With the 2018 Tax Cuts and Jobs Act there are important tax law changes and
some of the IRS tax forms are hardly recognizable. Even experienced lenders and
credit analysts will feel like they’re starting over. The good news is that the
basic concepts are the same. Tax returns show taxable income. But borrowers
don’t repay debt with taxable income; they use cash flow. The trick is learning
how to obtain a reliable monthly or annual cash flow from a personal tax return.
Incorrectly estimating cash flow from a tax return can result in bad loan
decisions – or missed opportunities. Once you’ve properly converted taxable
income into cash flow, that information can be used in your credit scoring
model, debt-to-income ratio, or disposable income calculation.
for consumer and commercial lenders, this two-part series will teach you an
easy, reliable method to convert a borrower’s personal tax return (Form 1040)
into a cash flow statement using the free software included with this course.
Part 2 will cover Schedule D (Capital Gains and Losses), Schedule E Page 1
(Rental Real Estate and Royalties), Schedule E Page 2 (Income or Loss From
Partnerships and S Corporations), and Schedule F (Profit or Loss From Farming).
(Note: This method does not follow Fannie, Freddie, or QM rules used in
- Schedule D: Are these sales/gains
recurring, qualifying incomes or one-time gains?
- Schedule E Page 1: More
than adding back depreciation, find the real cash flow from rentals and
- Schedule E Page 2: Most information ‘passed through’ from
partnerships or S corps doesn’t represent cash flow – learn to distinguish
phantom income from real cash flow
- Schedule F: How to identify hidden
income in farm tax returns
Tim Harrington, CPA, TEAM Resource