approval, our specialists can guide you through the process. Take the next step to secure your financing—Apply now.

Author Bio

David Ghazaryan is the expert mortgage strategist and founder behind iQRATE Mortgages. With a mission to fund home loans that traditional banks won't touch, David specializes in helping clients with unique financial situations, including those recovering from foreclosure or bankruptcy. He expertly crafts smart, strategic, and stress-free mortgages by leveraging a vast network of over 100 lenders to secure competitive rates for investors and homebuyers alike. Praised for exceptional customer service, David has helped hundreds of families with a 97% satisfaction rate, guiding them to the mortgage they deserve.