Your question:

Should we ever use capital gains income? My senior lender says we do not underwrite based on conversion of assets, only on income.

Linda says:

I had the opportunity recently to witness a fairly heated debate between the President of a Bank and the Loan Review Team from the holding company. Yes, voices were raised and neither side was backing down.

The point of the discussion was a stock transaction listed on Schedule D of a personal tax return. The stock had been purchased ten years previously for $169,032. It was sold in the current year for $125,000 resulting in a loss of ($44,032) shown on Schedule D. Due to the limits on deducting capital losses in excess of capital gains, only ($3,000) had been subtracted from AGI on the front of the 1040. With me so far?

Pop Quiz: What was the impact in the checkbook this year as a result of the transaction?

I’ll tell you the answer in a bit. Meanwhile, the Bank President did not want to use it at all since he adamantly insisted "we don’t underwrite based on asset conversion, we underwrite based on income."

I can’t completely disagree with him. He went on to ask if we should include in projected income the possibility of asset conversion just because a borrower says he plans to sell some stock. I think we all agreed the answer generally is no.

Then again, before you jump on the income-yes, asset conversion-no bandwagon, what is happening when a retired person:

  • Collects on their pension?
  • Takes distributions from their IRAs?
  • Sells a portion of their stock portfolio yearly to augment their income?

Asset conversion. And yet most of us would certainly use regular and continuing distributions from IRAs or Pensions as recurring cashflow available to pay debt, wouldn’t we?

Okay…my answer to the pop quiz. We don’t know. It is possible that the cashflow impact is $125,000 if no other stock was purchased. It is also possible the borrower simply called the broker and said “Sell 500 shares of That, Inc and purchase 300 shares of This, Inc.” Perhaps there is no net cash impact of the stock transactions at all.

And while it is very reasonable to ignore capital gains/(losses) in recurring cashflow for most borrowers with a capital gains transaction here and there, there are client categories who may have regular and recurring capital gains as a part of their normal activities. Real Estate Developers and Builders join retirees in this group.

My suggestion, consider the borrower. If the capital gains is not typical for the borrower or they are in the earning stage of life, you might leave it out of projected cashflow completely even if there was a significant cashflow impact this year. If they are a Real Estate Developer, builder, or someone else with regular capital gains…or are retired and using their built up capital assets to supplement their retirement… and you are projecting cashflow, I’d be inclined to use the proceeds this year offset by new purchases.

This means you’ll need the brokers statement or the RE closing statements. And if you don’t need the cashflow to qualify, consider simply noting the amount of proceeds as a possible cashflow source in your write-up and leaving it out of the numbers altogether.

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Linda Keith, CPA

Linda Keith CPA is an expert in credit risk readiness and credit analysis. She trains banks and credit unions throughout the United States, both in-house and in open-enrollment sessions, on Tax Return and Financial Statement Analysis.
She is in the trenches with lenders, analysts and underwriters helping them say "yes" to good loans.
Creator of the Tax Return Analysis Virtual Classroom at, she speaks at banking associations on risk management, lending and director finance topics.