Strategies for Home Ownership as a Real Estate Professional - Pay Taxes or Take Write Offs

Buying & Selling Real Estate Discussion 21 Replies

I have been in a good/bad dilema for some time based on my success as a real estate professional. Since we are growing and taking on new projects, my write offs have steadly increased or at least kept pace with my income to offset almost all income.

I am at a point where I want to buy a house and after looking at CFD's, private placement etc....I am exhausted and realize if I simply didn't take write offs for two years I could afford a very nice home with excellent terms.

I plan on talking to my accountants in detail about this, but has anyone simply not taken their write offs for 2 years to maximize their income and than use the 2 years back (Real Estate Professional) tax option to regain what they spent in taxes 2 years prior? Either that or ammend the return after you close on the home....which I could imagine might be illegal, but maybe not.

I am able to still do 2011 taxes and 2012 tax time is approaching quickly so I trying to wheigh the pros and cons of any options.

I welcome any online or offline e-mails on this subject since it has been a major hurdle for 3 plus years and I want to take advantage of fantastic rates and lower home prices in 2013.

If your taxes are showing no income, that would mean that you really don't have any/much free cash flow. In other words, if the write-offs are for actual expenses, that means that you've really spent that money and wouldn't have access to it to pay your mortgage.

Now, some of those deductions may not be actual expenses -- such as depreciation -- and if you ask the underwriter to do manual underwriting, they should be happy to add those types of deductions back to accurately reflect your free cash flow.

In other words, if you have to manipulate your tax returns to make it look like you have money, you probably don't have the money...

Medium lishproplogoJ Scott, Lish Properties, LLC | [email protected] | http://www.123flip.com | Podcast Guest on Show #10

There are many more deductions that don't directly change a mult-family investers base income. I don't see how choosing not to take deductions would be manipulating a tax return, but rather showing true income, while losing the benefit of taking advantage of any tax shelters that would lower net income.

Originally posted by Mike Tempel:
There are many more deductions that don't directly change a mult-family investers base income.

Can you give a few examples? I'm actually really curious...


I don't see how choosing not to take deductions would be manipulating a tax return, but rather showing true income, while losing the benefit of taking advantage of any tax shelters that would lower net income.

There's absolutely nothing wrong with choosing not to take deductions. But, that's not what you suggested doing. You suggested not taking deductions now and then in two years -- after you've gotten a loan -- going back and claiming those deductions on an amended return.

Sounds to me like you are purposefully attempting to mislead lenders, which to me sounds like fraud...

Medium lishproplogoJ Scott, Lish Properties, LLC | [email protected] | http://www.123flip.com | Podcast Guest on Show #10

I'd like to know what additional deductions you are talking about beyond depreciation as well. I own lots of rentals and my only non-cash deduction is depreciation (and a negligible amount of amortization).

I think the issue here is you are wanting to show more personal income to have a lender count it to give you a home loan so you can take advantage of today's low prices and interest rates.

What you don't want is to pay all the taxes on it.

Stated income loans used to work for this.The lender could see you cash flowed with your business like a monster you just wrote everything down in the business to show very little personal income at the end of the year.

What happened is some people used stated income loans that had no business doing so and now the lenders have pulled back the reigns way too far in the other direction.

I know doctors and some attorneys etc. with this problem. Credit score is in the 800's,they can put down 10% to 20%,but as far as personal income they are "poor on paper". Sure they show maybe a 40k personal annual income but they make more than that.

They simply aren't going to show high personal returns to pay more taxes just so a lender gives them a loan.I think stated will come back eventually in some form or another just not as loose as it was before.

Medium allworldrealtyJoel Owens, All World Realty | [email protected] | 678‑779‑2798 | http://www.AWcommercial.com | Podcast Guest on Show #47

The last post is exactly my situation. I never intended to mislead anyone, ammending a return was just a question that I didnt think was possible or a good thing to do.

I was referring to the ability to choose to take RE deductions 2 years forward or 2 years back, you have that option as an RE professional. I thought it might simply make sense to forgo deductions to show a high net income for 2 years and then use future deductions to make up for the lost income the 2 years prior and hopefully have more deductions going forward.

I think my original post was misunderstood.

Mike -

Unless you can give more examples of non-cash deductions (deductions that don't impact free cash flow), I still don't understand why you think your tax returns are not indicative of the amount of income you're pulling in. Can you explain?

You've said that there are more non-cash deductions (besides deprecitation) that are distorting your real income...what are those?

I think you may be deceiving yourself...and I would argue that those people Joel mentions in his post above are deceiving themselves as well. If there are cash deductions that you're not claiming, it may make your income look higher, but the deduction arose from SPENDING MONEY, which means your income isn't really higher.

Medium lishproplogoJ Scott, Lish Properties, LLC | [email protected] | http://www.123flip.com | Podcast Guest on Show #10

If you read the post regarding the doctor it is a perfect example. RE is one of many investments etc, but I am a full time real estate professional. Are you familiar with this tax code? You can choose to take deductions 2 years forward or backwards.

I am not a tax advisor so trying to give exact examples is outside of my scope of expertise and why I hire professionals to do so. You maybe absolutely correct, I am just exploring options and hoping for positive advice from others in the same situation. I have been told by lenders to talk to my accountant about preparing taxes differently to show a higher net income. Just looking for success stories since home ownership is very difficult for the self employed right now.

Originally posted by Mike Tempel:
If you read the post regarding the doctor it is a perfect example. RE is one of many investments etc, but I am a full time real estate professional. Are you familiar with this tax code?

You need to think about the fact that -- nearly all of the time -- a deduction is just a tax advantage on a real expense (a cash outlay). When you claim a deduction, it's because you spent money that decreased your gross income, thereby giving you a lower net income/protit/salary.

The major exception is depreciation,which is a deduction that makes your income APPEAR to be lower, but doesn't actually impact your bottom line profit. That's why many underwriters are willing to give you credit back for depreciation.

You mention the example of the doctor that Joel gave. For those examples to be true, the professionals would need to be taking large non-cash deductions, such as industry-specific tax credits -- I don't know of any common non-cash deductions for the typical apartment owner. If you don't know any either, it's probably because you're not claiming them.

If you think you are claiming them, perhaps ask your accountant -- he would certainly know.

But, barring more non-cash deductions, your net income on paper is going to be fairly close to what you're actually putting in your pocket, minus depreciation and a few other smaller standard deductions.

As for applying deductions two years back, I'm not sure what you're talking about. You can amend your tax returns after they've been filed, but this restricted to real estate professionals. Can you point to something more specific to elaborate on what you're talking about?

Medium lishproplogoJ Scott, Lish Properties, LLC | [email protected] | http://www.123flip.com | Podcast Guest on Show #10

I can't speak to Mike's situation, but the depreciation expense for a RE pro can be a very powerful tool for mitigating tax.

Example scenario: Investor has $3.9mm in improvements on his commercial properties that he is depreciating on a 39 year schedule. he takes $100k a year deduction, that offsets the same amount of taxable income each year.

Drawback? He has to recapture that depreciation when he sells. Workarounds? 1031 exchange into another property wher he sells. Or he doesn't sell, but just borrows against the asset. Loan proceeds are not taxable.

Mike mentions that he has taken some accelerated depreciation on some of his assets. My CPA doesn't like to do this, but it is allowed. Mike could forgo the acceleration to show higher income.

[email protected] | 214‑929‑6545 | Podcast Guest on Show #46

My brother, not a RE pro, but self-employed, chose to limit his qualified business deductions for 3 years to make sure he qualified, a smart move as using cash only for a down payment, the rest invested in his business, versus having to pay cash for the home. With a good accountant, it's easy for a self-employed person to have little reported income every year. Most of our family owns their own business, and they live quite well for their income tax bracket. My brother-in-law in December had to do something with selling his wife's Lexus to his business -- I remember him spending hours running around to get it done as his accountant told him it would save him x amount in taxes. My other brother-in-law will buy a new piece of construction equipment if his accountant tells him to, then rents it out to other contractors to pay for it in following years, so doesn't add to his costs, but saves him lots of tax dollars. I'm certain there are real estate equivalents to those examples, just don't know them.

I'm not sure about amended returns, but I would imagine if there is a window on them, you could wait a few years and do several at one time, including the 2 years you "forgot" to report some expenses, so at least on the surface your intent wasn't just to inflate those 2 years. I'll have to ask my brother if he should do that, see what his accountant says. It sounds like a good idea.

Originally posted by Lynn M.:
I'm not sure about amended returns, but I would imagine if there is a window on them, you could wait a few years and do several at one time, including the 2 years you "forgot" to report some expenses, so at least on the surface your intent wasn't just to inflate those 2 years. I'll have to ask my brother if he should do that, see what his accountant says. It sounds like a good idea.

It might sound like a good idea, but again, it's fraud.

When you turn in a mortgage app, you sign it verifying that it represents your financial situation to the best of your knowledge. If your plan is to later amend your tax returns, then you are lying about your financial situation on your mortgage app.

Medium lishproplogoJ Scott, Lish Properties, LLC | [email protected] | http://www.123flip.com | Podcast Guest on Show #10

Originally posted by Jon K.:
Mike mentions that he has taken some accelerated depreciation on some of his assets. My CPA doesn't like to do this, but it is allowed. Mike could forgo the acceleration to show higher income.

I know that many underwriters will add depreciation back to determine net income, so it may not even be necessary to forgo the acceleration or to make any adjustments to non-cash deductions.

Medium lishproplogoJ Scott, Lish Properties, LLC | [email protected] | http://www.123flip.com | Podcast Guest on Show #10

Originally posted by J Scott:

It might sound like a good idea, but again, it's fraud.

When you turn in a mortgage app, you sign it verifying that it represents your financial situation to the best of your knowledge. If your plan is to later amend your tax returns, then you are lying about your financial situation on your mortgage app.

I'm not a lawyer, but a glance at internet research shows that it might or might not be willful misrepresentation should the bank decide to sue (probably not if you're current on mortgage after a few years when you want to amend) -- grey area left up to the courts then to decide. You are required to show all actual income to the IRS, but deductions are allowed, not required, so not deducting every single thing you can and then deciding later that it's better for you to amend is probably not the same thing as outright lying about income. Everyone has their own level of comfort on these issues. I think banks probably review self-employed returns in more detail than employed persons to see if they are using all the standard accounting principles, anyway, so probably a moot point.

Originally posted by Lynn M.:
You are required to show all actual income to the IRS, but deductions are allowed, not required, so not deducting every single thing you can and then deciding later that it's better for you to amend is probably not the same thing as outright lying about income.

See the part in bold above...that's not what you said earlier...

In your previous post, you said that the plan was to go back an amend the tax return was already made, but that the action wouldn't be taken until later. In other words, you clearly said that you had a plan to not take deductions now but instead take them in a couple years and then willfully misrepresent the fact that this is your plan to the lender.

This a fraud. Will you get caught, prosecuted and/or found guilty? I have no idea. But, it's still fraud in the layman sense of the term.

I completely agree that not taking every deduction is perfectly legal and then applying for the loan based on your tax returns is legal...the part I believe is fraud is that you *intend* to modify your tax returns in a couple years, but aren't planning to disclose this.

If you really think this is okay, why not just disclose that this is your intent and see what the lender says...

Medium lishproplogoJ Scott, Lish Properties, LLC | [email protected] | http://www.123flip.com | Podcast Guest on Show #10

Originally posted by Lynn M.:
... My other brother-in-law will buy a new piece of construction equipment if his accountant tells him to, then rents it out to other contractors to pay for it in following years, so doesn't add to his costs, but saves him lots of tax dollars. ...

Do you know whether this brother in law declares the rent money received on this equipment as income? That's what it is ...

In a loan a few years ago the lender counted a capital expense as though we were going to do that capital expense (converting a garage into an office) every year and counted that against our income. Personally, I think that should be fraud as it is not reflective of a normal cash flow since it was saved for and paid in cash.

I have yet to met a lender that would count depreciation against income, though I don't doubt there are some.

Originally posted by Steve Babiak:
Originally posted by Lynn M.:
... My other brother-in-law will buy a new piece of construction equipment if his accountant tells him to, then rents it out to other contractors to pay for it in following years, so doesn't add to his costs, but saves him lots of tax dollars. ...

Do you know whether this brother in law declares the rent money received on this equipment as income? That's what it is ...

My brother-in-law has been through several audits with no issues, so I'm fairly certain he is accurately reporting, but I'm not a part of his business, so can't say for certain.

The problem with current tax system is just too many rules and too many grey areas, seems more of an art than a science, and I know it's just a harsh environment for self-employed people to qualify for mortgages these days.

Wow,

I have missed a lot in this conversation.

Mike Tempel,

You are required to report all earned income and expenses. To misrepresent your income on your tax return can be considered fraud; however, they probably won't complain about your higher income. As far as the mortgage goes, that IS mortgage fraud.

They can add back depreciation; however, that will be the only thing added back.

-Steven the Tax Guy

Your guide to IRS laws, rules and regulations.

Medium hta logoSteven Hamilton II EA, Hamilton Tax and Accounting | [email protected] | (224) 381‑2660 | http://www.HamiltonTax.Net

I am in a similar position as the original poster.

My accountant and I review the numbers in-depth.

But J Scott here are some samples:

- I think depreciation is a non-issue. Almost every lender adds that back-in.

- Most of the flexibility for me comes with capitalize versus expense. I buy 30 SFH rentals a year, each one needs repairs (let's say avg 15k). Some of that is definitely capital improvements, some is definitely an expense and some has some flexibility. So There is 75% of it or 300,000 that can either as an expense or capital improvement.

- I also have substantial finance fees we typically amortize those.

- SEP-IRA and retirement plans have income implications.

@Steve L. ,

It is pretty cut and dry. Capital expenditure or expense.

Repairs before it is ready for rent ARE BOTTOM LINE capital expenditures no ifs, ands, or buts about it. You can very over how long they are depreciated as long as you do it correctly.

-Steven the Tax Guy

Your guide to IRS laws, rules and regulations.

Medium hta logoSteven Hamilton II EA, Hamilton Tax and Accounting | [email protected] | (224) 381‑2660 | http://www.HamiltonTax.Net