Reducing Taxable Income - Shooting Myself in the Foot for a Loan?

23 Replies

I want to reduce my taxable income as much as possible. (Selling stocks and want to avoid long-term capital gains.)

Maxing out the 401k is $18,500, standard deduction is $24,000. 

My question is, what does the bank look at when deciding to give me a mortgage? Am I shooting myself in the foot when I'm applying for a mortgage (primary residence, I live-in flip) by reducing taxable income this year? Or do they look at gross income? (It's been a while since I got a mortgage and things have changed.)

Asking here so others can benefit from the answers. @Chris Mason

Originally posted by @Mindy Jensen :

I want to reduce my taxable income as much as possible. (Selling stocks and want to avoid long-term capital gains.)

Maxing out the 401k is $18,500, standard deduction is $24,000. 

My question is, what does the bank look at when deciding to give me a mortgage? Am I shooting myself in the foot when I'm applying for a mortgage (primary residence, I live-in flip) by reducing taxable income this year? Or do they look at gross income? (It's been a while since I got a mortgage and things have changed.)

Asking here so others can benefit from the answers. @Chris Mason ? 

 For self employment income, Fannie/Freddie/Jumbo/etc are MOSTLY the same. For a sneak preview, clicky click. I'm assuming you have one or more side gigs other than working for BP. 

401k contributions will not impact you either way. Same with health insurance. It turns out that Fannie Mae doesn't want people cancelling their 401k contributions and downgrading their health insurance to qualify for a mortgage, which is why we generally use gross income, not net, for W2 hourly/salary type work. 

Your W2 base salary working for BiggerPockets.com should/will be counted at 100% of value day 1, without waiting on two years of tax returns. So if you get a pay raise tomorrow (@Brandon Turner ) you will not have to wait for it to be reflected on tax returns to count. 

Commission, bonuses, the LLC AirBnB property management business you have, your real estate agent work on Schedule C, royalties from your books, etc - for that slice of your income, it'll be based on tax returns. Not everything you write off will 'hurt' your income calculation, many things can be 'added back,' which you can see at the link above. Specific to you as a real estate agent, track all miles you drive showing homes and write that off in Sch C P2 box 44A (yes I have that memorized) to the greatest extent your CPA tells you it's lawful to do -- this is one of those magic write-offs that minimizes your tax burden while having zero impact on mortgage qualifying income. There are cell phone apps that help with this tracking, but one of them might have been created by a client of mine (Bay Area, right?) making me a biased source for a specific app referral. :P

For book authors like yourself, things are often a bit silly. We have to wait for that newly published book's income to appear on tax returns, but by that time the initial rush of book sales will be over, and YTD will be less than historic (and, thus YTD will be used), unless you're constantly putting new books out, hurting your calculated income. So Steven King and the Game of Thrones guy will be fine, but the one-time author can have a hard time of it, since by the time we can count the income, most of that income is gone.

#1 thing I see landlords get wrong is Schedule E box 2, "Fair Rental Days." You purchased the property in August of last year, how can your "fair rental days" POSSIBLY be 365 for that year when you only even owned it 4 months and change? CPAs and/or CPA software default to putting 365 in there no matter the reality, so you have to micromanage this.

We spend a lot of time internally going over income calculations, and we do this for a living, so a full and complete answer is beyond the scope of one post. You can of course always give your lender a rough draft of your tax returns, before you file them. Sometimes the same write-off can be on line A or line B, and that choice can make a difference. 

Thanks for making me glad I tagged you, @Chris Mason . I am most concerned about the W2 income. (I also appreciate your tagging Brandon to try to get me a raise.)

You answered everything I needed and then some! Thanks!

@Mindy Jensen before you sell those stocks have you looked into qualified opportunity zones? You can potentially sell the stocks tax free and invest the proceeds into REI.

Also I don't know your specific situation- but depreciation is added back by most lenders. Something I've learned is lots of accountants don't take the most aggressive depreciation possible. I always recommend a review of this especially in a year when you know you'll have an influx income. The reason being if we adjust depreciation you get to take that back depreciation in the current year....and that impact of expense shouldn't impact your lending approval. @Chris Mason should be able to confirm that. 

Hope this helps! Feel free to reach out if you wanna chat. 

@Natalie Kolodij , I just heard about the opportunity zone thing maybe a week ago. I'm looking into that, too but I'd also like to liquidate some stocks to buy a primary residence. That's not available with opportunity zones, right?

Originally posted by @Mindy Jensen :

@Natalie Kolodij , I just heard about the opportunity zone thing maybe a week ago. I'm looking into that, too but I'd also like to liquidate some stocks to buy a primary residence. That's not available with opportunity zones, right?

 Hi Mindy, 

There is nothing that says that you can't occupy the home as long as it's in a qualifying zone and you substantially improve the property. (This is the harder part- means you need to spend at least the cost of the property on renovations). 

So if you wanted to buy a primary and build on a second AUD unit for a rental or something- still an option. 

Never hurts to have options!

@Natalie Kolodij have you noticed how arbitrary it is as to where a Individial state has designated its “opportunity zones”? For instance in Washington state they seem to have really chosen dumpy depressed areas which will be a challenge ti take advantage of; while here in neighboring Oregon they have designated some very mixed areas that seem to provide some real juicy opportunities for tax advantages.

@Mindy Jensen @Natalie Kolodij When I was reading this, I had this inclination to say that Mindy isnt going to want to live in an opportunity zone. Then I looked at the map of them out of curiosity, and Im absolutely shocked to look at some of the locations in my area on the map.  There are literally some neighborhoods that have homes pushing $1 million.

@Steve B. , my city's opportunity zone falls smack dab in the middle of the most desirable area of town. But the whole town used to be a dump, so I think the zones are just really outdated.

Following this thread... @Mindy Jensen can you explain what exactly  "qualified opportunity zones" are? How does this have change your buying ability? 

Keep in mind that a "significant renovation" has to exceed 100% of the purchase price. So if you buy a house for $300k you would need to put $300k into it which in a lot of cases is not likely. Otherwise a new build would qualify.

Another thing to keep in mind is that the investment must rise to the level of a "trade or business" Buying a principal residence (even if it is a new build)  would not be considered a trade or business and thus would not qualify (unless further guidance is issued)

@Melissa Gittens here is an overview of QOZ's:

https://www.biggerpockets.com/forums/51/topics/586...

Originally posted by @Austin Hendrickson :

Keep in mind that a "significant renovation" has to exceed 100% of the purchase price. So if you buy a house for $300k you would need to put $300k into it which in a lot of cases is not likely. Otherwise a new build would qualify.

Another thing to keep in mind is that the investment must rise to the level of a "trade or business" Buying a principal residence (even if it is a new build)  would not be considered a trade or business and thus would not qualify (unless further guidance is issued)

@Melissa Gittens here is an overview of QOZ's:

https://www.biggerpockets.com/forums/51/topics/586...

Austin- I haven't found any thing in the requirements that require it to be a "trade or business". Can you point me to the guidance on this? 


This has come up a lot regarding the new 199A- but I haven't seen anything related to QOZ related to needing to be a trade or business. I know that there was some guidance on relocating a primary headquarters for a business. 

Thanks!

Updated almost 3 years ago

*** I found the guidance on this. That's very odd that the attorney doing the CPE on this specifically addressed it could be occupied. I may reach out to him. Thanks!

Originally posted by @Russell Brazil :

@Mindy Jensen @Natalie Kolodij When I was reading this, I had this inclination to say that Mindy isnt going to want to live in an opportunity zone. Then I looked at the map of them out of curiosity, and Im absolutely shocked to look at some of the locations in my area on the map.  There are literally some neighborhoods that have homes pushing $1 million.


I thought this too. The way they set up the qualifying census tracts it had to due to high poverty, low income. 

However they added a second qualifier to it which ended up including many desirable areas....for example...lots of areas in the greater Seattle areas qualify. Areas where investors are already buying. 

Originally posted by @Steve B. :
@Natalie Kolodij have you noticed how arbitrary it is as to where a Individial state has designated its “opportunity zones”? For instance in Washington state they seem to have really chosen dumpy depressed areas which will be a challenge ti take advantage of; while here in neighboring Oregon they have designated some very mixed areas that seem to provide some real juicy opportunities for tax advantages.

I feel like there are some stellar areas in Washington...for Example...most of Everett and Tacoma qualify which is where a ton of investors are working currently any way. Everett has grown a ton in the last 3 years. 

Zone Criteria: 

Low-income census tracks are areas where the poverty rate is 20 percent or greater and/or family income is less than 80% of the area's median income.

"Family Income less than 80% of area's median income"......census tracts are pretty small areas. A handful of blocks. So if you have nice houses w/ some new apartments behind them...it may qualify due to the family income of those apartment occupants. 

@Natalie Kolodij good to see you found the guidance on the trade or business part. I have seen attorney's, CPA's, fund managers, etc. quote incorrect material on OZ's which is understandable since the topic is so new and a lot of the guidance is unclear.

It will be interesting to see how QOZ's play out!

Originally posted by @Chris Mason :
Originally posted by @Mindy Jensen:

I want to reduce my taxable income as much as possible. (Selling stocks and want to avoid long-term capital gains.)

Maxing out the 401k is $18,500, standard deduction is $24,000. 

My question is, what does the bank look at when deciding to give me a mortgage? Am I shooting myself in the foot when I'm applying for a mortgage (primary residence, I live-in flip) by reducing taxable income this year? Or do they look at gross income? (It's been a while since I got a mortgage and things have changed.)

Asking here so others can benefit from the answers. @Chris Mason ? 

 For self employment income, Fannie/Freddie/Jumbo/etc are MOSTLY the same. For a sneak preview, clicky click. I'm assuming you have one or more side gigs other than working for BP. 

401k contributions will not impact you either way. Same with health insurance. It turns out that Fannie Mae doesn't want people cancelling their 401k contributions and downgrading their health insurance to qualify for a mortgage, which is why we generally use gross income, not net, for W2 hourly/salary type work. 

Your W2 base salary working for BiggerPockets.com should/will be counted at 100% of value day 1, without waiting on two years of tax returns. So if you get a pay raise tomorrow (@Brandon Turner ) you will not have to wait for it to be reflected on tax returns to count. 

Commission, bonuses, the LLC AirBnB property management business you have, your real estate agent work on Schedule C, royalties from your books, etc - for that slice of your income, it'll be based on tax returns. Not everything you write off will 'hurt' your income calculation, many things can be 'added back,' which you can see at the link above. Specific to you as a real estate agent, track all miles you drive showing homes and write that off in Sch C P2 box 44A (yes I have that memorized) to the greatest extent your CPA tells you it's lawful to do -- this is one of those magic write-offs that minimizes your tax burden while having zero impact on mortgage qualifying income. There are cell phone apps that help with this tracking, but one of them might have been created by a client of mine (Bay Area, right?) making me a biased source for a specific app referral. :P

For book authors like yourself, things are often a bit silly. We have to wait for that newly published book's income to appear on tax returns, but by that time the initial rush of book sales will be over, and YTD will be less than historic (and, thus YTD will be used), unless you're constantly putting new books out, hurting your calculated income. So Steven King and the Game of Thrones guy will be fine, but the one-time author can have a hard time of it, since by the time we can count the income, most of that income is gone.

#1 thing I see landlords get wrong is Schedule E box 2, "Fair Rental Days." You purchased the property in August of last year, how can your "fair rental days" POSSIBLY be 365 for that year when you only even owned it 4 months and change? CPAs and/or CPA software default to putting 365 in there no matter the reality, so you have to micromanage this.

We spend a lot of time internally going over income calculations, and we do this for a living, so a full and complete answer is beyond the scope of one post. You can of course always give your lender a rough draft of your tax returns, before you file them. Sometimes the same write-off can be on line A or line B, and that choice can make a difference. 

That's some great info, thanks for taking the time to share all that Chris. Hope you don't mind an off topic question within this thread....

As a new investor, and 2018 being my first year filling taxes reflecting my rental income, I'm starting to think about how much of my rental income I want to write off. Of course I want to decrease my tax liability, but I also want to be able to show the banks how much positive cash flow I'm earning in order to help me qualify for next years investment properties...

When reviewing tax returns for income to determine eligibility for a loan, do you look at gross rental income or net? Will it lower my DTI if I write off half of my cash flow by writing off all of my rehab costs, etc.?

Thanks again for your input! 

Originally posted by @Greg Gaudet :
Originally posted by @Chris Mason:
Originally posted by @Mindy Jensen:

I want to reduce my taxable income as much as possible. (Selling stocks and want to avoid long-term capital gains.)

Maxing out the 401k is $18,500, standard deduction is $24,000. 

My question is, what does the bank look at when deciding to give me a mortgage? Am I shooting myself in the foot when I'm applying for a mortgage (primary residence, I live-in flip) by reducing taxable income this year? Or do they look at gross income? (It's been a while since I got a mortgage and things have changed.)

Asking here so others can benefit from the answers. @Chris Mason ? 

 For self employment income, Fannie/Freddie/Jumbo/etc are MOSTLY the same. For a sneak preview, clicky click. I'm assuming you have one or more side gigs other than working for BP. 

401k contributions will not impact you either way. Same with health insurance. It turns out that Fannie Mae doesn't want people cancelling their 401k contributions and downgrading their health insurance to qualify for a mortgage, which is why we generally use gross income, not net, for W2 hourly/salary type work. 

Your W2 base salary working for BiggerPockets.com should/will be counted at 100% of value day 1, without waiting on two years of tax returns. So if you get a pay raise tomorrow (@Brandon Turner ) you will not have to wait for it to be reflected on tax returns to count. 

Commission, bonuses, the LLC AirBnB property management business you have, your real estate agent work on Schedule C, royalties from your books, etc - for that slice of your income, it'll be based on tax returns. Not everything you write off will 'hurt' your income calculation, many things can be 'added back,' which you can see at the link above. Specific to you as a real estate agent, track all miles you drive showing homes and write that off in Sch C P2 box 44A (yes I have that memorized) to the greatest extent your CPA tells you it's lawful to do -- this is one of those magic write-offs that minimizes your tax burden while having zero impact on mortgage qualifying income. There are cell phone apps that help with this tracking, but one of them might have been created by a client of mine (Bay Area, right?) making me a biased source for a specific app referral. :P

For book authors like yourself, things are often a bit silly. We have to wait for that newly published book's income to appear on tax returns, but by that time the initial rush of book sales will be over, and YTD will be less than historic (and, thus YTD will be used), unless you're constantly putting new books out, hurting your calculated income. So Steven King and the Game of Thrones guy will be fine, but the one-time author can have a hard time of it, since by the time we can count the income, most of that income is gone.

#1 thing I see landlords get wrong is Schedule E box 2, "Fair Rental Days." You purchased the property in August of last year, how can your "fair rental days" POSSIBLY be 365 for that year when you only even owned it 4 months and change? CPAs and/or CPA software default to putting 365 in there no matter the reality, so you have to micromanage this.

We spend a lot of time internally going over income calculations, and we do this for a living, so a full and complete answer is beyond the scope of one post. You can of course always give your lender a rough draft of your tax returns, before you file them. Sometimes the same write-off can be on line A or line B, and that choice can make a difference. 

That's some great info, thanks for taking the time to share all that Chris. Hope you don't mind an off topic question within this thread....

As a new investor, and 2018 being my first year filling taxes reflecting my rental income, I'm starting to think about how much of my rental income I want to write off. Of course I want to decrease my tax liability, but I also want to be able to show the banks how much positive cash flow I'm earning in order to help me qualify for next years investment properties...

When reviewing tax returns for income to determine eligibility for a loan, do you look at gross rental income or net? Will it lower my DTI if I write off half of my cash flow by writing off all of my rehab costs, etc.?

Thanks again for your input! 

 The lender, if they are doing it right, will calculate a true accurate cashflow based on your tax returns.

- Make sure "fair rental days" is accurate.

- For rehab expenses, shove as much as you can in the "depreciation" line instead of the "repairs" line. Work with your CPA, make it clear you want to depreciate as much as possible. This is one of those magic write-offs that can reduce your tax liability, but not your mortgage qualifying income.

@Mindy Jensen they look at taxable income. This killed me for years and now I plan out my write offs to make sure that I can qualify for what I want. After you get enough rental income you'll be in great shape and will have other worries!

As a primary residence it already has one of the best free capital gains deals out there, so I'm not sure pursuing OZ, with its substantial rehab requirement, makes that much sense unless it just happens to fit with the deal you'd want anyway.