I have been employed in the mortgage industry for 27 years, primarily in the areas of underwriting, sales, credit risk and credit policy. I currently work for a major banking institution that provides residential mortgage financing including Conventional (Conforming, Nonconforming), Government (FHA, VA) and affordable housing products. For clarity, the underwriter of record is charged with determining what amount of income is acceptable and appropriate for use under his/her financial institution's published policy requirements, this is not determined by the borrower (you). Each financial institution does have their own credit policy and underwriting requirements, not all institutions have the same requirements - in general, they are determined by the institution's current risk appetite and contracts with its investors/what the investors will/will not allow. The information that I am sharing with you is based upon my history in underwriting and with the banking institution that I am currently employed by, it is in no way to be construed as a means of obtaining loan approval as only the designated underwriter assigned to your loan may make that determination.
I can tell you that if you file Sched C, depreciation claimed on Line 13 (page 1) is considered to be a paper loss, not an actual expense, therefore it may be considered for add-back to the net income reflected on Line 31. Business use of home (Line 30) is also a paper loss, not an actual expense, therefore it may also be added back to 'true-up' the net income. Non-recurring expenses (if they can be proven/documented as such) may be added back, non-recurring income must be deducted. 50% of the meals & entertainment expense must also be added back as only 50% of the full expense is included in the business cash flow. When determining qualifying income, we must account for 100% of the expense; the 50% the IRS allows you to exclude is something the IRS allows, it does not apply to mortgage underwriting. Thanks to Dodd/Frank, underwriters must determine your ability to repay (ATR or QM, depending upon the product type) which includes 'hitting' you with (or 'including') the full debt burden as in reality, you are responsible for 100% of those expenses regardless of IRS tax rules.
With a Sched C business, contributions you make to a SEP, IRA, KEOGH or other business retirement plans comes out of your net earnings after they have been paid to you, they are not pre-tax contributions like you would see with a Corporation or SCorp, therefore these contributions would not impact the Net Income reported on Line 31/Sched C or the amount of qualifying income that may be considered for use. These contributions are listed on the 1040 to allow minimization of your gross taxable income, they do not impact the actual net income declared on Sched C as they are not included in the business cash flow as an expense item. If you had incorporated and your business made contributions to a SEP/401K/Deferred Comp plan, etc...an uw could consider adding back that expense to 'true-up' the net profit/K1 Ordinary Business Income provided there aren't any penalties for not making future contributions and there wasn't a required amount that had to be contributed to the retirement plan.
Expenses claimed on Sched C for rent, utilities, etc...are actual expenses claimed by the business. As these are actual expenses, they cannot be added back. You have to keep in mind that what may be claimed as a tax write-off generally works against you when trying to qualify for financing. Basically, you cannot have the benefit of the write-off (the 'cake') and be allowed to ignore those expenses by saying they're 'non-business related' ('eating it, too'). Once the sin has been committed, you cannot take it back. Now, if your business paid your auto loan/lease payments for at least 12 months, the expense was included in the business cash flow as an expense item (Line 20a) and your business bank statements reflect the business paid the payment for each of the previous 12 mos (prior to your loan application date), the uw may consider exclusion of that debt payment from your personal liabilities total and DTI (debt-to-income) ratio. This may be considered for other personal liabilities that are included in your DTI calculation that have been paid by the business. Utilities are not included in the DTI calculation. Items reflected on your credit report, your housing payment (i.e. rent or mortgages for properties owned and retained) and any other debts you are contractually liable for repaying are what must be included in your DTI calculation. Discretionary debt (insurance, gym memberships, utilities, day care, etc...things you can elect to stop paying at any time without repercussion/that you are not under contract to repay) are generally not included in your DTI calculation. Again, each financial institution has its own rules/policies therefore this may vary depending upon where you submit your loan application request. I've gone off on a tangent, back to your Schedule C/income questions...
Standard or itemized deductions taken on the 1040 do not impact your qualifying income. The uw extracts the income from Sched C, prior to application of additional, allowable tax deductions. Generally, the uw starts with the Net Profit/Line 31, then adds back Depreciation (Line 13), Depletion (Line 12) and Business Use of Home (Line 30) which are paper losses (not actual expenses or losses) and any documented non-recurring expense items, then subtracts the Meals & Entertainment expense (50% claimed on Line 24b, the other 50% must be deducted to account for 100% of the expense in the business cash flow), non-recurring income (Line 6) to arrive at the adjusted Net Income figure. If net earnings have been stable to moderately increasing YOY for the most recent 2 tax years presented, the uw will run this calculation for both tax years, using a 24 month average of the net income. If the earnings trend reflects a decline in the most recent tax year filed (i.e. 2018) and the YTD P&L (2019)reflects that earnings have returned to levels realized in the oldest tax year (2017), the uw will use a 12 mo average of 2018 as that is the worst-case scenario aka 'most conservative approach'. YTD P&L income is rarely included in the calculation as those numbers have not been sufficiently verified (the income hasn't been declared to the IRS yet); use of earnings increases on the YTD P&L are not considered to be supported, thus eligible for use, until the final figures have been declared via that years' tax filing. If the YTD P&L reflects a declining income trend, earnings realized in the previous 2 tax years is no longer being earned by the business therefore, when this is the case, the uw must use an average of the YTD P&L earnings as that is what is realistic for the business at the present time and is the worst-case scenario/most conservative approach. An uw cannot use income to qualify you for financing when that income is no longer being earned.
I hope this information gives you a little more insight into how the Sched C income calculation works.
