Business Purpose Exemption Simplified
By Dennis Doss

[This post is intended as educational material, not legal advice. Consult a lawyer before implementing any of the information in this post.]

I get many questions about the Business Purpose Exemption to Regulation Z and RESPA’s Regulation X.

Here are some simple rules followed by the text of the exemption regulation:

  1. All business purpose loans are wholly exempt from TILA/RESPA coverage.
  2. All loans to bona fide business entities are wholly exempt from coverage, regardless of purpose.
  3. All real estate secured loans to natural persons for consumer purposes are subject to the new TIL Integrated Disclosure (e.g. a loan on a high-rise to pay school tuition)
  4. Only loans to natural persons for consumer purposes and secured by 1-4 property are subject to both the new TIL and Ability to Repay Rules. (e.g. a cash-out refi of a SFR rental to pay personal income taxes)
  5. Credit to “acquire, improve or maintain rental property” that is not owner-occupied is categorically exempt from TIL and ATR as a business purpose loan. Keep in mind that for this purpose that if the owner expects to occupy the property more than 14 days during the coming year, it is treated as a consumer loan (TIL and ATR) unless it contains more than 2 housing units.

In other situations you must apply a 5 part test for business vs. consumer:

  1. The relationship of the borrower’s primary occupation to the acquisition. The more closely related, the more likely it is to be business purpose. [we avoid hobbist flippers because they don’t pass this test]
  2. The degree to which the borrower will personally manage the acquisition. The more personal involvement there is, the more likely it is to be business purpose. [we avoid loans to fund passive investment because it does not pass this test]
  3. The ratio of income from the acquisition to the total income of the borrower. The higher the ratio, the more likely it is to be business purpose.
  4. The size of the transaction. The larger the transaction, the more likely it is to be business purpose.
  5. The borrower’s statement of purpose for the loan.

Regulation:

Business purpose purchases. i. Business-purpose credit cards—extensions of credit for consumer purposes. If a business-purpose credit card is issued to a person, the provisions of the regulation do not apply, other than as provided in §§1026.12(a) and 1026.12(b), even if extensions of credit for consumer purposes are occasionally made using that business-purpose credit card. For example, the billing error provisions set forth in §1026.13do not apply to consumer-purpose extensions of credit using a business-purpose credit card.

Consumer-purpose credit cards—extensions of credit for business purposes. If a consumer-purpose credit card is issued to a person, the provisions of the regulation apply, even to occasional extensions of credit for business purposes made using that consumer-purpose credit card. For example, a consumer may assert a billing error with respect to any extension of credit using a consumer-purpose credit card, even if the specific extension of credit on such credit card or open-end credit plan that is the subject of the dispute was made for business purposes.

Factors. In determining whether credit to finance an acquisition—such as securities, antiques, or art—is primarily for business or commercial purposes (as opposed to a consumer purpose), the following factors should be considered:

A. The relationship of the borrower’s primary occupation to the acquisition. The more closely related, the more likely it is to be business purpose.
B. The degree to which the borrower will personally manage the acquisition. The more personal involvement there is, the more likely it is to be business purpose.
C. The ratio of income from the acquisition to the total income of the borrower. The higher the ratio, the more likely it is to be business purpose.
D. The size of the transaction. The larger the transaction, the more likely it is to be business purpose.
E. The borrower’s statement of purpose for the loan.
Business-purpose examples. Examples of business-purpose credit include:
A loan to expand a business, even if it is secured by the borrower’s residence or personal property.
A loan to improve a principal residence by putting in a business office.
A business account used occasionally for consumer purposes.

iii. Consumer-purpose examples. Examples of consumer-purpose credit include:

  • Credit extensions by a company to its employees or agents if the loans are used for personal purposes.
  • A loan secured by a mechanic’s tools to pay a child’s tuition.
  • A personal account used occasionally for business purposes.

Non-owner-occupied rental property. Credit extended to acquire, improve, or maintain rental property (regardless of the number of housing units) that is not owner-occupied is deemed to be for business purposes. This includes, for example, the acquisition of a warehouse that will be leased or a single-family house that will be rented to another person to live in. If the owner expects to occupy the property for more than 14 days during the coming year, the property cannot be considered non-owner-occupied and this special rule will not apply. For example, a beach house that the owner will occupy for a month in the coming summer and rent out the rest of the year is owner occupied and is not governed by this special rule. ( See comment 3(a)–5, however, for rules relating to owner-occupied rental property.)

Owner-occupied rental property. If credit is extended to acquire, improve, or maintain rental property that is or will be owner-occupied within the coming year, different rules apply:

  1. Credit extended to acquire the rental property is deemed to be for business purposes if it contains more than 2 housing units.
  2. Credit extended to improve or maintain the rental property is deemed to be for business purposes if it contains more than 4 housing units. Since the amended statute defines dwelling to include 1 to 4 housing units, this rule preserves the right of rescission for credit extended for purposes other than acquisition. Neither of these rules means that an extension of credit for property containing fewer than the requisite number of units is necessarily consumer credit. In such cases, the determination of whether it is business or consumer credit should be made by considering the factors listed in comment 3(a)–3.
  3. Business credit later refinanced. Business-purpose credit that is exempt from the regulation may later be rewritten for consumer purposes. Such a transaction is consumer credit requiring disclosures only if the existing obligation is satisfied and replaced by a new obligation made for consumer purposes undertaken by the same obligor.