How do Banks look Self Employed (1099) v. W-2

Question

I am a W-2 employee and have no problem refinancing my rental properties from private lenders.  One day I plan on being self employed with RE Investing as my full-time career.  What impact am I looking at from lenders for refinancing my rental properties?

Chris Mason · Answer

Quick note on re-reading this thread:

Giving yourself a W-2 isn't a magic spell that will automatically help you. I've had more than one person reset their 1-2 year self employment waiting period by doing this.

If you own 25% or more of the business entity, it's going to fall under the self employment underwriting guidelines, no matter what tax forms you use. Period, end of story, no exceptions in the Agency 30YF low interest rate world.

There are also cases where it makes no difference, so they issue themselves a W-2 and it's fine. Depends on what appears on the tax returns. EG, for the last several years they have been W2-ing themselves to include an end-of-the-year bonus that makes the business have a net taxable income close to zero. It's still going to be underwritten as self employment, and their qualifying income would have been exactly the same had no W-2 been issued, but that business owner can quite possibly be none the wiser of that fact (so they might, say, run around on an internet forum telling everyone to W-2 themselves thinking they are helping...).

"W-2!" is not a magic spell that a self employed person can invoke to suddenly not be self employed, if they are in fact self employed.

In 2007 things were different, and people wold in fact give themselves a crazy W-2 for a million dollars to qualify for a mortgage (presumably with several years of net loss carryover in the future?). Now, in 2017, we're going to go ahead and look at that business, and confirm first and foremost that it even has a million dollars to pay it's owner, according to what your personal and business tax returns say, and see if this is how you've been running your business for a while...

Chris Mason · Answer

Hi @Kenneth Garrett,

If you're ONLY using REI activity to qualify, there are several caveats, and I'll tell you right off the bat that most MLOs will not be able to do it. We are going to ask for two years of tax returns, but we can do more than blindly take a 2 year average.

• Rental income is qualifying income. We can "add back" depreciation, and one-time rehab BRRRR expenses appearing on Schedule E. We do not have to use a 2 year average for rental income if there is justification, like you just purchased the property last week. To discount one-time rehab expenses, it's best to put the rehab stuff on line 19 "See Statement 1" and then have an itemized list (Statement 1) that matches receipts you can provide 100% perfectly included in the tax returns.
• Capital gains income can only be used if we take a three year average & you receive it in all three years.
• Be consistent with which schedule you report income on. Don't throw a bunch of non-rental income sources on Schedule C this year, and then randomly throw it on Schedule D or an S corp next year. Anything fancier than Schedule E, assume we will use a 2 year average and not count it until that 2 tax years is up. This means if your flipping activity was Schedule C two years ago and an S corp the most recent tax year, "underwriter discretion" very well may mean you get ZERO mortgage qualifying income from that source, even though you've been doing it for two years: Your tax returns say that there was a Sole Proprietorship that shut down a year ago (can't be used for income), and a brand new S corp that just opened in the most recent year (can't be used for income), even though you will insist that it's "really" the same business. If it was "really" the same business, that's what your tax returns would say. I know, that makes no sense, but it is what it is.
• Usually I see one or two properties that are cash cows, basically the cornerstone of the mortgage qualifying income. Don't do anything fancy here, let me see those on Schedule E.
• Put a little manila folder together for any real estate appearing anywhere on the most recent three years of tax returns. Throw in this folder: Closing Disclosures, mortgage statements, settlement statements from the purchase/sale, homeowner's insurance declaration pages, property taxes, leases, and receipts/invoices from one-time BRRRR rehab expenses. Normal self employment we mostly just go off of tax returns and a quick P&L and Balance Sheet you work up, but for REI stuff we're basically going to fully audit your entire business.

Cliff T. · Answer

Hey Chris,I know this is an old post but I found the content to be very relevant for my situation. Can you explain what you meant by "I've had more than one person reset their 1-2 year self employment waiting period by doing this."

Kenneth Garrett · Answer

Great points everyone.  Its never as simple as it seems.

Dan Bryskin · Answer

@Kenneth Garrett, yes. 1099 income can always go through corp to become W2.

David D Painter · Answer

I don't find a big difference. If you're self employed be prepared to show 2 years of tax returns and sometimes extra documentation.

Kenneth Garrett · Answer

@Dan Bryskin

Hi Dan, are you referring to running your income through a s-corp or c-corp and issue yourself a W-2.?

Dan Bryskin · Answer

For 1099 income to count, some require 2 years of it, most look at average of 2 years. At some point it is not so much about 1099 or w2, as it is about P&L, reserves and having experience. Another thought - you can always turn 1099 into w2.

How do Banks look Self Employed (1099) v. W-2

Most Popular Reply