Self-employed borrowers often adjust their business structure for tax planning, liability protection, or long-term growth. While these changes may make sense from a business perspective, they can create unexpected challenges during mortgage qualification, especially when trying to use one year of tax returns.
A recent update from Freddie Mac directly addresses this issue and is especially important for self-employed borrowers and their advisors to understand.
What Changed?
Effective November 8, 2024, Freddie Mac issued updated guidance clarifying how a change in a borrower’s business tax structure is treated for underwriting purposes.
Under the new guideline, when a borrower changes corporate structure, such as moving from a Schedule C sole proprietorship to an S-Corporation, the percentage of ownership must remain the same for the business to be considered the same entity. If the ownership percentage changes, Freddie Mac may view the business as new, which can trigger additional documentation requirements or disqualify the borrower from using reduced income history options.
For Self-Employed Borrowers
This update is especially relevant for borrowers seeking to qualify under Freddie Mac’s rules using one year of tax returns. Freddie Mac allows only one year of tax returns when the borrower can demonstrate at least 5 years of self-employment with the same business entity. A change in tax structure does not automatically reset the clock unless ownership remains consistent.
If ownership changes:
- The business may no longer be considered the same entity
- The five-year self-employment history may be interrupted
- Two years of tax returns may be required instead of one
Common Scenario We’re Seeing
A borrower:
- Operated as a Schedule C sole proprietor for several years
- Converted to an S-Corporation for tax efficiency
- Maintained the same ownership percentage
Under Freddie Mac’s updated guidance, this can still be treated as the same business, preserving eligibility for a one-year tax return qualification. However, if ownership shifts, even slightly, this benefit may be lost.
If you’re self-employed, it’s critical to understand how these changes affect mortgage qualification before you apply. Speak with MortgageDepot early so we can align your business structure with the right loan strategy.
