Unfortunately, that is correct. For self-employed the adjusted income is use, or the income after self-employment taxes are paid. Basically, anything that reduces your taxable income. The exceptions (and added back in) are depreciation and depletion, IRA accounts opened on the front section of the 1040 (near where the self-employment tax is).
Capital gains and losses are averaged over two years, so the fact you took half in 2008 and the other half in 2009, is really the same, anyway you cut it.
If you really want to see how it's calculated, I have attached the Fannie Mae Self Employed Income Analysis. I can't argue the merits of why they do it the way they do (for example, if you have a car that is written off at 80%, you can't take 80% of the car payment off, with most lenders).
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